How to Transfer Business Ownership to a Family Member

Establishing and operating a successful family business comes with a variety of challenges. Chief among these is striking the right balance between tending to the needs of your family and those of your business. This is especially true when it comes time to consider how the business will continue after you step away from it.

For many business owners, their retirement plan is their business. But whether you’re considering retirement or just looking to free yourself from the constraint of operating a specific business, transferring business ownership of a small family business comes with a separate set of responsibilities. Here’s what you should consider if you’re contemplating transferring your business to a family member or members. (And, of course, you can also use these insights if you’re on the other end of the looking glass and becoming the owner of a family business.)

Plan for the future

The first issue that you should consider when deciding to transfer business ownership to family members is to what degree the business should stay in the family. In many instances, businesses do stay in the family. In fact, two-thirds of U.S. family businesses already have next-generation family members working in the business. The passing of a business from one generation to the next raises questions about how to accomplish that transfer. Too often, this transfer only takes place after the founder is no longer living. At that point, a transition becomes even more challenging.

However, even when giving up a business voluntarily, the accompanying decisions can strain relationships, so having a succession plan in place is a great place to start. For family business owners, estate planning is critical to both the success of your business and, by extension, your family’s income. Therefore, the first step for any business owner should be to create an estate plan that covers the succession details of your business and addresses your family needs.

Selling or transferring your business can be an emotional burden in the best of circumstances. Selling a business to a family member complicates things further. It’s imperative that you engage your family (and other relatives, as necessary) in multiple frank and open conversations about the transfer, as they will be curious about what the sale of your business means for them as well as the business itself.

Remember, transferring a business to a family member will likely involve more than two people; it may be necessary to involve a broader family group to ensure there is understanding and transparency. If handled properly and with the right amount of preparation and diplomacy, it can be both rewarding and successful.

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Value your business

The next step in considering a transfer of your business should be to determine the value of your business. Just as when you would be considering a sale of your business to outsiders, you’ll need to know its value to structure the transaction properly. A valuation will help estimate the current worth of your company as well as identify risks within your business. There are a number of different approaches that can be used to establish the current market value of your business. The three most common valuation techniques include:

1. Asset-based valuation – This simple method considers your assets (anything that can be converted to cash) and liabilities (your debt) and establishes your business value by subtracting your liabilities from your assets. The result is your business value.
2. Cash flow-based valuation –  This popular valuation method establishes your business’s value by using the company’s current and future earnings to determine a valuation. One of the most common types of this method is the discounted cash flow analysis, which uses a discount rate to calculate the value of the business’s future cash flows in today’s dollars. 
3. Market-based valuation – This method estimates a company’s valuation based on recent sale transactions of similar businesses. This approach utilizes ratios or multiples from market transactions of other businesses applied to metrics of your business to determine an estimated valuation.

Consider enlisting the services of an independent valuation professional who can provide you with a full breakdown of your company’s worth through all of the valuation approaches above.

How to structure the transfer

Now that you know who you want the new owners of the company to be and you have an accurate valuation established, what are the next steps of how to transfer ownership of a small family business? It’s important to determine the most advantageous transfer structure for both you and the next-generation owners who may be buying the family business. Things to keep in mind are your income needs in retirement, the current financial situation of the new owners, and the tax implications of the structure you decide on. Here are several structures you can use to transfer ownership of your business:

1. Gift your business. One solution owners may choose is transferring the business as a gift to the next generation. This may trigger the gift tax on the value above the exemption limit, but once a business is no longer part of your estate, any future growth in the company won’t affect you from a tax perspective. You may also be able to continue to draw income from the new owners. The biggest benefit of this approach to the new owners is that it requires no upfront capital to purchase the business.
2. Sell your business outright (with or without financial assistance to the buyer). You could choose to directly sell your business to family members. If they are unable to fund the entire purchase, you could assist them by lending them the required funds in exchange for a promissory note, where the new owner will pay you back over time. These funds could then be used to fund your retirement. The business must be priced at a fair market value. Otherwise, you could incur gift taxes.
3. Partial Sale. This is a viable option for those who want to retain a portion of ownership or assets of the company. You become subject to capital gains taxes from profits on the sale, but you can still maintain ownership of specific assets (such as an office building), which could be leased back to the company.

In addition to the methods above, it may be possible to incorporate other family business buyout strategies, such as the use of various trust structures or utilizing a combination of the structures above (like a partial sale, partial gift transaction) to accomplish your specific goals. However you choose to implement the transfer, be clear about any conditions and the roles the original owner and the new owners will have going forward.

Get professional advice

If you’re a business owner contemplating how to transfer your business to your family, a good place to start is with a licensed attorney who has experience working with family businesses. Every business has its own unique set of qualifiers and characteristics, and the best way to guarantee success and peace of mind is to consult with professional advisors as you begin planning to ensure your business, your family, and you are protected.