Whether you’re hoping to sell a family business or expecting to inherit your parents’ estate soon, it’s important to have a plan in place that empowers you to manage your increased wealth.
Here is some practical guidance, drawn from years of working with high-net-worth clients, to help you navigate the complexities of wealth transition with clarity and foresight.
Q: What happens when you experience a liquidity event, like selling a business?
A: The sale of a family business — or any event that creates an inflow of wealth, often referred to as a liquidity event — can usher in a world of opportunity. At the same time, it adds complexity to your family’s finances and may lead you to reevaluate your goals and plans. And, especially when you’re selling a business, it’s easy to focus so completely on the logistics of the event itself that you can find yourself unprepared for what happens afterward.
While most people wait until after the deal to plan for what comes next, if you start thinking about it afterward, it becomes a much more difficult task.
Q: What are the key areas you should address with your advisor ahead of a liquidity event?
A: With any anticipated major infusion of cash — whether it’s from the sale of a business, an inheritance or a sizable compensation package — the issues you may want to discuss with your advisor well in advance include updating your estate plans, anticipating the potential tax consequences, providing for the ongoing administration of your wealth and preparing your family for your new circumstances. Doing so will put you in a better position to decide on your family’s investment strategy and, more specifically, the allocation of your portfolio among asset classes. To help accommodate this more complex set of needs, you may want to consider establishing a family office.
Q: Why is it important to start preparing early?
A: When you’re preparing to sell a business, there are two tracks to process — planning for the business and planning on the personal side. And often the personal side gets overlooked, but there’s a lot that you can do beforehand.
In fact, you may want to start preparing as many as three to five years in advance, when you’re just beginning to consider the possibility of selling. That will give you a range of options to minimize taxes and allow you to have the systems in place to handle your new wealth. A trusted advisor can assist with those tasks and help you manage the emotional side of selling a business.
Q: What are some key questions to ask your advisor?
A: Before a major liquidity event, you may want to raise these topics with your advisor and legal and/or tax advisor.
- What tax planning strategies can I employ in advance?
- What role can trusts play in my planning?
- How should my investment strategy change?
- Will I need to establish a family office?
- What’s the best way to involve the next generation?
- How can I establish a philanthropic legacy?
- What updates should I consider for my estate plans?
Q: How can you define goals for your new wealth?
A: In advance of any liquidity event, ask yourself, ‘What is the purpose of this new wealth?’ Do you want to spend it on yourself, gift it to your family, give it to charity or something else? For example, consider:
- Do you want to undertake a fresh entrepreneurial or investment project?
- How do you want your new wealth to be structured and managed?
- Will you expand your philanthropic efforts and encourage active involvement from your family, too?
- Do you envision a role for your children or grandchildren as managers of the family wealth?
It’s worth spending some time deliberating on these questions and articulating your answers, preferably in writing. You may be surprised at what you come up with. After a substantial infusion of cash, a person’s goals can become more real to them, and those goals may change.
This is a time to involve your entire family, enlisting them in your planning, sharing your values and mission, and setting them up to be good stewards of this new wealth.
Q: What strategies should you put in place once your goals are clear?
A: Whatever your specific goals turn out to be, you should next move toward a plan, including a thorough review of your estate. Your advisor, along with other experts, can help you identify the right tax strategies for your wealth transfer goals. These can include assessing what trusts you might need, as well as deciding whether to make tax-free gifts to family members and establishing philanthropic vehicles such as donor-advised funds or family foundations.
One strategy you might want to discuss with your advisor and estate professional is a dynasty trust. It’s so named because it’s designed to continue over generations rather than ending when the grantor passes away, as is the case with a family trust. A dynasty trust can help families avoid estate and generation-skipping taxes.
Another planning approach involves transferring shares in the business directly to family members. No matter what strategy you employ, you’ll want to discuss options with your advisor long before any sale.
Bear in mind that the value of a closely held family business can be difficult to determine, and having the business appraised early in the process can help you optimize discounts. Often, that presale value is significantly lower than the eventual sales price, enabling the owner to gift more shares of the business to family members or a trust without reaching the lifetime gift tax exemption.
Q: What is a family office, and should you create one?
A: The sale of a business or any sort of sudden surge of family wealth could leave you with many new and complex responsibilities. If that’s the case, you may want to establish a family office to help manage these new financial needs. A family office can be especially valuable if the sale of your business means losing access to the services employees have been providing for the family, from travel bookings and bill paying to tax preparation and property management.
Your finances may become even more complex in the wake of a liquidity event. A family office can provide unified oversight of the family’s wealth, financial education for younger generations, legacy planning and the structure to prepare heirs for future stewardship of the family’s wealth.
The way your family office is organized, and whether you staff a standalone office or outsource all or some of the functions, will depend on its mission, which could encompass investment and real estate management, tax planning and compliance, bookkeeping and financial reporting, philanthropic grantmaking, trust administration, services to family members and more.
Whatever your ultimate decision, this is another issue to consider well before selling the family business. Historically, most people wait to set up a family office, but they generally find that it’s much more difficult after the sale. It is better to be prepared to invest the sale proceeds and make the most of your windfall.
Editor’s note: Matt McDaniel is a Certified Financial Planner, Senior Vice President, and Private Client Manager at Bank of America Private Bank. The opinions expressed are those of the author.
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