How you transfer your company to your children depends on your financial situation, your vision of the company's future, and the confidence you have in the next generation. Here are some arrangements to explore with your advisers:
1. Buy/Sell Agreement. "This is far and away the most popular, since owners often need a source of future income," says Tom Ochsenschlager, a partner in the Washington, D.C., office of Grant Thornton. Typically, an owner holds a note for his or her children, who pay over time using company profits. To protect yourself, you can include the same kinds of covenants a bank might impose, such as restrictions on salary.
2. Gifts. "If Mom and Dad are well situated for retirement, gifting may be a viable avenue," says Craig Damos, a partner in the Des Moines office of McGladrey & Pullen. You and your spouse both have the option of giving each child $10,000 a year in assets tax-free, so you could pass the business on over a period of years. Also, the Taxpayer Relief Act of 1997 allows each spouse in a family business to bequeath $1.3 million in assets tax-free--provided the spouses own the stock individually, not jointly.
3. Redemption. "If the company has a lot of cash, it can redeem the parents' shares," says Ochsenschlager. "This works well when a company has undistributed earnings and profits, but the technique is tricky and requires financial advice." As the parents' shares are redeemed the children's ownership increases.
4. Other options. Less common and more complex methods include family limited partnerships and charitable remainder trusts. Both have the effect of reducing the value of the company in the parents' estate while allowing the parents to maintain a controlling interest until their death. Both methods can raise red flags with the Internal Revenue Service, so you'll need sophisticated advice if you go either route.