Effective Exit Strategies for Family Businesses
Difficult as it might be to imagine giving up the business you’ve worked so hard to build, family business owners should start planning their exit strategy well before they’re ready to move on.
Whether your exit plan is to sell the business, transfer ownership to family members, or close it, you’ll need the time to choose the best options for your own financial future and the future of the business, get all the stakeholders on board, and ensure a smooth transition.
Sole-owner entrepreneurs have two main questions to consider when planning their exit:
- “How much can I sell my business for?” and
- “How can I avoid paying taxes on the proceeds of a sale?”
But if you own a family business, you’ll be asking those questions and at least a few more as you plan your exit strategy. Among the issues, a family business exit strategy must address:
- Are other family members interested in taking over and do they have the necessary skills to run the business successfully?
- What is the company’s future, and can it support the next generation of ownership for the long haul?
- What is the current value of your business, and can family members afford to buy you out?
- How can you ensure key employees remain with the company?
- How can you make sure that ownership and decision-making remain with the family members you identify when marriage, divorce, and any other potential changes to family structure occur?
Start by Assessing Your Needs
How you approach your business exit strategy depends first and foremost on your own financial needs, your goals for your company, and your timeframe for exiting the business.
Do you want to reap the rewards of all your hard work by getting top value for the business? Is your vision for the future to have the family business live on under the next generation’s leadership? Do you need an income stream to supplement your savings? How much tax liability can you assume?
The answers to these questions will help you to choose your exit strategy.
Exit Strategies for Family Businesses
Exit plan options for a family-owned business are the same as those for any other type of business. They include:
- Selling the business to family members, a third party, or employees
- Transferring ownership of the business to family members
- Structuring a family business buyout
- Closing or liquidating the business.
But a successful transition for another business owner might not be the right transition for you.
You’ll have to weigh these exit plan strategies in consideration of your business, your individual needs, and your family dynamics.
Selling Your Family Business
Suppose you are the sole owner of your business and other family members are employees with no ownership stake. In that case, you can sell the business on the open market to a third party, your management team or key employees, or to family members.
Just because family members don’t have ownership in the company, however, doesn’t mean you can ignore family dynamics in your decision-making. Family members who have been working at the company (and even those who haven’t) might expect to be considered in your exit plan, even if they have no ownership stake in the business.
Transferring Ownership to Family Members
Transferring ownership of your business essentially gifts the company to your family members. If you have alternate sources of income and don’t have to cash out of your business, transferring ownership will continue the legacy you’ve built.
This exit strategy should be part of a larger wealth management plan to assure that you will have enough income to support yourself and to avoid as much tax liability as possible. And, as with any exit strategy, your plan should pay careful attention to family dynamics.
If you have a succession plan in place, then you’ve probably already determined which family members are both interested in and equipped to take control of the business. If succession hasn’t been part of your exit planning, you’ll need to identify which family members are eligible to inherit the business and allow time to train them to take over. It would be a good idea to include key employees in your plan, to help guide the new generation of owners.
Your plan should also have provisions for those family members who aren’t eligible to assume ownership. While you don’t want to leave the future of your business in the hands of those who won’t be able to manage it, you also want to avoid animosity and in-fighting among family members. Consider setting up non-voting shares or another source of potential income for the family members excluded from running the business.
Tax Implications When Transferring Ownership
Typically, the value you assign to your company in a transfer will be less than your company’s value on the open market, and that difference is taxable. In 2023, the IRS permits you to exclude $17,000 of gift and estate taxes per recipient. For example, if you transfer ownership of your business equally to three family members, you can exclude $51,000 from your transfer tax liability.
However, the IRS also permits a lifetime gift tax exclusion of $12.92 million as of 2023 (that exclusion is set to drop to $5 million in 2026). Unless the difference between your company’s market value and the transfer value you set exceeds the lifetime exclusion, you likely won’t have to pay gift taxes on the transfer. Still, it’s a good idea to consult a CPA or other tax professional before making any decisions.
Structuring a Family Business Buyout
If you need the business to generate income to retire, relocate, or for whatever your exit plans involve, structuring a family business buyout might provide the financial security you need. With a buyout, family members buy out your shares at an agreed-upon price.
A family business buyout doesn’t have to occur all at once. If your exit plan is to sell the business, and the next generation cannot pay the agreed upon value in a lump sum, you can lend the family members the money in exchange for a promissory note with terms for paying you back the principal with interest. (Remember that lending funds free of interest triggers gift tax rules.) This arrangement also gives you the added benefit of a steady stream of income if you need it.
Alternatively, you can structure a family business buyout where the next generation takes a reduced salary over a set period of time and the balance of their earnings go to you until the loan is paid off.
If you own real estate associated with your business, another way to structure a buyout is to lease the real estate back to the next generation. This option also provides you with an income stream.
Closing Your Business
The options discussed above assume that your business is healthy and has the potential for long term growth. But some family businesses, even those that support the needs of the current owners, might not have what it takes to continue to a new generation.
If your revenue is weak or has weakened over the years and your industry is declining, your best exit plan might be to close the business. Especially if you are leaving your business to your children, you want to be certain that the business can support them until their retirement.
By closing your business, you can liquidate assets, then use the proceeds for your own or your family’s financial future and avoid strapping your heirs with a business that won’t serve their best interests.
Developing a Buy-Sell Agreement
Once you’ve chosen an exit strategy, you’ll need to create a buy-sell agreement to document your plans.
Ideally, business owners have included succession planning as part of their estate planning. A solid succession plan lays the groundwork for your exit strategy by defining the roles of all the stakeholders in the family business. It defines who will assume leadership if the owner steps down, retires, or dies, and how the company will be valued.
A succession plan also serves as the foundation for a buy-sell agreement by establishing the terms for selling or transferring ownership of the business.
You’ll need a current appraisal of the value of your business to create a buy-sell agreement. An objective appraisal by a CPA, M&A advisor, attorney, or other professional will help you to establish a purchase price and value each owner’s shares in the company.
Your buy-sell agreement should include:
- The purchase price for the business and terms of the transaction
- An agreed-upon method for funding the purchase
- The events that will trigger implementing the buy-sell agreement
Keep in mind that the purpose of a buy-sell agreement is to create stability for the business. It should define who can and cannot sell the business and account for future changes in the family unit such as marriage and divorce.
Planning your exit strategy for a family business is a complex process and the earlier you begin planning, the better prepared you’ll be when it comes time to sell your business. Now’s the time to determine the best options for yourself, your business, and your family and to get all stakeholders on board to ensure a smooth transition.