Author: Paul Spare, CPA, CA

In my previous post, I emphasized the importance of long-term and comprehensive planning to ensure that a business succession is as trouble-free as possible, and will leave the most after-tax dollars in your pocket.

When that succession plan involves passing the business to a child or other family member, a host of considerations come in to play. Many of these have nothing to do with dollars and cents. Interpersonal relationships can quickly complicate, even sink, any business transaction.

But, regardless of who is involved, this is a business transaction. The best way to minimize the potential for conflict and financial loss is to develop a plan that addresses all of the possible tax, income and legal issues that can arise.

Cap your expectations

In a majority of cases, business owners are accustomed to pulling whatever available cash from the business they want, for whatever purpose, at their discretion. But that cash is an asset of the business, and your successor(s) may have something to say about how it’s expended.

Your successor(s), on the other hand, must appreciate that you will likely maintain some ownership in the business. This stake may represent a source of passive retirement income on which you will depend for a number of years. They are obligated to ensure the business decisions they make don’t put that in peril.

It’s vital for both parties to appreciate that a relationship of give, take, and mutual consideration and respect, must reign for years, if not decades, to come.

Then cap your tax liability

The next step is to consider how this transfer of ownership will take place. Will it be in the form of a gift, a sale at fair market value or an estate freeze? There is no one right answer. Each scenario has its own considerations and implications for you and your successor(s). This is where you need that group of trusted tax, legal and financial advisors to help you clarify your needs and identify the most beneficial course of action.

One approach is an estate freeze. In most instances, the owner will exchange their existing common shares for fixed-value preferred shares. The company then issues common stock to the successors. This allows the current owner to “freeze” the value of their shares and their ultimate tax liability, while continuing to control the asset. The successors, meanwhile, can benefit from (and be liable for the taxes payable on) the increase in value of the asset after the date of the estate freeze.

To decide which course of action is best, everyone must be at the table. Clear and honest communication among all your business’s stakeholders and advisors is crucial.

And remember – if your intent is to pass the business on to your children, you must have a plan in place now, regardless of how far off that transition may be. Tragedy strikes when we least expect it. Take the time to sort out your will and consider the role that family trusts can play in your estate planning.

In my final post on the subject, I’ll discuss the options and challenges related to a third-party sale.