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A Transfer Tsunami for Family Biz

By July 25, 2006July 12th, 2023Finance & Wealth Management4 min read

Over the next 20 years, nearly $4.8 trillion of wealth is set to be transferred to the next generation of heirs. Much of that wealth will consist of the assets of family businesses, about 40% of which are due to hand the reins to the next generation during the current decade alone.

However, most family businesses are not adequately prepared to handle the tidal-wave transfer of wealth. In fact, the majority of family businesses have made few or no provisions for turning the business over to the next generation.

In one sense, that’s not surprising. Few vibrant and active family leaders find it easy to envision their own retirement or, worse, demise. Another problem is that the challenges of family-business succession tend to be exceedingly thorny. It’s relatively easy for business leaders to accept their impermanence to the extent of purchasing a life insurance policy. It’s much more difficult to engage in the sort of personal soul-searching, family dialogue, and complex financial planning required to really prepare for succession.

The job, however, can be done. Millions of family businesses have successfully transitioned ownership from one generation to the next, and the journey is well-worn, with proven techniques and experts ready to help at every stage. Many of these experts are the same attorneys, accountants, family business consultants, financial planners, and others who may already advise you and your company. And many of the actions required by financial planning for succession are ones that you should be doing already, even if today succession seems to be no more than a fuzzy image on a far horizon.

1. Set a specific goal. At the top of the “to do” list is to get straight about the purpose of the business with regard to the family and succession. Deciding whether you hope to provide lifetime employment for as many family members as possible, maximize profits to uninvolved family shareholders, or pursue some other goal is essential to charting a smooth course. What your goals are is not as important as selecting them through discussions with other family and business members, and communicating them to all interested parties. Remember, people will tend to support what they help to create.

You’ll likely find some difference in the goals of the current business leadership and the next-generation heirs. For instance, the current chief executive officer may want to allocate significant money to invest in a new venture or buy new equipment while the heirs may believe that available funds should funnel to shareholders. Even if both generations’ plans are identical, now is the time to get the agendas out in the open and make sure you’re all sailing in the same direction.

2. Get a professional valuation of your business. The techniques for planning a transfer are many, sometimes complicated, and often only applicable to certain specific situations. However, all planning will call for an accurate and current valuation of the family business to move forward. One of your first moves should be to get a valuation of the enterprise by an experienced business appraiser with good credentials.

3. Determine how to pay estate taxes. Once the value of the family enterprise is documented, you can address specific methods for minimizing the trauma of transfer. One issue that will, no doubt, surface immediately is to find a way to pay estate taxes. The current unified tax credit allows for you to pass on $2 million in assets to heirs without paying tax (this number is scheduled to change several times within the coming few years), but transferring any business valued at more than the allowance will likely trigger a graduated federal tax that can prove debilitating.

It’s a nice problem to have, but dealing with estates over the $2 million allowance can sometimes be surprisingly simple, if planned for properly. For instance, you may be able to merely defer the payment of any estate taxes for up to 14 years, paying interest to the Internal Revenue Service periodically and avoid the kind of lump-sum payment that is likely to exceed any business’ ability to pay. Buy/sell agreements funded with life insurance offer another possibility. You’ll need to work with a certified public accountant to come up with your own customized strategy.

4. Plan for retirement now. One common error is for the current leader to neglect to provide for adequate income and financial security during his or her own retirement. This may result in the CEO being forced to continue working for the business long after he or she is effective, just to draw a salary. Setting up a retirement savings plan and trimming pre- and post-retirement lifestyle expenses are two ways to overcome this common obstacle.

Succession is accurately described as the most important event in the life of a family business, as it is for the family in the business. Financial planning, however, is not the only hurdle. You must also prepare future leaders with training, experience, and exposure to life at the top. No plan that attempts to anticipate the future is perfect. Tax laws change, human frailty shows itself, and every business transfer presents unique risks. But simply attempting in good faith and due diligence to plan for a transfer will go a long way toward improving the outcome.