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Why so many family businesses fail and why yours won’t

November 10, 2015

It’s estimated that about 40% of all family businesses are successfully passed down to the next generation, and only 13% survive being passed down to a third generation. If you’re a business owner looking to transfer ownership to one of your children or another family member when you retire, those numbers might worry you. But the reasoning is simple: Unless the person who runs your business next is just as passionate, motivated, and dedicated as you are, things will get bumpy.

Succession planning for your family business needs to be a formal process; there’s a lot more to it than just handing over the keys to your kid one day. Here’s how to pass down your family business the right way.

STEP 1: Educate the Next Generation
If you know your family business will be passed down in the future, the planning needs to start right now. In some cases, the family member who will be taking over will need to go to school to learn about business management and marketing. Even if he or she already has the actual skills involved in the day-to-day job, it’s important that they have a solid base of management education — preferably a degree in it. They are not opening a new business like you did, but taking over a profitable, existing company. There’s so much more to learn in order to flourish at this stage.

The future owner also needs to work day-to-day in the business. Often, the next generation wants to step in and make changes. While some of these changes may be positive, it’s important for that family member to start by learning about the customers and employees, and managing the processes as they are. 

STEP 2: Determine the Best Financial Method for Transferring Ownership
The legal process of passing ownership from one person to the next is often a big decision in itself. Generally, there are three options: You can gift it to the next generation of your family, you can sell them your business at market value, or you can decide to use a trust — which may reduce some taxes while providing some level of control to you. But which method is right for you?

In gifts, the company’s value is removed from your estate. You’ll have to pay gift taxes on your business if it exceeds $1 million in lifetime gift tax exemption. In addition, you will not get any proceeds from the sale. However, this is the best method for reducing taxation hits.

On the other hand, selling your business to your kids can be a great option. In most cases, the new owner or owners will make payments from the profits of the business. That means you are not taking money from your children’s pockets. In this situation, you’ll need to pay capital gains tax if your business has improved in value during your ownership. It’s best to work closely with your tax planner and an attorney to determine the most effective method of transferring a family business based on its value and your needs.

STEP 3: Discuss Management and Control
Before making the transfer official, sit down and talk to the family member who will be taking over your business. It’s important to learn what their expectations are of you, of the business, and about the future. For example, does your company have significant debt? What contracts are in place that may require renegotiating? How much of a role will you have in the business going forward, if any? Clear communication is critical to this process, and the transition can become very difficult if there is hidden information or a lack of communication between the two parties. 

So should you pass on your business to a family member — the one you built from the ground up? It can be a good idea if you’ve invested the time into careful planning, and you have the right experts by your side. Just make sure that the family member taking over has the same dedication to the success of your business as you do.

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