Accounting Articles > Estate Planning:

Common mistakes made in small business succession and business continuity planning

There are two common mistakes:

1. Experience and ability

   Just because a person is your relative, doesn’t mean that they are in any way capable of guiding, managing and mastering a business. If you want a pet, buy a dog.

   Most second or third generation owners are pretty lousy at what they do. They just don’t have the skills necessary to guide and control a business. Make sure that your heir does have the ability before you consider handing over the reins. Go on a long vacation, a really long one. See what they screw up. See how many times a day they call you. Baptize them by fire, the way that you were brought into the foal. Get out of that business and see if they sink or swim.

   They’re probably not going to do either, but rather something in between. Determine whether or not you think that whatever they did wrong can be corrected. Can they be taught to handle things correctly? Do they have the makings of at least a reasonable leader?

   If they don’t, then you have two alternatives. Hire a professional manager for the business and try to teach your relative to be an absentee owner. Or sell the business.

   Many business do very well in an absentee ownership situation. Controls can be put into place so that this can work over the long haul. If this is impossible, then it would probably be much better for you to sell the business and will your relative the proceeds. If you give them the business, and they are completely incapable of operating it, then they will loose it. What will they have then? Nothing. They will be much better off working for someone else and getting an inheritance then they would be if they lose the business.

   If they are capable and worthy, then go to the next step, and begin the process of succession planning. But please, be objective. If they can’t do it, then don’t put your customers, your suppliers, your employees, and yourself through watching your business go bankrupt. Either find a professional manager, or sell it.

2. Taxes

   If you have a capable heir, then the ever-present issue of taxes will consistently raise its ugly head. The transaction must be arm’s length, or bona fide. You can’t just give your business to your son and expect not to have a taxable situation. The business is worth something. If it is worth more than the annual gift tax exclusion, which is $11,000 this year, then there are going to be either gift or inheritance tax issues.

   The value of the business must be determined by a valuation completed by a valuation professional. That valuation specialist must follow the Internal Revenue Service code in coming up with a fair market value. If you normally could sell your business for $1,000,000, you cannot arbitrarily assign it a value of $200,000, and only pay taxes based upon the lower figure.

   The transaction itself must be bona fide. Consideration for the business must be satisfied. If your heir does not have the money for the business, then you can certainly give it away and face gift or estate taxes. If only a portion of the business is given away in smaller chunks, let’s say less than $11,000 per year, then there is not a taxable situation annually. Or the heir can earn it, via payroll. Let’s say, that a reasonable compensation for the work that they perform for the company is $80,000 per year. If they are paid $40,000 in cash, and the additional $40,000 in stock, as long as they pay the applicable income and payroll taxes on the $80,000, and $80,000 is reasonable compensation for the work that they do, then the transaction would be considered bona fide.

If you make the common mistake of not following the rules, then the IRS can either unravel the transaction or include the business in estate taxes upon your death.