YOUR FAMILY BUSINESS AND YOUR ESTATEWritten by Dave Kauppi
As Penn State professor William Rothwell ominously points out in forward to Exit Right: A Guided Tour of Succession Planning for Families in Business Together, more than 40% of people who run closely held operations that comprise 80% of North American economy will retire by 2007. Those businesses will either be sold to a third party or management team, closed down, or passed on to next generation. In this article I will focus on passing business on to next generation. Tax laws still favor home ownership with mortgage interest as a tax-deductible expense. The government has also encouraged passing of a business from one generation to next with several favorable estate and gift tax rulings. Estate planning attorneys have utilized IRS ruling 5960 to minimize estate and gift tax owed for a business either gifted to or inherited by next generation. The business is often placed in one or more LLC’s and divided up into minority pieces to take advantage of very substantial and legal minority discounts, often as high as 40%. As is often case, a business owner will have, for example, 4 children. Two sons will be actively involved in running businesses and two daughters have built lives totally separate from business. Because 85% of value of estate is tied up in value of business, to be “fair” business is gifted and willed to four siblings in almost equal proportion. Because sons are running business, they will get slightly more of business and slightly less of remaining estate. This gives them majority interest in business. After dad leaves business, two sons will continue to run and grow business without any input or participation from their two sisters. Typically business does not pay any dividends and two sisters’ portions are non-liquid because there is not a good market for selling minority stakes in a privately held business. Also, there is generally a very restrictive buy sell agreement that favors majority holders. The sisters have no idea what “fair value” of business is and only indication they have ever gotten is an official IRS gift tax or estate tax return with 40% discounts applied. If enterprise value were, for example, $50 million and two sisters owned a combined 40%, you would think that they had an asset worth $20 million. The only document they have seen, however, is gift or estate return, valuing their portion at only 60% of that number, or $12 million. The brothers feel entitled to lions share because Ann and Julie had nothing to do with building this business. The brothers pay themselves big salaries and benefits and pay out little of no dividends. They may approach sisters with gift tax return and restrictive buy sell agreement in hand and offer to generously buy out sisters for a combined 8 million, because that is “all company can afford to pay.”
| | PASSING THE FAMILY BUSINESS TO THE NEXT GENERATION - IS IT THE BEST CHOICE?Written by Dave Kauppi
As Penn State professor William Rothwell ominously points out in forward to Exit Right: A Guided Tour of Succession Planning for Families in Business Together, more than 40% of people who run closely held operations that comprise 80% of North American economy will retire by 2007. It makes me wonder, what is going to happen to all of those businesses? Although it is a noble gesture, passing a business down to next generation is more often than not, unsuccessful. In fact, statistics show that only one-third of all family businesses are successfully transferred to next generation and only 13% are transferred onto third generation. Many family business consultants say primary reason for this low survival rate is failure to develop and effectively plan for transfer of ownership and management of closely held family business. I agree that this is a factor, but in my dealing with family businesses I find that there are some more fundamental reasons. The first is that next generation has a lot different life style than business founder and entrepreneur. They do not share same drive and commitment that dad needed to build business from scratch. They go to good schools, get a taste of good life and generally do not share passion of business founder. I recently was involved in selling a produce distributor. I found that most of firms were in their second or third generation. I asked a third generation owner why this particular industry had such success with keeping business in family. He said, “When you are up and on docks at 3 am and work 12 hour days, you don’t have time to spend money.” The next generation may have a grand scheme to turn traditional printing business into a media empire or a liquor business into an entertainment enterprise. A few years back second generation of a well known Chicago area computer leasing and IT Services Firm tried to turn it into an Internet Venture Firm with disastrous results. Before you just assume that your torch will be carried by next generation, make sure that next generation even wants to run business. Imagine loss in value that would have occurred if real estate billionaire from western suburbs had turned his empire over to his son who simply wanted to produce plays.
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