Many business owners look forward to the day when their kids take over the family business. It can be the beginning of a lasting legacy for the family. But as retirement nears, those parents will also realize that passing down the business could result in a cash crunch down the road. Jeff Halpern, Business Succession Advisor with TD Wealth, joins Kim Parlee to discuss some ways you can structure the transfer or sale of your business to fund your retirement.
Jeff, the question is, "I own a construction company. My kids want to take over the business, but I planned on selling to fund my retirement. What are my options?"
- Well, Kim, thanks for having me on your show today. There's a number of good options that are available to your listeners. One option is to sell the business to their children and ask the children to repay them through a promissory note that-- it might be repayable over, say, five years. Another option might be to suggest to the children to visit a friendly bank, like TD, and borrow the money to pay them, although the parent may have to guarantee the loan if the children don't have their credit score necessary for that.
- Got it. So first one-- again, you can sell your business, get the promissory note paid out over five years, help the kids with cash flow, borrow the money. But let's just say the kids-- that's not an option on either front. Maybe they just don't have any money or access to money-- do either one of those. Are there other ways to structure the transition to make sure this happens well?
- Well, Kim, absolutely. In fact, in most cases, the kids don't have the money or the creditworthiness to borrow the money from a bank. And so most parents have to consider something called an estate freeze, which is a benevolent way for them to sell their business to their children.
- Can you give me a bit of detail, because I've heard the term "estate freeze?" I know there's some complexity to it. But at a high level, what does it mean?
- Absolutely. It's a fairly simple transaction where a parent exchanges their shares, the shares that they typically own when they own the business from the formation, as common shares.
So what they do is they hire a lawyer to create a new class of shares called preferred shares. And what they do is they value the company at the point in time that the estate freeze is done. They exchange their common shares for preferred shares that have a value equal to the value of the business at the time of the estate freeze. And then children can subscribe for new common shares for a nominal value-- maybe $100.
And the common shares that the children subscribe for are entitled to all the future growth. All the current value goes to the preferred shares, which is like an IOU to the parent. And then all the future growth goes for the children, who are the new common shareholder of the business.
- What are the tax implications for the parent who's doing that with the children?
- Well, it's a tax-deferred exchange, meaning that there's no tax consequence at the time that the parent exchanges their common shares for preferred shares. But now they are going to carry in their net worth statement those preferred shares, and they will have a disposition either when those shares are sold or redeemed or when they pass away, when we have the deemed disposition for tax purposes.
- Oh, interesting. One thing I noted when you were talking about-- you talk about having the business valued. You mentioned that in the first thing we talked about in terms of when you sell it, and I'm assuming that's one final consideration-- is to get the business properly valued by somebody neutral.
- Kim, family harmony is extremely important in terms of the outcome of all of this planning. If you have a written valuation, there is no chance or a much smaller chance that the family is going to fight over the value of the business that has been sold. What you want is people to feel that they had a fair outcome from this whole exercise, and a business valuation will help to ensure that.
- Jeff, always a pleasure-- thanks so much.
- Thanks, Kim.
- Jeff Halpern from TD Wealth-- and if you have a question you like to ask MoneyTalk, send an email to firstname.lastname@example.org, "Ask MoneyTalk" in the subject line. Ask us your question. We'll find the right person, and then you can find the answer on moneytalkgo.com.