How to Transition a Family Business: Pitfalls and Preparation

Robert Buchanan, ASA, CFP®

Asain mother and daughter, daughter pouring mild in mug

KEY TAKEAWAYS 

  • Be clear about what you want to achieve and what you need to achieve
  • Understand the risks and benefits, both economic and emotional, of various transaction structures
  • Set up governance and support frameworks before making any transfers
  • Begin conversations with the next generation early and seek professional assistance

As a business owner considering transition alternatives, you may have the option to transfer ownership and/or management to your family members. 

Many intrafamily transfers are to the next generation: children of the current owners. Other options may also be available. In completing these types of transitions, there are a number of issues to consider that can impact the future of your business and your family. If you are wondering how to transition a family business, defining these areas is an effective starting point.

  • The economic effect on you and the business.
  • Questions around management, ownership or both.
  • To whom, the business will be transferred, when and how.
  • Family and business governance.

In any business transition plan, thoughtful preparation and communication will help you achieve your goals. However, there are always a few key areas that can impact your decision-making in more meaningful ways than others. Focusing on these areas first leads to more successful results.

ECONOMIC EFFECT FOR YOU AND THE BUSINESS 

In any assessment of what to do with your business, you should always begin with an analysis of your personal needs. This analysis should drive other considerations and decisions. 

Wondering how to transfer a family business? Begin by asking these few questions:

  1. What do you want to do after you transition? What are your goals?
  2. How much money do you need to accomplish your goals?
  3. Will you need money from the business or have you earned enough from it already?
  4. Can the business provide that shortfall, assuming it’s needed, if you aren’t running it?

Understanding your financial needs is the first step on the path toward transitioning your business. 

Your priorities will determine how a transfer to family members can occur and whether the business can fund your future. Without a clear understanding of your financial needs and the company’s ability to meet those needs, all other decisions are meaningless.

Once you are sure that your financial future can be secure in a transition that involves a transfer to your family, determine what kind of transition suits you best and consider your other goals. That could include leaving an inheritance to your family or establishing a legacy. Personal goals are often just as important as financial goals, and should play a central role in your decision-making.

MANAGEMENT, OWNERSHIP, OR BOTH? 

Determining exactly what you are transferring should be an early task in your larger decision-making process. This question may be tied closely to the next couple of overarching questions (to whom you are transferring, when, and how?), but deserves independent consideration. 

Begin by thinking about what you want your role to be in the future. If you would like to walk away from day-to-day operations, but want to retain ultimate decision-making, it’s possible to transfer management without ownership. Likewise, it’s possible to transfer non-controlling interests in the business and retain control. Assuming, however, that the ultimate goal is to transfer ownership to the next generation, you should implement a plan that provides for the transfer of both management and ownership along some defined timeline.

A related question to consider is whether ownership must also include operational management. There are some circumstances in which you might consider hiring a professional management team and transferring only ownership. While the next generation of owners can always exercise their ownership control and take over management, there is no requirement that you “give” them operational management from the beginning.

TO WHOM, WHEN AND HOW? 

These questions are central to any intrafamily transfer and are closely tied to the previous question, as together the answers may determine the future success of the business.  

How do you decide who gets what, exactly? How do you decide who, if anyone, takes operational control? Assuming there are children to whom you wish to pass your business, early and frequent communication is the key to ensuring that:

  • They want to own and/or run the business, and
  • They’re capable of owning and/or running the business successfully. If either is not the case, keeping your company in your family may not be your best option.

"How do you decide who gets what, exactly? How do you decide who, if anyone, takes operational control?"

Once you’ve determined that your children, or some subset of your children, are capable and want to own your business, you then have to think about the timing of transfers, how to divide ownership and operational control and how to transfer the interests. There are many variables to consider and many options available to transfer your ownership. 

If there are multiple children, who gets what?

  • Should ownership pass equally? If not, can I “equalize” them using other assets?
  • Will everyone work in the company? In what roles?
  • How will this affect my relationships with my children or their relationships with each other?

Should I gift or sell the interests to them (this ties back to whether you need money from the business to fund your needs)?

  • How do I structure a sale in a way that meets my needs, doesn’t over burden the company, and is fair to the buyer(s)?
  • What are the tax implications of different transfer structures?

How much should I keep?

  • How much risk am I willing to take?
  • How much do I want to participate in the business going forward?

These are just a few of the questions that are important to consider. 

There are many more unknowns to consider as you determine how to transition a family business, and the answers to each may uncover others. The key is to start early, be thoughtful and communicate openly and often, including all parties in the conversations. Remember that, when choosing a successor, what is important to you and what is important to the next generation may differ. Selecting a leader can be different than choosing a manager; management is doing things right, leadership is doing the right things. 

FAMILY AND BUSINESS GOVERNANCE 

One of the best ways to support success when transferring ownership to the next generation of family is to create a governance framework that clearly defines rights and responsibilities for both the business and the family. 

Often, sole owners, especially founders, have no formal governance structures in place because they weren’t needed. When you own all of a business, it’s clear who makes the decisions, where responsibility lies, and what rights you have – it’s all you. However, as ownership is dispersed among multiple shareholders, complexities arise.

A shareholders’ agreement can provide clarity and comfort for new owners by defining not only their roles as shareholders but their responsibilities to both the company and to other shareholders as well. A well-written agreement will also define the events and terms upon which they can transfer their ownership, how the company will be managed (election of a Board of Directors, etc.), the payment of distributions, and a myriad of other topics. 

Likewise, the transfer of ownership to the next generation has the potential to create familial conflict. Brothers and sisters are no longer tied together solely by their sibling relationships but now have common economic interests. Sharing this type of common interest does not necessarily mean that they have common economic goals, nor does it mean that they will always agree on strategic or tactical issues related to the operation of the company (some may be working in the business and some may not, for example). 

It is important to recognize that these conflicts may arise. Prepare for them by creating a system through which family issues can be resolved in much the same way that business issues are resolved through a shareholders’ agreement. 

While it is impossible to foresee and address every potential issue, it is important to anticipate that this change in relationship could create friction. Having systems and processes in place to address both company and family concerns is critical. The more thoughtful these structures are, the more likely the transfers will be successful for everyone.

A PLAN FOR MOVING FORWARD 

There are many ways to transition away from your business. Keeping your company – your life’s work – within your family may be very appealing. 

When considering if this option is the best available, or even if it is advisable, there are many factors to take into account, and we’ve addressed only a few of the most important considerations. Transferring your business to the next generation of your family may seem like an easier alternative than selling to a third party, but there are multiple topics to consider and address to increase your likelihood of success in this type of transition. 

The single most important thing you can do is to begin thoughtful planning early and to include those to whom you are considering as new owners. Understanding their aspirations and concerns will help guide your decision-making process. That means finding a more resilient approach that successfully answers the question of how to transition a family business.

DOWNLOAD ARTICLE(PDF, 500KB)(PDF, 213 KB)
Watch Replay: LinkedIn Live Event Thursday, Ferbruary 17, 2022


Get started on your business transition journey.

Schedule your 30-minute assessment with Bob.

 

Robert Buchanan ASA, CFP® VP, National Practice Leader, Business Transition Planning, Comerica Wealth Management

This is not a complete analysis of every material fact regarding any company, industry or security. The information and materials herein have been obtained from sources we consider to be reliable, but Comerica Wealth Management does not warrant, or guarantee, its completeness or accuracy. Materials prepared by Comerica Wealth Management personnel are based on public information. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Comerica Wealth Management, including investment banking personnel.

The views expressed are those of the author at the time of writing and are subject to change without notice. We do not assume any liability for losses that may result from the reliance by any person upon any such information or opinions. This material has been distributed for general educational/informational purposes only and should not be considered as investment advice or a recommendation for any particular security, strategy or investment product, or as personalized investment advice.

Comerica Wealth Management consists of various divisions and affiliates of Comerica Bank, including Comerica Bank & Trust, N.A.; Comerica Securities, Inc.; and Comerica Insurance Services, Inc. and its affiliated insurance agencies. Comerica Securities, Inc. is a federally registered investment advisors. Registrations do not imply a certain level of skill or training. Comerica Bank and its affiliates do not provide tax or legal advice. Please consult with your tax and legal advisors regarding your specific situation.

Senior Vice President and National Practice Leader at Comerica Bank

Robert Buchanan, ASA, CFP®

Senior Vice President

Related Content