One of the biggest dreams for many small business owners is to pass their business onto their children. With many business owners investing decades into their business, successfully passing down their business to their children is more than a business decision, it is part of a legacy.
It’s important for business owners to do due diligence on the process because it’s one of the largest financial transactions in their lifetime and likely the same for a family member taking on the business.
By educating yourself on the process, you can take a proactive approach and make the transition for your business as seamless as possible. Since the business is going to a family member, it’s important to understand that emotions may come into play that may not otherwise be present with a 3rd party buyer.
The Importance Of Legal Agreements When Passing Down A Business
In the majority of cases where a business is passed down, it’s highly recommended to have legal agreements in place. Although you may think you can pass down a business informally, there can be legal and financial issues that arise for the new owner if they don’t have legal ownership of the business. This can be more complicated if the business is being passed down to several children. It’s best to consult with a lawyer and perhaps a Certified Public Accountant (CPA) to explore how you’re planning to pass the business down and the steps to take.
Issues That Can Arise From Not Having A Legal Agreement
There are several issues that can arise from not having a legal agreement, some of them include:
- You may still be legally responsible for all the operations and liabilities related to your business
- Your heirs may be limited on actions they can take on behalf of the business
- Not making clear to the new owner that you have confidence in them to take over the business
Being aware of these issues now will help you avoid them and facilitate the transfer of your business to your children or other family members.
What Types Of Legal Agreements Do You Need?
A purchase agreement or a transfer of ownership agreement:
You will need an agreement that is a legal contract that states a purchase or the transfer of ownership between you and your children. This agreement will outline they are now responsible for all the assets and liabilities of the business as well as having control over business decisions going forward. This agreement should outline how ownership will be transferred, the value of the business and if and how the business will operate once you are no longer involved in the business.
A living trust (optional):
When passing down businesses to family members, lawyers advise using a trust in some instances. If you decide to use a trust to transfer the business to your child, you will need to have a living trust and appoint the child as the successor of the trust. A living trust comes with a lot of legal benefits that can protect the child in case any legal filings are made against them. It’s very important to consult with your lawyer on how the trust is structured so it can account for instances of illness and death.
While you may have the utmost trust and confidence in a child taking over your business, it is important to set them up for success and have the right agreements and documentation in place. Consulting with an attorney and a CPA can help ensure you are compliant with state and local laws and give your child peace of mind that they can operate the business into the future.