Selling a Family Business to Your Family
"In a family business, success can only be achieved when each and every one tries to balance the business life with the duty assigned to them."
An organization which is run and owned by a family and in which decision making is influenced by multiple generations of the family is known as family business. It is the oldest form of economic organization. Businesses like these are usually underestimated because of the disputes that arise among the family members. Such businesses can range from small ownerships to large enterprises spread across industries. A family business can either be owned by one person or more. Committed family members can easily balance their differing interests to successfully manage the business. The maturity of the business directly depends upon the ownership in the family business.
Considering the situation, selling a family business is usually a difficult one. It is of least importance to know whether the business has been nurtured and handed down through several generations or is still in the hand of the current owner. What matters the most is deciding whether to sell the business or not. Once decided, it is of prime importance to decide whether to keep the business within the family or to sell to some outside stakeholder.
There are many cases where a family business is sold or transferred to other members of the family. For an instance, children usually borrow money from their parents for the purchase of the business at an very low-interest rate without incurring gift tax implications. As a result, a smooth transition occurs while the parents are still alive and the child becomes the successful owner of the business. Reasons for passing on a family business to other members of the family are:
- The arrival of the retirement stage of parents whose children are ready to take over the ownership of the family business.
- The dispute, which is the main reason why family businesses are underestimated, can also lead to the change in ownership of the business within a family.
- Families that are destructive are advised to transfer the ownership.
- The owner is not able to support a viable business under the current circumstances.
- Owner has no interest in the business anymore. Lost passion for the business can provoke the owner to transfer the business to any other member of the family.
- Legal issues and sudden death in the family are some other reasons that provoke the owners to sell the business to other members of the family.
If any of the above elements are present in the current business, it is suggested that the owner should transfer the business in some other hands. The initial step is to identify the issue and discuss it as an ownership group. The very next step is to find a suitable person who is capable of running the business. It is advisable to seek the help of a family business consultant who would be able to resolve the dissension or come to compromises the family can live with.
Challenges in selling a family business
Everything we do in our lives involves some kind of risks. Selling the business within a family can lead to hidden traps getting out of which becomes nearly impossible. For instance, if the parent selling the business dies before the installment sale to the buying child, then the process of sale hangs up. Is such situations, the seller should mention the clause for forgiveness of the remaining debt in the will. In such a case the children who are not involved in the family business, suffer which is a major drawback of this type of sale. Some challenges involved in transferring a family business to other members are:
Sudden deaths – sudden deaths in a family business can create major problems for those who are next in the line to acquire the business. If a parent dies leaving behind the balance more than fifty percent due on the loan, then the child receives an amount equal to one mentioned in the will. Such type of transfers, trigger an increased amount of income tax to the estate equal to the face note value minus the child’s share. The amount left over is income in respect of a decedent (IRD) and also represents the taxable income of the estate. This situation is similar to a situation in which a child has paid off the note at his parent’s death but without the offsetting funds.
Buyer’s share in the transfer – a problem which concern the buyer the most is whether the will specifically reduce buyer’s share of the estate. If there is no such provision, then the buyers suffer the tax burden. Whether it is the children who are acquiring the business or any other member of the family, both are residuary beneficiaries of the estate.
These challenges are unpleasant to contemplate and difficult to predict. Yet, with the help of family business consultants, the owners can land up to effective solutions. Among many solutions, the most effective ones are:
- The major issue of inequitable distribution of tax can be avoided by including a provision in the will apportioning taxes. For instance, if the business is to be transferred to both son and daughter, then they would equally be liable to taxes that are supposed to be paid. In other words, if the parent dies before any will is prepared, then the children will have taxes attributable to the forgiveness of the business loan subtracted from their remaining inheritance. Such a transaction would make the children better off as now they would have a more fair distribution of their parent’s residuary assets.
- The buyer can make use of any of the two strategies which are used to sell a family business that result in any remaining debt ceasing at the seller’s death. The first strategy is known as self-cancelling installment note (SCIN). This note is designed to cancel at the seller’s death just as its name implies. It includes a combination of a higher principal or interest rate which is built into the calculation of the remaining loan.
- The other strategy is called private annuity. In this case, the buyer’s payments are calculated based on the life expectancy of the seller. It directly depends on when the seller dies. The buyer would benefit if the seller dies a premature death whereas a longer-than-expected lifespan would benefit the seller. Both the strategies have their own pros and cons. With the former one, the correct valuation of the payments would be difficult to determine and may become a red flag for the buyer. In the same way, there are tax issues with the latter one. Moreover, there is also an issue of never ending payments for the buyer in case of private annuity. The buyer is supposed to continue his payments even if he far exceeds seller’s life expectancy.
- Life insurance comes as a major help for the buyer. It is the simplest solution in which seller’s premature death will trigger a tax-free death benefit that the buyer can use to pay off the loan. In this way, the estate would pay the tax as the payoff of the will is ultimately an income to the estate. Moreover, if the seller is insured and such kind of approach is employed, then he/she is not supposed to provide a will to be transferred to the buyer at death. The buyer would get a proportional share of the will as long as taxed are properly apportioned.
The most advisable form of sale is to transfer the family business to a child when the parents are still alive. The seller has to be sure whether the child would be able to manage the business properly or not. Building up a family business is quite difficult and successive generations should try to maintain the business in their hands. Selling the business can benefit the family if the sale is structured carefully.