The generations should communicate candidly and frequently. What do the children want to do in the business? How much ownership do they expect? When does the older generation plan to retire, and how much money will they need to do so? If your family's not good at communication, family business counselors can help.
And start early. Herb Daroff of Baystate Financial Services in Boston had a 65-year-old client who wanted to begin a succession plan, but his 95-year-old father still owned two-thirds of the company. "I guess he was just waiting until the kid was ready," Daroff says.
Put the plan for the stock transfer and the management succession in a formal document. Consult the generations involved and senior management, and let everyone know what to expect. "Avoid surprises," says Myra Salzer of the Wealth Conservancy in Boulder, Colorado. Consider assembling an outside board, if you haven't already done so. According to Leon Danco of the Center for Family Business in Cleveland, "the board can serve as a surrogate parent, guiding the management of the company and acting as mediator, reconciler, cautioner, and supporter."
Bring on a business valuation firm. Even if you're passing on the business as a gift, the IRS will want to know its fair value for tax purposes. Then get an estate-planning lawyer, a financial adviser, and an accountant.
There are a lot of financial and legal strategies for passing on a business. Some factors to consider: how involved the senior generation wants to be, who's going to run the business when the senior generation's gone, who's going to own it, and how much value the senior generation wants from the business (some want to get the full amount of cash from it, while others want to pass it to their kids as cheaply as possible).
We'll toss out the major strategies here so you can ask your advisers about them. They're complicated, so involve your attorney and financial adviser from day one.
Gifting takes advantage of IRS rules that say individuals can pass $1 million in tax-free gifts, plus $12,000 a year, to each recipient.
A family limited partnership is the vehicle Sam Walton used to move big chunks of Wal-Mart (NYSE:WMT) to his heirs while still holding the operational reins of the company. It lets owners transfer up to 99 percent of their business to their children while retaining control.
A self-canceling installment note is a series of installment payments over a predetermined period, with fair-market interest added, set up for the younger generation to pay to the older one. The obligation is terminated upon the death of the seller, which makes this particularly suited for older sellers.
Private annuities work similarly to self-canceling installment notes, except the payments usually continue throughout the seller's lifetime rather than for a specific amount of time. The interest payments with these aren't tax-deductible, though, as they are for a SCIN.
Buy-sell agreements dictate how co-owners deal with the shares of an equity holder who leaves the company (through death or otherwise). In some cases, they involve co-owners all holding life insurance policies on one another and using the insurance settlement to pay for a buyout.
A grantor-retained annuity trust is one of several vehicles that let the owner maintain control of the business, and enjoy profits from the company, while gradually transferring ownership. Basically, the owner transfers equity to an irrevocable trust, then takes a fixed amount of the trust's value annually, for a specified length of time, after which the equity is transferred to the owner's heir or heirs.
A separate-share trust, for S corporations, is a trust that acts as a shareholder in the corporation. A separate trust is established and managed for each heir.
An intentionally defective grantor trust treats a business owner as the owner for income tax purposes but not for estate tax purposes. You create a trust for your family's benefit, then sell an asset (here, the business) to the trust in return for a long-term installment note.