Family businesses are quite common. A family business is controlled by a single or extended family entity, whether it is siblings, parents, and/or children. Regardless of the owners’ relationship, they generally believe the company is family-controlled in both its management and each aspect of the business.
Many of these businesses will eventually be passed down to the children of their founders. Unfortunately, many aging owners do not plan ahead for this transfer, which can lead to the business falling apart in the future. To ensure your business operates seamlessly after the transfer, you should follow certain formalities and plan for it. That’s what I hope to explain on this page.
What Formalities Should Be Followed When Transferring a Family Business to Another Family Member?
Many family businesses are successful because of the strong relationship between their owners. But relationships change, and many family businesses that rely on strong family ties assume they do not need to follow basic business formalities in the future. For example, many family businesses do not explicitly document the contributions each member is expected to make to the business, and they have prepared nothing in writing. In the event the relationship between the family turns for the worse, the business can be left in controversy, and families will disintegrate within a short time. It is important to establish formal written procedures to ensure your business is governed objectively should an unexpected event occur.
It is a good idea to establish a vision plan for all family members in the business. This involves documenting the many aspects of your business, including the mission and core values, shareholders’ agreements, employer-employee agreements, company policies, and plans for how the company will be transferred when that time comes.
A formal governance structure should always be implemented, regardless of how many family members are in your company. Many family businesses today use a shareholder system, with shareholder meetings to discuss official company matters. Other closely-held businesses have a committee or board that represents the owners and decides on the company’s matters. Others have a verbal communication system, meaning Mom or Dad gives the orders.
A shareholder’s agreement, partnership, or operating agreement is arguably the most important document to be implemented immediately if you do not have one. Each of these agreements functions the same depending on the legal formation documents of the enterprise. Each document describes the composition of the governing board and contains buy-sell agreements among owners. Buy-sell agreements are important because they specify the terms of sale in the event that any owner of the business decides to exit the company. While everyone always believes the company will run smoothly, personal relationships may break up. A proper buy-sell agreement states how the company will be transferred, who purchases the shares, how much the departing shareholder will receive, etc. This reduces the risk of controversy when someone departs.
Why Should I Start the Planning Process Now? What Problems Will This Planning Help Me Avoid?
Transferring your business to a child or other family member should be considered and planned for years in advance, regardless of how far away it is. Many people believe that since they won’t be transferring their business to their children for many years, they don’t have to worry about it right now. Maybe that is correct, but oftentimes it is not. Why? Accidents occur, relationships are harmed, and businesses change through the years. Planning for the transfer of your business now is the best way to ensure a smooth, successful transfer to your children, regardless of what the future holds.
What problems does a written agreement help you avoid? I’m glad you asked. Notably, many businesses falter during the transition process due to estate and death taxes. When someone owns a business and does not pass it to their heir before they die, it remains part of their estate. When your estate is passed on to your heirs, it may be heavily taxed by the state, as the federal government has both an income and an estate tax. The value of your family business being transferred will determine how much you are taxed. Unfortunately, many family businesses fall victim to this tax, and the heirs are unable to pay the government to keep the business going.
Other potential problems also exist. Sometimes, there is a lack of capable or interested successors. This may occur if a child is too young, too disinterested, or incapable of running the business, and no one is willing to step up. Lack of family teamwork can also prevent a business from surviving. For example, if a father with three son’s gifts 50% to one and 25% to each of the others, maybe the sons with the 25% are unwilling to assist in running the business out of jealousy and spite. This could lead to the business’s collapse if the son, who owns 50%, is unable to run it on his own. A detailed transition plan can help any family business avoid these problems. It can put money aside in a trust to pay the estate taxes, name a successor, and help settle any disputes today, rather than down the road when the issues may harm the business.
One must view family business succession as a process, rather than an event. Putting together a plan today can ease the transition process later in life and ultimately help assure that your business will successfully pass to your children.
Fredrick P. Niemann Esq.
Please don’t hesitate to contact Fredrick P. Niemann, a New Jersey Business Succession Planning Attorney, today at (732) 863-9900 or by email at fniemann@hnlawfirm.com. He would be happy to meet with you to answer any questions you may have or assist you in starting up your own business succession plan today.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Business Law Attorney