Let’s face it – the family run business is the backbone of the American economy.  One-third of all Fortune 500 companies are family controlled .  Seventy-eight percent of all new jobs created in the country are in family-owned companies.

However, the average life span of any business, including a family-owned business, is only 24 years.  Two-thirds of family businesses don’t succeed to the second generation and eighty-five percent don’t make it to the third generation.  Why?  Possibly because the owner never gives much, if any, thought to the following issues:

Who Will Manage the Business?
It is vital that the business have a successor to manage it after the death or departure of the owner.  If the owner has already identified or trained key people in the organization to take over, that will smooth the transition.  It can also prevent time-consuming disagreements and power struggles, possibly even avoiding litigation over “promises” made by the owner.

Who Will Own the Business?
A spouse may have little or no interest or expertise in operating the business.  Similarly, the owner may not want to divide the business equally between children, especially if some are active in the business and others are not.  Also, if there are other, non-family, owners, are they ready to share ownership or control with the co-owner’s family?  Without the proper planning, friction can develop and result in a deadlock in management or an expensive lawsuit.

What Is the Company Worth?
Because a family business is not publicly traded, it is difficult to determine the value of the business.  Whether the business is sold or inherited, a competent business valuation is usually needed. A proper value, agreed to in advance, can avoid a costly battle between valuation experts or a fight with the Internal Revenue Service to determine the proper price of the company.

So, how does an owner help insure that these issues do not arise and that his wishes are carried out after he leaves the day-to-day operation of the business? Basically, he needs to “get it in writing”.  The two most effective tools to use are a buy-sell agreement and a complete estate plan.

Buy-Sell Agreements.  There are several points that should be covered by any Buy-Sell Agreement:

• What events will cause an owner to be bought out?  The most common are death, disability, divorce, bankruptcy or retirement from the business.  The buy sell agreement guarantees that there will be a market for the owner’s stock at the time he needs to sell it, thereby providing cash to his spouse or his estate.  It also guarantees that control remains with the surviving owners without any dispute from the departing owner’s spouse/heirs. A buy sell agreement is useful even when one of the owner’s children is going to continue the business, since it can head off disputes with children who are not active in the business.
• What is the purchase price?  The owners can decide on a particular method 
  of valuing the business (to be used when an owner departs from the 
  company), or they can set a fixed price for the business (and re-evaluate that price at certain fixed times).  This price avoids the need for a battle between valuation expert at the time an owner departs and may streamline any  dealings with the IRS. 
•  How will the purchase price be paid?  If the business does not have sufficient 
  savings or cash flow to pay off a departing owner, it can be allowed to 
  purchase the stock on an installment plan.  Alternatively, the business or the 
  other owner(s) may decide to purchase life insurance on each owner. This is 
  usually the least expensive way to fund a buy out and the insurance proceeds are tax free to the beneficiary.

Estate Planning. Since the family-owned business is often the most valuable asset the owner has in his estate, the owner must make sure that the succession plan for the business complements his estate plan. The owner should specifically consider:

Gifting Stock

By gifting stock to those children who are active in the business, the owner can:

• Minimize the cost to those children of buying the remaining stock at a later date.
• Remove the value of the gifted stock, and all future appreciation, from the owner’s estate, thereby lowering the amount of estate taxes.
  

Trusts

In order to given an equal inheritance to the children that are not active in the business, the owner can provide for a formula in his trust that equalizes the inheritance to each child.  The owner may also wish to create an irrevocable life insurance trust.  The latter holds an insurance policy on the owner’s life, which can be paid to the non-active children at the owner’s death. Again, the insurance proceeds are tax free to the beneficiary.  In addition, any premiums paid by the owner, have reduced the total value of his estate, possibly lowering his estate taxes.

Naturally, the any buy-sell agreement and/or estate plan must be drafted to complement each other.  It is recommended that the business owner seek professional assistance, from his accountant, attorney and financial planner, before starting any plan to transfer ownership of his business.