Parents wishing to transfer their family businesses to their children have a couple of options. They can give their business to them. Or, they can sell it to them. These choices aren’t binary – they can be used in combination with one another. Either choice will be better, however, if preceded by careful thought and planning.
Choosing the gifting (or bequeathing, if done by will) alternative calls for thorough planning by the parents. There are tax advantaged ways to effect gifts and maximize benefits to the parents, such as grantor retained annuity trusts and preferred ownership value freezes, that should be explored. So should the strategic use of life insurance. Good wealth management, legal, tax and estate planning advisers can be worth their weight in gold here.
The other alternative for transferring ownership is selling. And while taking money from one’s children may feel parsimonious, there are a number of commentators who tout selling to the kids, at full value, as the transfer means of choice.
Selling to one’s children has several benefits. One of the more obvious is that it will help fund the parents’ retirement, something that otherwise may be difficult when leaving behind what has been an illiquid business investment. Selling also reinforces the kids in their thinking and acting like business owners, rather than heirs. Having real skin in the game – being personally on the hook for financing a buy-out – will test the kids’ commitment and resolve to take over and run the business.
There are several ways for the kids to finance their buy-out. Commercial loans and mezzanine debt financing are available. The business can be recapitalized to bring in third party equity ownership alongside the family. Seller financing by the parents and earn-outs can be considered. And despite some tricky tax planning requirements, converting the parents’ ownership to preferred interests with a fixed value that may be purchased over time can help ease the pain for the kids.
If the kids are the right ones to take over the business, they should be able to get the financing they need. Investment banks can help here. And a buy-out by the kids can provide a true win-win outcome for both generations.