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Family matters: two-thirds of family-owned businesses don't make it to the second generation. Don't let yours be one of them.

Peter and Nathan--brothers who were newly involved in running the family rental housing business--finally decided to take bold action. They whisked away the domineering president of their company--who also happened to be their father--for a long weekend. The purpose of the trip? Peter and Nathan simply wanted to know more about the business--its history, successes and failures, renter base, competitors and prospects for the future.

In particular, they got their father to open up about his own future with the company and his plans to eventually pass on the business. Back home three days later, they all agreed that the time together had enabled them to share valuable information and strengthen their working relationship.

A long weekend away together is just one way to approach the issue of succession planning. When it comes to passing the torch, maintaining open lines of communication in a family business is critical.

Most family apartment owners avoid succession planning. Nearly three-quarters of all business owners who intend to pass the company to another family member have no written plan indicating who should assume control of the business upon the owner's retirement or death, according to the National Family Business Council. It should come as no surprise, then, that only about one-third of family-owned or controlled businesses survive into the second generation. The odds of continuing into the third generation are even slimmer--about 13 percent.

Jealousy and Favorites

For many older business owners, the difficulty in accepting their own mortality causes them to delay succession planning. Owners who started and built up the family firm, in particular, see the enterprise as part of their core identities from which they derive much of their self-esteem. Leaving the business may mean losing a sense of purpose. Further, they may be concerned that their successors will destroy their legacies.

Letting go of the power and perquisites that come with the president's chair is also difficult for some parent-owners. Others refuse to relinquish control because they are envious of their children's' emerging talents.

Additionally, singling out one child as a successor forces parents to confront long-cherished beliefs that all of their children are equal and may open long-dormant sibling rivalries. Children may be able to avert conflict by clearly stating their interests and future goals to their parents.

Taxes Impede Transition

Roadblocks to preparing for a shift in ownership often involve highly complex emotional and psychological issues. These subjects are taboo in many families. But there also are other, more tangible topics involved in succession planning. For example, highly confiscatory estate taxes can threaten the very existence of the company apartment owners have worked so hard to build.

One of the reasons so few family businesses survive into the next to do estate planning. When owners die, the remaining family members may be forced to sell the business simply to cover the estate taxes, which are levied on the transfer of an owner's property upon death.

The Economic Growth and Tax Reconciliation Act of 2001 changed the estate tax rules. (See sidebar, below.) Further, since 2001, there have been several efforts by Congress to make the estate tax repeal permanent. The uncertainty created by the act and the long-term prospects of estate tax repeal make planning in advance more essential than ever.

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One way apartment owners can transfer the family business and reduce the size of their estates--and their potential tax liability--is by giving gifts of stock in the family business to the children. This strategy can reduce transfer taxes substantially, particularly for rental housing companies that are not yet highly appreciated in value but which are expected to grow over time.

Parents should consider giving stock only to children who will manage the business and other assets to those who are inactive in the firm so that inactive siblings do not have the power to undermine active siblings' authority by outvoting them.

Buy-Sell Agreement

Another reason why so many family apartment owners procrastinate transferring managerial control or stock ownership to the next generation is their fear of losing financial security. In addition to worrying about how their businesses will survive without them, they also worry about how they will survive without their businesses.

One way to address these issues is with a buy-sell agreement. The buy-sell agreement is a legal document that spells out how ownership will change hands in case of an owner's death, disability or retirement.

The agreement might provide, for instance, that in the event one of three co-owner siblings retires or dies, the remaining two owners have the right to purchase those shares so as to keep the business within the family.

To work as intended, buy-sell agreements must specify the value of the company's stock and a way to pay for the shares. One funding option is life insurance, which can be purchased by the corporation, or by each owner taking out a policy on the others.

Consider this common situation: A father with two children--Sarah and Steve--owns the family business and plans on running it until his death when Steve, the one who is involved in the company, will take over. The father's primary goal is to provide sufficient financial security for his wife upon his death.

She is looking to the money from its sale to support her for the rest of her life. Steve, however, does not have enough cash to purchase the business and fears he will have to sell it outside the family.

If the father and son had a buy-sell agreement funded with life insurance, however, Steve could use the life insurance proceeds to buy his father's interest in the business, providing an income to his mother and, at the same time, a source of funds for Sarah, to fulfill his father's other goal of providing equally for his children.

If Steve wants to buy the family business during his father's lifetime, before any insurance proceeds are available, there are other options.

If Steve was short of the necessary cash, he might consider a buyout that includes a combination of cash, installment payments and a compensation package in return for his father remaining on board as a consultant for a few years during the transition of ownership.

BY RONALD F. SMITH, CLU, ChFC, and PAUL E. HONEYCUTT, CFP[c]

Paul E. Honeycutt, CFP[R] Practitioner, and Ronald F. Smith, CLU, ChFC, are registered representatives with/and offering securities and advisory services through Commonwealth Financial Network. They can be contacted at 858/200-0900 or www.honeycuttsmith.com.
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Author:Smith, Ronald F.; Honeycutt, Paul E.
Publication:Units
Date:Nov 1, 2008
Words:1081
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