Your Family Tree

Family owned businesses are the engine of our economy, employing 60% of our workforce and contributing 64% to our total GDP (KPMG, 2013). Return on assets is greater in family businesses, averaging 6.65% more return than non-family owned businesses (University of Vermont Family Business Facts). And yet, the average lifespan of a family business is a mere 24 years (KPMG). About 70% of family owned businesses fail or are sold before being passed to the next generation (Harvard Business Review, 2012). For many such families, the old saying, “T-shirt to T-shirt in three generations” holds true.

Why do so many family owned businesses barely survive a generation? One major reason is that owners either have no succession plan (beyond a simple will) or have not clearly thought out what a successful plan would entail. Passing a family business from one generation to the next, or planning for the disposition of an ongoing business to benefit heirs, can be a challenging estate planning problem. Therefore it is critical to the survival of a family business that the owner begin the planning process early with the assistance of an experienced estate and business planning attorney. An experienced attorney can insure that a business passes seamlessly to the heirs in a timely manner, subject to a minimum amount of estate taxes and other estate settlement costs.

One reason passing a family business to the next generation can be so complex is that family relationships are complex. Parents may expect too much or too little of their children. There may be sibling competition, or at the other extreme, apathy about the business. In some ways, a good estate planner is also a mediator, negotiating a fair arrangement to satisfy all family members and insure the success of the business.

Take the hypothetical example of Arizona Balloon Company, a successful 25-year-old business founded and run by John Smith. He employs his wife and three daughters, as well as 20 other employees. He has two younger children who are not involved in the business. One day, John dies suddenly of a heart attack. His business is worth $12, 000, 000. His wife, daughters and employees are left to fight over their disparate visions for the business. They also argue over their respective interests in and responsibilities for the company. In the end, after spending hundreds of thousands of dollars in legal fees, with the business floundering, the only path forward is liquidation.

How can these problems be avoided? One option is to place the family business (whether in LLC, partnership or corporate form) into a revocable trust designating the business owner as grantor and trustee. The grantor funds the trust with business assets, and as trustee, retains control over the assets. Upon certain events (such as death or disability of the owner), the trust distributes the assets to the beneficiaries. The business owner can also determine other distribution triggering event(s) such as a beneficiary reaching a certain age or obtaining certain goals. The business owner can also decide who controls the trust after his or her death by naming alternate trustees. Two distinct advantages of a trust include avoiding the cost of probate (as high as 10% in some states) and avoiding delays in the transfer and control of business assets to beneficiaries. Another advantage of a trust is that if members of the next generation are too young or inexperienced to take on the responsibility of running a business, the power to control the business assets can be given to a trustee until the heirs are a certain age and experienced enough to take control.

There are also tax advantages of placing a family business into a trust. Estate taxes can be mitigated by employing certain planning techniques. Irrevocable trusts are often used in an asset ‘freeze.’ Business assets placed into an irrevocable trust can shelter appreciation from estate taxes. For example, if you were to create and gift to an irrevocable trust with privately held shares of $5.43 million (the current estate / gift lifetime tax exemption) and the trust assets grow to $6.43 million, the $1 million appreciation is estate tax free (along with the initial $5.43 million lifetime exemption gift). This technique is especially effective when healthy future growth of a business is expected. A gift of $5.43 million into an irrevocable trust now can keep future appreciation and the income generated by that gifted interest out of a taxable estate.