The path from starting up a business to planning your exit is a winding one, with plenty of speed bumps and potholes. One of the biggest potholes results from the failure to include liquidity planning as part of the business succession planning process.

As part of the preparations to sell the company or pass it on to a family member, a business owner should develop a wealth management strategy that minimizes taxes.

Regardless of the size of their companies, all business owners should create a succession plan that meets their personal needs as well as the needs of the business. The effect of the asset transfer on the business owner’s estate plan should also be addressed. If the business is sold, the entire family will be affected by the transaction. A well-thought-out and well-executed personal plan provides greater opportunities for generational wealth creation and helps reduce anxiety. 

Here are some questions family business owners should consider as a first step in the planning process, along with examples from a real-world family situation.

Is selling the business the best option for your family? Many business owners need an exit plan that provides retirement income for themselves and their spouses. Those who want to name a family member as their successor may be torn between realizing the dream of continuing family ownership and meeting their personal liquidity needs. Another complicating factor arises when the prospective successor is not yet ready to lead the business. With proper planning and time to address these issues, a strategy can be developed that provides an income stream for the retiring leader.

As Mr. Smith approached his 69th birthday, he realized that no member of his family was ready to succeed him at the helm of his company. Neither of his children had joined the business. His nephew, who worked in the company, was only 27 and needed at least a decade’s worth of experience before he’d be ready to take the reins. At that point, Mr. Smith would be nearly 80. He began to rethink his plans and decided to sell the company. Eventually, we helped him structure a succession plan through a private equity buyout that allowed him to exit the company just before his 71st birthday.

Are you and your spouse interested in charitable giving? It makes sense to time a philanthropic gift so as to counteract capital gains taxes. Techniques to maximize charitable giving and minimize income taxes can be executed prior to your exit from the business. You and your financial adviser should determine which strategy — such as a donor-advised fund, a family foundation or a charitable trust — would work best for your financial situation. Additionally, creating a charitable vehicle can provide the family with an opportunity to continue to work together after the family business is sold.

The Smith family wanted to give back to the community that supported their business. Mr. and Mrs. Smith also wanted the family’s next generation to participate in their philanthropic endeavors. During the business succession planning process, the whole family discussed their charitable goals. The Smiths created a donor-advised fund and transferred some of the company shares to the fund. The fund held the shares until the company was sold. When the transaction occurred, there were no tax implications on the shares of the company held within the donor-advised fund. After the sale, the family used the liquidity within the fund to make gifts to local charities.

Should you establish trust funds for your children/grandchildren? If you want your children and grandchildren to benefit from the sale of your business, it may be more beneficial — for both you and them — to establish a trust and fund it with business interests before the ownership transition. Simple planning techniques implemented before an event can significantly increase the transaction value for the family as a whole. In addition to being tax-efficient, a trust allows you to establish provisions governing how and when money will be distributed to your heirs.

The Smiths wanted to set aside money not only for their children and grandchildren, but also for their nephew, who had worked in the company since his teenage years. They wanted to encourage their nephew’s entrepreneurial spirit now that the operating company was to be sold.

The Smiths established a trust — funded with stock before the sale — to benefit their children and grandchildren. The trust was structured so that the children and grandchildren could access money immediately for education and health needs. More generous access was delayed until later in life, because the parents felt it was important that each member of the family have a strong work ethic.

The business’s real estate holdings were not part of the sale; the Smiths gifted these interests to a trust for the nephew’s benefit. The nephew became actively involved in managing the real estate.

How will each family member handle the wealth? This may be the hardest question to answer. If your family didn’t always have significant wealth, will everyone be able to responsibly manage money after your liquidity event? This is something you’ll need to discuss candidly with your spouse. It is important to develop a life plan for you and your family members after the transaction. Most importantly, take time before the liquidity event to educate the family and discuss your goals and expectations.

Many business owners begin the education process well in advance of a transition. Turning over a small amount of money to family members gives them experience in working with an adviser and offers insight into how each individual might invest (or spend) in the future. This information can be helpful in determining whether to turn over future assets outright or in trust.

In the months leading up to the sale of the Smiths’ business, they held facilitated educational sessions and family meetings for their adult children. The conversations were dynamic and included not only financial matters, but also the family values and mission. This helped promote stewardship of the assets.

Planning for the future
Pondering these questions and working with your advisers to come up with answers will help you to develop a business succession plan in parallel with a family financial plan. You may not be ready to retire or exit from your business right now, but having a plan in your back pocket will smooth the way for you, your company and your family when it’s time to think about a transition.                      

Amy M. Kane is a senior wealth planner and Brooks Rarden is a senior portfolio manager for U.S. Bank’s Private Wealth Management. Both are based in Denver.

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