Passing on a business

Surveys of business owners consistently find a large majority intending to transfer their business to family or management, and a small minority having documented how.

The options

Transfer to family. The common intention, and it has the highest failure rate.

Research on family businesses generally finds that a minority survive into the second generation and considerably fewer into the third.

Sale to management. Selling to the people already running it, frequently financed over time from the business's own cash flow.

Sale to a third party. Either a competitor, a strategic buyer or a financial buyer.

Employee ownership, through an employee stock ownership plan or a cooperative structure, which has specific tax advantages and substantial complexity.

Orderly wind-down, which is the honest answer for many businesses whose value is entirely the owner.

The saleability question

Worth confronting early, because many owners assume a value that does not exist.

A business dependent on the owner's personal relationships, expertise and daily presence is difficult to sell, because the buyer is purchasing something that leaves with the seller.

What makes a business transferable: documented processes, a management team that can operate without the owner, diversified customers rather than concentration in a few, clean and audited financial records, and contracts that survive a change of ownership.

Building these takes years, which is why succession planning is generally described as a five to ten year process rather than a transaction.

Valuation

Owners consistently overestimate what their business is worth.

Valuation methods vary by industry and typically involve multiples of earnings, asset-based approaches, or discounted cash flow.

Obtaining an independent valuation early is worth doing, both to set expectations and because it is required for tax purposes in most transfer structures.

Where a business is being transferred to family at below market value, the difference is generally treated as a gift with tax consequences, which makes a defensible valuation essential.

Family transfers specifically

Where the difficulties are as much about family as about business.

Is the successor capable and willing? Assumed far more often than it is asked.

Children frequently accept a role out of obligation, which serves nobody.

What about children not in the business? The central fairness problem.

Leaving the business to one child and equivalent value to others requires either substantial other assets or a mechanism to create them — life insurance being the common solution.

Leaving the business jointly to children who do not all work in it reliably produces conflict between those running it and those receiving income from it.

What is the owner's role afterwards? A defined and diminishing involvement works. An undefined one produces a successor who never actually takes over.

Does the owner need income from it? Where retirement depends on continuing payments from the business, the transfer structure has to accommodate that.

The documents required

A buy-sell agreement, where there is more than one owner.

This governs what happens on death, disability, divorce, retirement or dispute — who can buy, at what price, and how it is funded.

Its absence is the single most common cause of serious problems when a co-owner dies, since the surviving owners may find themselves in business with a spouse or children who know nothing about it.

Funding for the agreement, generally through life and disability insurance, since a buyout obligation with no money behind it is unenforceable in practice.

Governance documents setting out how decisions are made.

An estate plan that coordinates with all of it, since a will leaving business interests in a way inconsistent with a buy-sell agreement produces litigation.

The contingency nobody plans

What happens if the owner dies or becomes incapacitated tomorrow.

Most succession planning assumes an orderly timetable. A substantial proportion of transitions are not orderly.

The minimum protection: someone with authority to act, access to accounts and systems, key relationships known to more than one person, and a written summary of what would need to happen immediately.

This costs almost nothing and it is the difference between a business that survives an unexpected death and one that does not.

General information only, not legal, tax or business advice. Consult qualified professionals about your own circumstances.