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Inheriting the Family Business: Succession Planning Secures Your Legacy

Preserving a family business’s legacy is challenging. Studies show that only about one-third of family businesses make it to the second generation. The numbers have been declining over the years, and one major reason is the lack of proper business succession planning.

Without a clear plan, businesses are more likely to fall apart during leadership transitions.  How can you prepare the next generation to successfully take over the family business?

Why Don’t Family Businesses Survive?

There are several reasons why family businesses struggle to stay within the family. One common issue is that the older generation often avoids discussing succession plans, hoping everything will fall into place naturally.

However, without a solid plan, when leadership needs to change, chaos can ensue.  Younger family members might also not feel ready or willing to take on the responsibility of running the business.

What Could Happen without a Business Succession Plan

Many business owners believe that their children or relatives will smoothly step into leadership roles. However, this isn’t always the case. Sometimes, younger family members aren’t allowed to learn critical skills, like decision-making and management, because the older generation maintains strict control. This lack of preparation can leave younger members feeling overwhelmed when it’s their turn to lead.

Running a family business can also seem like a burden. For some, the idea of constant problem-solving and stress may deter them from stepping into leadership roles. Younger generations may opt out of continuing the family tradition without excitement or encouragement.

Passing on the Family Business Successfully

The Harvard Business Review shared a story that highlights the importance of preparation. In one case, a family business expected one sibling to take over the company. Unfortunately, a tragic accident left that sibling unable to fulfill this role. The other sibling had no experience in the business but had to step in regardless.

This is one of many situations that can compromise your legacy. The article also discussed parents not properly including their children in decision-making, leaving them without leadership skills.

Depending on their parents’ relationship with work, children may be turned off by the perception of too much work for too little reward. Frank, honest conversations about the future are one key step in establishing a firm business legacy.

How Can You Prepare the Next Generation?

Passing on a family business doesn’t have to be stressful or uncertain. There are many ways to ensure that younger generations are ready to take over when the time comes. Consider the questions below to help you decide how to prepare your family for a successful business succession.

1.   Do Your Children Understand the Business?

Successful business succession planning requires that your successors know how the business operates. This can start at a young age by encouraging children to visit the workplace, meet employees and get a feel for the environment. They can begin with minor roles to gain deeper familiarity. However, you’ll eventually need to take their experience to the next level.

2.   Are They Gaining Leadership Experience?

Future leaders can’t just show up at the business and have functional roles. If you want someone to inherit the business, you need to give them decision-making responsibilities in different areas of the company. Having your children gain work experience outside the business may also be valuable.

3.   Do They Understand the Company’s Goals?

Regular conversations about the company’s mission, challenges and successes can help younger family members see the bigger picture. When they understand the company’s goals, they’ll be more prepared to make decisions that align with its future growth.

4.   Are You Setting a Good Example as the Business Owner?

Family businesses often involve close relationships and, at times, family conflict. Parents and business owners need to set clear expectations about business behavior and manage personal needs.

5.   Is There a Plan for the Future?

Most importantly, a clear business succession plan should be put in writing. This plan will outline who will take over leadership roles, their responsibilities and how the transition will occur. Without a formal plan, the business risks falling apart when it’s time to hand over the reins.

Act Today to Protect Your Family Business

Business succession planning is essential for the long-term success of a family-owned business. Whether your children are ready to step in or you’re just starting to think about the future, having a well-thought-out plan in place is key to keeping the business alive for generations to come.

Contact our firm today to schedule a consultation and learn more about how business succession planning can protect your company’s legacy for years to come.

Key Takeaways:

  • Understand the Business: Involve younger generations early to familiarize them with the company.
  • Build Leadership Experience: Offer opportunities for decision-making and managing key areas.
  • Align with Company Goals: Share the mission and values to ensure that decisions support the company’s future.
  • Set Clear Expectations: Address family dynamics to prevent conflicts from affecting business operations.
  • Formalize the Plan: Create a written succession plan to ensure a smooth leadership transition.

Reference: Harvard Business Review (Sep. 27, 2022) “How to Prepare the Next Generation to Run the Family Business”

What’s an LLC and Why Create One for Your Business?

The Limited Liability Company (LLC) is a popular choice for starting a small business. While it may not be suitable for everyone, there are good reasons for its enduring popularity. An article by NerdWallet discusses the basics of LLCs, why they’re so popular, and the potential drawbacks of this business structure.

What Is an LLC?

An LLC is a business structure combining some of the best features of partnerships and corporations. It provides the flexibility of a partnership while offering the liability protection typically associated with a corporation. This means that if your business encounters financial difficulties or legal issues, your personal assets—like your home or savings—are generally protected.

Who Can Be an LLC Member?

One of the advantages of an LLC is that it can have as many members as you want. These members can be individuals or even other businesses. It’s even possible to form a single-person LLC with just one member. This makes the LLC one of the most flexible business structures, whether you’re a solo entrepreneur or part of a larger group.

How are LLCs Taxed?

LLCs are unique because the federal government doesn’t recognize them as a specific tax entity. Instead, an LLC can choose how it wants to be taxed. By default, a single-member LLC is taxed as a disregarded entity, meaning the profits and losses pass directly to the owner’s personal tax return.

Multi-member LLCs are usually taxed as partnerships, with each member reporting their share of profits and losses. However, an LLC can also choose to be taxed as a corporation, either as a C-corporation or an S-corporation, depending on what makes the most sense for the business.

What are the Benefits of an LLC?

There are several reasons why an LLC might be the right choice for your business:

  • Limited Liability: As mentioned earlier, one of the most significant advantages of an LLC is that it protects your personal assets from business-related debts and liabilities. This means that if your LLC is sued or incurs debt, your personal belongings are typically safe.
  • Pass-Through Taxation: By default, LLCs enjoy pass-through taxation and don’t pay taxes directly. Instead, they use a simplified tax process with profits and losses that pass through to the members’ personal returns.
  • Flexibility in Management: An LLC can be managed by its members, or they can choose to hire an outside manager. This allows members to be as involved in the day-to-day operations of the business as they want to be.
  • Easy to Set Up and Maintain: Setting up an LLC is relatively straightforward and involves less paperwork and regulatory requirements than other business structures like corporations. Ongoing maintenance typically includes an annual report and minor fees.

What are the Potential Drawbacks?

While LLCs offer many benefits, it’s important to be aware of potential drawbacks. The protection of limited liability isn’t absolute; in certain situations, such as mixing personal and business finances or engaging in fraudulent activities, a court may decide to “pierce the corporate veil,” leaving your personal assets vulnerable.

Additionally, if your LLC is taxed as a partnership, you’re considered self-employed and must pay Social Security and Medicare taxes on your share of the profits. Changes in membership can also be complicated. Some states require the LLC to be dissolved and reformed, which leads to additional legal and financial responsibilities.

How Do You Form an LLC?

Forming an LLC involves choosing a name, filing articles of organization with your state, and creating an operating agreement. You’ll also need to select a registered agent to handle official correspondence and obtain an Employer Identification Number (EIN) from the IRS if you plan to hire employees or operate as a partnership or corporation.

Is an LLC Right for Your Business?

Deciding whether an LLC is the best structure for your business involves weighing the pros and cons and considering your specific needs. Whether you’re a solo entrepreneur or part of a larger group, the flexibility, liability protection, and tax benefits of an LLC can make it an attractive option.

Form Your LLC Today

If you’re considering forming an LLC or need help understanding your options, now is the perfect time to consult with an experienced estate planning attorney. A well-crafted business plan can set you on the path to success, protecting both your business and personal assets. Contact our office today to schedule a consultation and take the first step in securing your business’s future.

Key Takeaways

  • Protect Personal Assets: An LLC helps shield your personal belongings, like your home and savings, from business liabilities and debts.
  • Simplify Taxes: LLCs offer pass-through taxation, allowing business profits and losses to be reported on your personal tax return, simplifying the tax process.
  • Flexible Management: LLCs can be managed by the members or an outside manager, giving you control over how involved you want to be in daily operations.
  • Tailor to Your Needs: Whether you’re a solo entrepreneur or part of a team, LLCs offer the flexibility to structure your business according to your specific goals.
  • Seek Legal Support: Consulting with an estate planning attorney can help you navigate the process of forming an LLC and ensure that your business is set up for long-term success.

Reference: NerdWallet (Mar. 11, 2024) “What Is an LLC? Pros and Cons of a Limited Liability Company”

Does an Estate Plan Help with Taxes for Business Owners?

The current lifetime exemption (the amount of assets an individual may transfer without paying federal gift or estate tax) of $13.61 million per person (and $27.22 million per married couple) is expected to revert to pre-Tax Cuts and Jobs Act level of $5.6 million per person and $12.2 million for married couples. According to a recent article, “3 Underutilized Estate Planning Strategies for Business Owners,” from Wealth Management, the time to take advantage of these historically high levels is now.

This is of particular importance for anyone whose wealth reaches these thresholds or who is planning on selling their business in the next year and a half if the sale could put them above these gross estate thresholds. Every dollar over that lifetime exemption will be taxed at a 40% tax rate upon death. This can be avoided with proper estate planning.

Three estate planning strategies detailed here take time to complete, and the IRS is known to scrutinize planning techniques that are done after a letter of intent (LOI) is signed. These strategies should be implemented before documenting an offer or drafting an LOI, ideally six to eight months before a transaction occurs.

The IRS has stated there will not be any “claw backs” if the estate tax exemptions fall to pre-2017 levels. This clear imperative makes this the opportune time to get these strategies underway without delay. Your estate planning attorney will know what works best for your unique situation, but these three are fairly common.

Spousal Lifetime Access Trust, or SLAT, is used to remove assets from the taxable estate so they aren’t subject to estate tax at death while retaining the ability of the spouse to access assets for the couple. This is despite not having a retained interest in the trust as long as the spouse is living and you are still married to said spouse.

A SLAT may be especially helpful for couples who aren’t ready to transfer wealth out of their estate and are concerned about having access to their assets. Remember that you’ll need to try not to use any of these funds until you’ve exhausted the money in your personal name.

A Grantor Retained Annuity Trust (GRAT) transfers the future growth of assets out of the taxable estate either outright or into a trust for descendants. The creator of a GRAT retains an interest in trust assets for a set period through the receipt of an annual annuity payment until the value of the asset originally put into the GRAT is returned. Basically, the GRAT pays back the money that went into the trust over the term of the trust plus interest. However, all future appreciation placed into the GRAT grows without being subject to federal gift or estate tax.

Sale to Defective Grantor Trust or Installment Sale is another strategy for business owners. This strategy is more effective if the timing of the business sale is not definite. Here’s how it works: business stock is sold to a trust in exchange for a promissory note. In the case of an installment sale, only the IRS-mandated interest has to be paid back annually. The outstanding principal owed to the trust creator may take place at the end of the term in a balloon payment. The principal remains in the trust longer and, ideally, will produce more growth and income than if the person used a GRAT.

Business owners need to work with their estate planning attorney to ensure that any of these strategies will be coordinated with any other estate planning strategies already in place. For most business owners, a combination of trusts and corporations is designed to achieve the twin goals of protecting assets and minimizing taxes.

Reference: Wealth Management (July 15, 2024) “3 Underutilized Estate Planning Strategies for Business Owners”

Why Estate Planning Is Essential for Small Business Owners

Estate planning should be a top priority for anyone who has built and grown a successful small business, especially if they intend to build generational wealth and create a legacy. The title of a recent article from Business Insider says it all: “You might not want to think about estate planning, but as a financial planner, I know it’s essential for small-business owners.”

There are more complex issues for business owners than employees for estate planning. Therefore, be sure to work with an experienced estate planning attorney who will create a plan to protect you, your family and your business. As you go through the process, keep these basics in mind:

Last Will and Testament. This document is the foundation of an estate plan, providing directions to the state probate court regarding your wishes for distributing assets. It also names a guardian responsible for minor children upon your passing. If you don’t have a will, assets are distributed according to your state’s intestacy laws, typically based on kinship. You can update and change your will throughout your lifetime, and it should be reviewed every three to five years.

Revocable Living Trust. Having a revocable living trust gives you more control over assets, which could be necessary to distribute business assets. A revocable living trust can be altered while you are living, so changes in your business can be reflected in the directions in the trust.

Financial Power of Attorney. This document is critical if you are the business owner who performs most of the financial tasks of your business. When a business owner becomes incapacitated, having someone named Power of Attorney gives the POA the ability to pay bills, make bank deposits and withdrawals, file business and personal taxes and make any other financial decisions you wish. POA can be limited if you only want someone to pay bills, or they can be broad, allowing the agent to do anything you would do to keep the business running while you are incapacitated. Your estate planning attorney can craft a POA to suit your needs.

Business Succession Plan. A business succession plan should be in place as soon as your business gains traction and becomes successful. Distributing shares of the business after you pass is fine. However, what if your heirs don’t have a clue how the business works? Do you want them to sell it after you pass or maintain it for the next generation? A succession plan requires the help of an estate planning attorney, CPA and financial professionals to create a management team, define roles, set performance guidelines, etc.

Digital Estate Plan. We spend so much time online. However, few have plans for our digital assets. If your business is online, has a website, and uses social media, online finances, and cell phones, you need a digital estate plan to identify assets and provide instructions on what you want to be done with those assets after you have passed.

Review Beneficiary Designations. Any account that can name a beneficiary, such as retirement plans, investment accounts, or life insurance policies, must be reviewed every few years or whenever a trigger event, including birth, death, divorce, or remarriage. Upon your passing, these assets will be passed directly to the beneficiary. Be sure the person you named twenty years ago on your life insurance policy is still the right person to receive proceeds upon your passing.

An experienced estate planning attorney can review your current estate plan to ensure that it covers all bases for you and your business.

Reference: Business Insider (March 22, 2024) “You might not want to think about estate planning, but as a financial planner, I know it’s essential for small-business owners”

How Do You Plan a Business Succession?

When business owners die without estate or succession plans, chaos ensues as family members clash over leadership decisions and determining the direction of the business. Even the closest families can quickly descend into a battlefield of hurt feelings, endless arguments and faction-building, according to the article “How to Make Your Business Outlive You” from next avenue.

Family disagreements often escalate into legal disputes. Lacking leadership, businesses spiral downward and often must be liquidated, leaving behind broken families with severely depleted assets.

This scenario occurs in small businesses on a regular basis. Owners with the vision and tenacity to take their ideas and create a successful enterprise are often so passionate that they can’t imagine the business without them.

A well-defined succession plan matters to more than just the family and their customers. According to the Small Business Association, businesses with less than 500 employees account for 99.9% of all firms in the U.S., 43.5% of the country’s total economic output, and just under 66% of new jobs created. A well-designed succession plan contributes to the national economy,

Having a succession plan in place protects the business and the family from unforeseen circumstances and creates a roadmap for the future. What is the best time to start? When all is well, leaders are healthy and there’s no internal drama.

Start by contemplating your legacy. How do you want your family and employees to benefit from the value created by the business? Clarifying this will drive much of what follows.

Seek professional guidance. An estate planning attorney should be one of several professionals to ensure that the plan complies with laws and regulations in your jurisdiction. You also want to be sure your business succession plan aligns with your estate plan. Otherwise, the resulting confusion could lead to prolonged difficulties and even litigation.

You’ll need a power of attorney for someone to be able to make decisions if the business owner becomes incapacitated. A buy-sell agreement establishes a fair market value for the company. Life and disability insurance policies provide financial security for the owner and key personnel.

Put it in legally enforceable documents. Discussions only go so far. Executing a formal series of documents ensures that the plan will be enforceable by a court if needed. Language should be clear, with no ambiguity, to transfer ownership and business shares.

Potential successors need to be identified. Will everyone step up to the next level if the business owner becomes incapacitated or dies? This isn’t always the best solution. Sometimes, skills override structure.

Reviewing and updating the business plan should be done as often as you update an estate plan. Whenever there is a major event in the business, review the plan to see if it is still relevant.

A succession plan is all about legacy, continuity, safeguarding a business, letting employees know they are valued and reducing volatility in the family’s future. It allows the business owner to communicate their values and vision, even if they are not present to be part of the future.

Reference: next avenue (Dec. 12, 2023) “How to Make Your Business Outlive You”

Estate Planning and Tax Planning for Business Owners

Business owners who want long-term financial success must navigate an intricate web of taxes, estate planning and asset protection. Pre- and post-transactional tax strategies, combined with estate planning, can safeguard assets, optimize tax positions and help strategically pass wealth along to future generations or charitable organizations, as reported in a recent article from Forbes, “Strategic Tax and Estate Planning For Business Owners.”

Pre-transactional tax planning includes reviewing the business entity structure to align it with tax objectives. For example, converting to a Limited Liability Company (LLC) may be a better structure if it is currently a solo proprietorship.

Implementing qualified retirement plans, like 401(k)s and defined benefit plans, gives tax advantages for owners and is attractive to employees. Contributions are typically tax-deductible, offering immediate tax savings.

There are federal, state, and local tax credits and incentives to reduce tax liability, all requiring careful research to be sure they are legitimate tax planning strategies. Overly aggressive practices can lead to audits, penalties, and reputational damage.

After a transaction, shielding assets becomes even more critical. Establishing a limited liability entity, like a Family Limited Partnership (FLP), may be helpful to protect assets.

Remember to keep personal and business assets separate to avoid putting asset protection efforts at risk. Review and update asset protection strategies when there are changes in your personal or business life or new laws that may provide new opportunities.

Developing a succession plan is critical to ensure that the transition of a family business from one to the next. Be honest about family dynamics and individual capabilities. Start early and work with an experienced estate planning attorney to align the succession and tax plan with your overall estate plan.

Philanthropy positively impacts, establishes, or builds on an existing legacy and creates tax advantages. Donating appreciated assets, using charitable trusts, or creating a private foundation can all achieve personal goals while attaining tax benefits.

Estate taxes can erode the value of wealth when transferring it to the next generation. Gifting, trusts, or life insurance are all means of minimizing estate taxes and preserving wealth. Your estate planning attorney will know about estate tax exemption limits and changes coming soon. They will advise you about gifting assets during your lifetime, using annual gift exclusions, and determine if lifetime gifts should be used to generate estate tax benefits.

Reference: Forbes (Sep. 28, 2023) “Strategic Tax and Estate Planning For Business Owners”

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