Helping Clients Transition a Business to the Next Generation

When your clients rely on you to guide their family wealth planning, there are many inheritance issues you must address. Here, we’ll focus on just one of the concerns you may encounter when putting wealth transfer strategies into action: helping clients transition a business to the next generation.

Holding a family meeting is a great start when reviewing and refining your clients’ wealth transfer goals. It can help strengthen ties and resolve important planning matters by encouraging open discussion and allowing family members to ask questions about the client’s estate plan and portfolio.

Keep in mind that unexpected questions, challenges, and conflicts may arise during the discussion, which may prompt your client to reconsider some aspects of the plan. Even if the meeting doesn’t go as planned, however, this is a valuable part of the process. Getting issues and concerns out on the table can prevent conflict later and help ensure the successful deployment of the client’s estate plan.

Much thought and planning go into the initial family meeting, but it’s likely just the beginning of the wealth transfer conversation. Now, it’s time to take stock and assess the next steps. 

• Did family dynamics shift when it came to discussing money?
• Were there any conflicts between family members?
• Are there issues that need to be resolved before moving forward?
• What are the main concerns that require planning solutions?

For clients who own a business, succession planning is likely a key topic that you’ll need to address going forward.

One of the most important steps in transitioning a business to the next generation is communicating a vision for its future. After all, it was the current owner’s vision that got the business to where it is today. Losing sight of this could result in failure going forward. 

Be sure that the future owners understand where the company is going and how they will continue to guide it along that path. Communicating this vision well ahead of time will help prevent confusion and disagreements once the transition process begins.

There are a number of ways to transfer a family business to the next generation, and performing a proper business valuation is a necessity. Depending on your client’s circumstances and financial situation, he or she may want to sell the business, gift the business, or use some combination of the two strategies.

Gifting. If the client is in a strong financial position, he or she may decide to gift the business to children or other family members. Again, the value of the business will dictate the most efficient way to accomplish this. Often, it's possible for the client to transfer the business interest using the lifetime gift and estate tax exclusion ($5.49 million for 2017). If the business is co-owned by a spouse, this would allow for a transfer of property of up to $10.98 million with no transfer taxes. Of course, you’ll need to determine whether the client has already used any of his or her lifetime exclusion amount for prior gifts to children.

Selling. If the business is your client’s most valuable asset, he or she may need to sell it in order to support his or her retirement income needs. This can be achieved in several ways.

1. Standard installment sale. Here, the client sells the business to his or her heirs for a note, which they will pay down from business profits over the installment period. To avoid gift characterization of the transaction, the business should be sold for fair market value and include the minimum interest rate published by the IRS every month. The benefit to the seller is that taxation on the sale is spread over a period of years; the benefit to the buyers is that they can purchase the business over time with profits derived from running the business.
2. Self-canceling installment note (SCIN). This is a form of installment sale with unique characteristics. With a SCIN, if the owner dies during the installment period, the note automatically terminates and the deceased seller’s estate cannot collect any balance due from the buyer. The SCIN has the additional benefit of removing the value of any remaining installment payments from the estate of the deceased seller. The installment period on a SCIN cannot exceed the life expectancy of the seller.
3. Private annuity. This option combines the need for lifetime income with the desire to sell the business to the next generation. With this strategy, the owner sells the business to his or her children in exchange for a promise to make payments to the seller for his or her lifetime. The private annuity removes the business from the client’s estate, allows taxation to be spread over his or her lifetime, and gives the children the ability to pay for the business over time.

You may have clients who have one or more children who are interested in carrying on the family business and others whose interests lie elsewhere. If so, they may want to equalize the estate for the children who won’t be working in the business. In cases where the family has considerable wealth outside of the business, equalization can be accomplished relatively simply, by leaving other assets to those children.

Families whose business makes up the bulk of their wealth may need other ways to accomplish equalization, however. Life insurance is often an effective solution to this problem. For children who won’t be involved in the business, an insurance policy with a death benefit of a certain amount may be an easy and cost-effective method for equalizing the estate.

Regardless of the method chosen, the client should clearly communicate his or her intentions to the children, which will help prevent hurt feelings and resentment when the client is gone.

The executor and/or trustee has the major responsibility of coordinating your client’s affairs, and not all family members may be up to the task. If a family business is involved, it makes sense to choose someone who is familiar with its operations, in order to effect the transfer quickly and efficiently while avoiding interruption to the business.

In addition, your client should consider several other important factors: 

• Does the family member have the time required for the process?
• Does he or she have the financial competency to take on the task?
• Does he or she have the ability to mitigate conflicts between siblings, as well as the respect of all interested parties?

Your client may want to consider tapping someone outside the family, like an attorney, bank, or CPA, especially if family dynamics dictate a need for an unbiased and disinterested fiduciary.

Planning for the orderly transfer of wealth to the next generation can be daunting, especially when it involves the family business. After all, nobody likes to think about death, and the prospect of giving away a cherished business can be stressful for your clients. But your planning expertise can do much to calm the waters. The key is to foster open communication between family members throughout the process, bringing in your clients’ other financial professionals as needed.

What other factors do you consider when helping your client with the transfer of a family business? How do you help your clients communicate their vision for the future of the business? Please share your thoughts with us below!

Commonwealth Financial Network^® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.