2019 Is Your Year! Transitioning Your Family Business to the Next Generation
By Trip Holmes
2019 is going to be a big year for a lot of us. At Sabre Capital, we’re celebrating our 35th anniversary in August. Since 1984, we’ve been helping family business owners in the middle market with their business planning, from financial consulting to assisting with mergers, acquisitions, and ultimately, their exits.
Conditions, While Still Favorable, Are Worsening
This year should be unprecedented with regard to the number of Baby Boomer business owners, both in small businesses and the middle market, looking to move on to retirement. There are a variety of factors that have converged to make this seller’s market one of the better ones we’ve seen in the modern era, but it can’t last much longer.
Interest rates, which held firm until just a couple of years ago, are finally moving in a consistent rise. The economy, while continuing to add jobs at an impressive rate, is slowing down significantly by other measures. And changes to the tax code via the Tax and Jobs Act, implemented just last year, make certain sale circumstances less strategic and advantageous than others, as with any major reform.
There’s Still Time to Protect Your Legacy, and Do It the Right Way
What many small and middle market business owners don’t realize is that selling your business to your children is usually a better strategy than transferring by gift. A gift can create a very unfavorable tax situation for the children, and a gift may fail to enable an ownership mentality that a buyout would achieve.
In order to avoid gift taxes, you can’t simply say you’re financing the business to the kids at a low interest rate of your making. The IRS publishes what’s called the Applicable Federal Rate, the minimum individuals must charge, based on the term (there’s a short-term, mid-term, and long-term AFR published). The current long-term AFR, for example, is 3.04 percent.
While the AFR is this low, parents can effectively transition the family business to their children at a low interest rate and structure the financing based on a lower valuation (also possible since we’re now leaving our long seller’s market and entering more neutral space). Lower values and lower interest rates can be very empowering for next generation buyers.
In this scenario, which will be available for many Boomer business owners in 2019, the kids buy the business at a lower valuation and at a low interest rate, with a much greater cash flow position enabling them to simply buy out their parents monthly with proceeds from the newly-acquired business. And since they are actually buying the business—albeit on much friendlier terms than with a non-family buyer—they will be more likely to have the ownership mentality required to run the business right and honor the legacy and opportunity bestowed by their parents.
Of course, the buyout terms enable the selling parents to have another revenue stream, in addition to Social Security and other investment income, through several years of retirement.
To keep all of your options on the table, it’s important to plan for succession, as well as your exit, as early as possible. Not all children are cut out for managing a family business. They may lack industry expertise, management savvy, or even a desire to participate. It’s important that you select as your successors the children who have all of these qualities or are keen on developing skills where they have gaps.
It’s also important not to treat your children’s legacy as literally equal. What we mean by this is that if you have two children who are suited to take over and one who is not, you don’t want to transition the business to all three. For that unsuitable child, it’s important to take care of their inheritance and treat them equitably through non-business assets.
Call Us Today to Get Started
Helping family business owners figure out the best ways to protect their legacies and their children is what we do every day at Sabre Capital since 1984. Each business is unique, having been built by unique individuals through their unique circumstances and experiences. It’s important to have an understanding of this dynamic, as well as the fact that there are a variety of financial, tax, and risk tools that will guide your decision-making regardless of your situation.
Call us today at 919-847-0099 to start your retirement journey. You deserve it, and there probably won’t be a better time in the foreseeable future to pursue that dream while protecting the dreams of your children.