Years ago, you had no idea what you were getting yourself into with this business. While you knew your craft, you couldn’t have anticipated the years of sacrifice, hard lessons learned, and requisite faith that things would work out. After decades of keeping your head down and the show running, you’ve started to realize that things are looking pretty good — better than you ever could have expected, in fact.
Though you’re just now adjusting to this level of comfort, you’re also looking ahead to the future. While your years as a business owner have taught you that things can change in an instant, if things continue the way they’re going, your grown kids might just be ready to take the reins of the business as you step into the background.
Preserving the legacy you’ve given so much of yourself to build is going to ask even more of you. It’s going to take careful consideration to plan a smooth transition of ownership and an exit strategy for yourself.
In this article, we’ll guide you through strategies to transfer business ownership to your children or other family members. Whether you’re looking to retire completely or keep yourself in the game a while longer, we’ll look at the pros and cons of selling, gifting, or setting up trusts. As you’re particularly aware, family dynamics take center stage here, so it’s important to thoughtfully consider everything and everyone before deciding how to move forward.
Transferring Family Business
How do I transfer business ownership to my children?
Sell your business to your kids. While they probably don’t have the cash to buy it outright, an installment sale will provide cash and flexibility.
Gift a business to a family member, but keep in mind the possible downstream negative tax consequences.
Set up a trust to allow for a seamless transition of ownership and the opportunity to clearly outline who gets what and when.
Write clear directives in your will, and let your children inherit the business after you pass away.
What if I don’t make plans to transfer my business before I die?
If left to your kids as part of your estate upon your passing, they won’t need the capital to buy you out and they’ll get a step-up in basis.
However, without any proceeds, you may not be able to support yourself financially throughout retirement.
With your business included in your estate, you’ll likely have more of your hard-earned money going to taxes than you would prefer.
Sell Your Business
Since much of your wealth is likely tied up in your business, selling when you’re ready to retire has likely been part of your retirement plan all along. Selling your business at its fair market value (FMV) is a great way of transferring ownership of a business to a family member. You have the flexibility to negotiate terms that benefit everyone. It’s important to establish clear conditions and delineate the roles of all parties going forward.
If you’re not ready to hand over the reins completely, you can sell a portion of your company while retaining majority ownership. Clear arrangements should be established beforehand and documented in the formal transfer of business ownership agreement with your children. You’ll probably pay taxes on capital gains from the sale, but retaining partial ownership lets you keep that income flowing while your children take over operational responsibilities.
It’s very likely that your kids won’t have the cash on hand to buy you out of your business outright. However, structuring the sale as an installment sale will provide some much-welcomed flexibility. As your children accumulate more ownership of the company, they will be entitled to more distributions. With the higher distribution amounts, their cash flow will be in a better situation to pay you out.
Gift Your Business
While gifting the business to your kids sounds easy enough, it comes with its own downstream implications that need to be considered.
If you gift the business, you are foregoing income that may or may not be necessary to support your own lifestyle throughout retirement. Nevermind that you may want the kids to have some “skin in the game” and not have your years of hard work handed over to them. However, if there are no objections there, there are still a couple of finer points to consider when it comes to taxes.
While you are planning on transferring ownership to the next generation, who knows what will come after that? Your kids may keep it a family business, or they may decide to sell the business down the road. If you gift the business to them, their basis in the company (essentially, what they paid for it) is carried over from what your basis was. Without knowing your specific situation, it’s more than probable that your basis is close to $0. This means that when they sell the business 20 years from now, the entire amount will be taxable.
Depending on the value of your business and any prior gifting you’ve done, you may not be totally free from estate taxes. Any dollar you give above the IRS annual exclusion (this article is being written in 2024 when that amount is $18,000) will reduce the amount that you can die with before the IRS wants to tax your estate.
While gifting the business to the kids sounds like a great strategy in theory, you can easily see how it is rife with complications.
Let Your Children Inherit Your Business
Without advance planning, ownership of your business will pass to your heirs through your will. Usually, this means to your spouse and then to your kids equally, which is nice for them for a couple of reasons. First off, they don’t have to come up with the cash to buy you out. Additionally, they will have a step-up in basis to whatever the business is valued at at the time of your death. Should they ever choose to sell the business, this will provide them tax savings.
By foregoing any sale proceeds, you may be limiting your ability to enjoy a financially comfortable retirement and your children’s ability to share in your business’s profits. When you pass, the business will be included in your estate, likely incurring significant estate taxes that have not been planned for.
Estate taxes on an inherited illiquid business are intense. Depending on what other assets you leave behind, your children could be put under significant financial strain trying to pay the tax bill.
If your children have been working hard for the company and looking forward to exercising ownership rights, they may get a little frustrated waiting for you to die. And as things unfortunately tend to go, a major loss in the family often leads to unforeseen familial conflict. Your lack of planning around transitioning the business may end up being a major area of tension once you’re gone.
Family Dynamics
When transferring your business to your children, or even beginning discussions around transferring ownership, it’s important to be prepared for family tensions that may arise. If you have several children involved in the business, each with different roles and responsibilities, be prepared to account for that. Splitting ownership equally might seem fair, but it may not align with the diverse contributions each child makes to the business’s success.
For children already contributing their own set of skills to the success of the business, it may make sense to split ownership rights equally and to structure compensation for each child based on the market value of their position. Everyone has equal stake in the company you’ve built, but their regular income is on par with their individual roles and responsibilities.
You may decide to allocate ownership proportionally to the responsibilities they have taken on. Or not! Deciding what is right for you, your family, and the future of your business will require some deliberate thinking on your part.
You may also have children that are not involved in your business. Most likely, you’ll want to provide for them with some sort of inheritance. Given that the business is likely your largest asset, if you are not “equalizing” their inheritance with other assets or insurance proceeds, they may feel left out and forgotten.
However, if you leave one of your kids an illiquid business that they need to work at to continue to generate income, and you leave another kid a pile of cash worth the same amount that requires no work on their part, the child with the business may feel like they got the raw end of the deal.
As you can see, succession planning for a family business is rife with potential areas of conflict and tension. However, with careful planning and open communication, you can pass on the product of your years of hard work and dedication to your children. A well thought-out succession plan can provide a comfortable retirement for you, a thriving career for your children, and peace of mind knowing your business stays in hands you trust.
Final Thoughts
As you consider transferring your business to your children, don’t forget to plan for your own financial needs throughout retirement. While your business’s value may seem sufficient to fund your retirement, don’t overlook additional expenses like healthcare and memberships that the business currently covers. A simple salary match might not cover these new costs. Consult with your financial advisor to help you make the right decision for all your retirement needs.
Once you decide how ownership is to be transferred, be sure all your plans are comprehensively documented in legally binding agreements and directives. Consulting with your lawyer will help get all necessary paperwork completed accurately.
Regardless of how you choose to do it, transferring your business to your children is the culmination of your dedication and a lifetime of hard work. The way you choose to transfer ownership can help cover your income needs for your next chapter or, if you prefer, allows you to remain involved in a business you love. Ultimately, you want to see that your vision has the potential to endure for generations.
At SK Wealth, our financial planners are skilled at helping you make informed choices about your family business and retirement plans. Refined over the last 25 years, our financial planning process, known as The Integrated Financial Advantage™, provides personalized recommendations to empower you to live with intention, tomorrow and today.
