Business, Too Close To Home

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Along with a strategy, those passing on businesses need to follow an organized plan. They should seek advice from an estate-planning attorney and a financial planner who are experienced in working with family-owned small businesses. Experts say each family has to evaluate which method of succession is best for its particular needs and for its type of business. A trusted board of directors, of whom half are family members, should assist in the succession plan. "Too many entrepreneurs work in the business, not on the business," says Eddy. "This is where an impartial board can help with a strategy that's based on logic and sense and not emotion."

It's very important to know how much the business is actually worth. A good appraisal should take into account about five years' worth of financial statements, public comparables and the performance of competitors, says John Connell, an accountant with the financial-planning and valuation firm Causey Demgen & Moore in Denver. An appraisal can cost anywhere from $5,000 to $15,000 and take anywhere from two weeks to two months to complete. "Given the competition and your particular market niche, you want to know that there is really a viable business to pass on before it's too late," Connell says.

The older generation also has a responsibility to look out for itself, if for no other reason than to avoid becoming an unexpected burden later. Entrepreneurs should determine how much they will need for retirement, after taxes and adjusted for inflation, and make sure they have the funds. "You don't want Mom and Dad to have to come back to work at age 80 because they need the money," says Drew Mendoza, president of the Family Business Consulting Group in Marietta, Ga. There are any number of ways to ensure continuing income. Parents can receive compensation as advisers or consultants, with a set salary or retainer, notes Diahann Lassus, co-owner of Lassus Wherley & Associates, a New Providence, N.J., financial-planning firm. Or parents can lease the site of the business to the children and get a rent check, Messervey says. In some cases, children may choose to give their parents a share of profits or an annuity.

Business owners can also enhance their financial security by making sure they do not sink all their assets back into the business. "You do want to have a varied financial mixed portfolio that includes items like stocks, IRAs, T-bills and the like," says Tom Zanecchia, president and founder of Wealth Management Consultants, a Denver firm. "If the business should sour with the next generation and you're planning to live off only those proceeds, you may run into some hard times."

Probably the best way to lower the tax burden of succession is by gifting shares of stock over a period of years to the next generation. If the business is going to remain in the family and has a sizable worth, gifting should be done over as long a time as possible, Messervey says. A maximum of $10,000 in stock may be passed down annually to each child by an individual. Currently there is a lifetime exemption of $675,000 for tax-free gifts. Any offspring who is not going to be involved in the business can still receive a minority interest and nonvoting stock--or, upon the parents' death, can be given other assets, such as homes, iras, stocks and life insurance. Another option is to sell the business through a promissory note, payable over a specified number of years.

Many family businesses are passed down through a combination of promissory notes and gifting. This worked best for Karen Caplan, 44, president and CEO of Frieda's, a Los Alamitos, Calif., marketer and distributor of exotic fruits with more than $30 million in sales last year. Caplan and her sister Jackie Caplan Wiggins, 42, who is vice president, bought the 38-year-old business from their parents in 1990. Almost half the transfer was paid with a 10-year note, and the rest came through a one-time gifting of $600,000 from each parent after a company valuation. Karen Caplan, who has been working in the business since high school, has 55% ownership, and her sister has the rest. "We got a great deal, and we knew our parents would be well taken care of this way," says Caplan, whose 77-year-old mother still holds the title of chairwoman and comes to the business five days a week.

In other cases, partnership agreements can be drawn up between family members. That was how Bruce Carlow, 54, took over Trio Hardware, a store his father Bernie started in 1963 in Plainview, N.Y. With 15 full- and part-time employees, Trio Hardware currently generates $1.2 million a year in revenues. The deal prevented the elder Carlow from selling the store out from under his son, by giving Bruce the right of first refusal should a sale be contemplated. In return, Bruce agreed to pay his father $2,500 a month plus 7% interest over a 10-year period and to retain him under the company's health-insurance policy. "My father has been very generous with me, and I know that he will be taken care of," says Carlow, who bought the store in 1990. "I also know that I have some security for myself and my family."