Lines May Blur When it Comes to Estate and Family Business Succession Planning

Owners of closely held businesses typically have a significant portion of their wealth tied up in
their enterprises. If you own a closely held business with your relatives involved, and don’t take
the proper estate planning steps to ensure that it lives on after you’re gone, you may be placing
your family at financial risk.

Differences between ownership and management succession
One challenge of transferring a family-owned business is distinguishing between ownership and
management succession. When a business is sold to a third party, ownership and management
succession typically happen simultaneously. But in a family-owned business, there may be reasons
to separate the two.

From an estate planning perspective, transferring assets to the younger generation as early as
possible allows you to remove future appreciation from your estate, minimizing any estate tax
liability. However, you may not be ready to hand over the reins of your business or you may feel
that your children aren’t yet ready to take over.

There are several strategies owners can use to transfer ownership without immediately giving up
control, including:
 Placing business interests in a trust, family limited partnership (FLP) or other vehicle that
      allows the owner to transfer substantial ownership interests to the younger generation
      while retaining management control,
 Transferring ownership to the next generation in the form of nonvoting stock, or
 Establishing an employee stock ownership plan.

Another reason to separate ownership and management succession is to deal with family members
who aren’t involved in the business. Providing heirs outside the business with nonvoting stock or
other equity interests that don’t confer control can be an effective way to share the wealth while
allowing those who work in the business to take over management.

Conflicts may arise
Another unique challenge presented by family businesses is that the older and younger generations
may have conflicting financial needs. Fortunately, several strategies are available to generate cash
flow for the owner while minimizing the burden on the next generation. They include:
An installment sale of the business to children or other family members. This provides
liquidity for the owners while easing the burden on the younger generation and improving the
chances that the purchase can be funded by cash flows from the business. Plus, as long as the price
and terms are comparable to arm’s-length transactions between unrelated parties, the sale shouldn’t
trigger gift or estate taxes.
A grantor retained annuity trust (GRAT). By transferring business interests to a GRAT, owners
obtain a variety of gift and estate tax benefits (provided they survive the trust term) while enjoying
a fixed income stream for a period of years. At the end of the term, the business is transferred to
the owners’ children or other beneficiaries. GRATs are typically designed to be gift-tax-free.