Katherine M. Sheehan
Succession planning is critical for business owners in every industry, but for those who have built a successful real estate business, there are specific questions owners should ask when starting to craft a succession plan.
Once these questions are answered, it will help guide how the plan is developed and help to determine if a sale, rather than a transfer to the next generation, is the best course of action.
It is critical to know the corporate and tax structure of the business, as well as if the business owner holds a whole or partial interest in the entity. The business owner will also need to determine whether a valuation of the business has been conducted recently and if any of the real estate is individually owned, look hard at the market in the areas where the properties are located and identify which properties are residential or commercial and if they are generating an income stream.
Do the Kids Really Want It?
When business interests are transferred it is often to the one child who has remained interested or involved in the business, while the others have gone off in the pursuit of other interests. But many times, business owners intend to transfer a business to their children even though those children have no interest, capability or capacity to continue the business.
With real estate, the next generation may have little interest in being a landlord or maintaining commercial property that has had inconsistent retail tenants and has not produced a steady stream of income in years.
The best way to ensure the continuity of a family business is to have a strategy for its endurance. This requires thoughtful planning and discussions with all family members, including those who wish to remain involved and those who do not.
Sometimes this can, and often does, create tricky family dynamics when not all parties wish to remain involved. It can be trickier still when parties believe mom or dad are playing favorites or leaving more assets to one or more siblings, making it even more important to thoughtfully plan and equalize the distribution of assets in the estate plan if that is the desired result.
How to Successfully Transfer Ownership
If discussions with children elicit no interest in maintaining the business, then sale opportunities can and should be pursued. If the kids are interested, then it is time to execute a succession plan, and there are many strategies that can be utilized to facilitate a plan.
Shares of the business can be gifted now or in the future, outright or in trust. Shares can also be sold to children or to an intentional grantor trust for their benefit in exchange for a promissory note. And a grantor retained annuity trust can be utilized to “give” shares of the business to the next generation.
Be sure all trusts contain dispositive language to transfer and distribute shares of the business not transferred during the owner’s lifetime, and make sure any trusts contain language allowing fiduciaries to manage affairs relating to the business and language matching the tax structure of the business – for example, use S corporation language if the business is an S Corp.
Before any gifting or sale can be executed, a valuation of the business is required. Where there are minority interests or lack of marketability, there is an opportunity to utilize discounts, thereby using less exemption.
Ensure proper liquidity to meet administration expenses and estate tax liability. Estates heavily concentrated with illiquid assets may have difficulty meeting cash needs. Determine how those needs will be met.
Pre- and post-transaction planning is an essential part of the business succession process and should start months and sometimes years before the sale or transfer. Assembling a trusted team of advisors is key to yielding the best results.
Cautionary Tales Everywhere
Over the course of my career, I have met with many business owners who chose to put their heads in the sand rather than plan.
One refused to put a succession plan in place for a successful commercial real estate business even though their health was rapidly declining. Another held on to unprofitable commercial properties too long, refused to sell and had estate planning documents that left the commercial real estate to 20 different individuals.
Both examples are recipes for disaster.
Two things in life – death and taxes – are certain, and if we do not plan for them, we are setting ourselves, our businesses and our loved ones up for failure. Only 30 percent of family businesses survive the transition from first to second generation, so if you do not want to be part of that statistic, you must plan.
Katherine M. Sheehan is a wealth strategist and managing director at Crestwood Advisors, a boutique investment advisory and wealth management firm based in Boston.
