True story: After having a family grocery business professionally valuated, a semi-retired father gave his shares of the business outright to the child who showed the most aptitude for—and interest in—running the store. His other children received other assets. “The key to the success [of this succession] was the recognition that from a business perspective, only one of the children was an appropriate owner,” says Deborah Taylor, financial analyst and wealth management specialist with Legg Mason, Lake Mary, Fla., who helped coordinate the succession.

Another true story: The child of a retired jeweler mismanaged the business so badly that the parent stepped in and ordered the child out of the store. “I don’t think that parent ever got his money out of that store for retirement,” says Bobby Wilkerson, president of Wilkerson & Associates, Stuttgart, Ark., a liquidation planning company that helps jewelers streamline inventory before retirement and sales of stores.

Poor succession planning can lead not only to an impoverished retirement for the former owner but also to a store’s demise. A Michigan jeweler recounts the story of a family who didn’t have a succession plan in place when the owner-parent suddenly died. The remaining family members had to sell all their assets just to pay the estate taxes.

But a jeweler from Wisconsin benefited from an effective succession plan. John Hayes, the owner of Goodman’s Jewelers in Madison, Wis., bought the store from his employers of 17 years, two brothers with no children. Guidelines for the sale established by the brothers ensured that everyday business “maintained the status quo,” says Hayes. “There was really no big hoopla about me buying the business,” he says. For the benefit of shoppers, appearances (including reduced work schedules for the brothers) and community involvement (including donations and assistance to the University of Wisconsin Athletic Department) remained the same. “I gained from [the brothers’] wealth of experience and advice, and the guidelines they set for this succession meant it would be seamless,” notes Hayes.

Tips for Parents

• Rule No. 1: Plan early. Eileen Eichhorn, owner of Eichhorn Jewelry, Decatur, Ind., understands the importance of early planning. On Oct. 31, 2002, she purchased the last of her father’s stock from a trust established in 1989. Eichhorn now owns 100% of the business and has begun succession planning for the next generation: “I already have a 25-year buyout in place with my 24-year-old nephew,” she says. “By age 75, I’d like to be devoid of stock.”

• Ask your children what they want. Once they get a taste of the business under your tutelage, they’ll know if it’s right for them—or not. “Just because it has always been assumed that the business will stay within the family doesn’t mean that it’s the right strategy,” observes Taylor.

• Be sure your child has worked in someone else’s store for a period of time before settling into yours. “There are some messages heard best from a third party and not a parent,” advises Brian Whitlock, JD, LLM, CPA, and partner in charge of wealth transfer services for Blackman Kallick Bartelstein LLP in Chicago. Working for strangers puts a person on his best behavior, he says, whereas working for parents means he’s a child first and an employee second.
  Working for others also provides a diverse perspective. “If the child has worked only for you, then all he knows is what you’ve taught him,” says Whitlock. “But if he works for someone else, he learns different merchandising skills, and his knowledge will be of greater value to you.”

• Delegate your responsibilities early so the store can function independent of you. Training others in your areas of expertise gives your work schedule flexibility, strengthens the store overall, and helps to groom your successor. “This helps kids appreciate the responsibilities and burdens of running a business, so that maybe they won’t begrudge what others get [in terms of assets],” says Whitlock.
  Though not directly involved in his family’s well-orchestrated succession plan, Stephen Alie, owner of A.E. Alie & Sons Inc., Portsmouth, N.H., knows firsthand the value of this advice. “The second generation [in our store] was constantly delegating new duties and taking on new responsibilities,” he recalls.
  One way to handle delegation is to create a family council. Any potential successors (not just blood relations) can participate, and the meeting agenda typically revolves around minimum criteria for employees, store vision and mission statement, and the role of stakeholders.

• Communicate with all of your children during succession planning. Tell children who aren’t joining the business about your decisions concerning division of property and assets—and why you think those decisions are fair. “You’ll never satisfy everybody, but at least you can communicate that you gave it thought,” says Whitlock. This move may help prevent family squabbles—sparked by resentment over perceived unfair treatment—after parents die.

• Stay involved during the transition period. This signals to customers that operations are normal. Randy Wimmer, owner of Wimmer’s Jewelers, Fargo, N.D., recalls the transition engineered by his parents—the former store owners—over a period of five years. “My parents didn’t really work that much over that period,” he says. “They just needed the feeling of comfort that we [Wimmer and his brother] were running the store satisfactorily.”

Advice for Generation Next

• Respect parents’ or owners’ lifelong dedication to the business by making the transition a comfortable one. Assure the sellers you’ll give the business the same loving care they did. “I stay in touch with the previous owners regularly to let them know how things are and to remind them that they made the right decision to let me continue their name in the community,” says Hayes. Another jeweler, who purchased his business from an uncle, agrees with that advice. “His terms were reasonable,” says Gilbert Davidson Jr., owner of Klar Brothers Jewelers, Muskogee, Okla. “He set up the terms to be beneficial to me and acceptable to him.”

• Clearly define the “transition period” and draft a contract citing its length and terms so controversies can be avoided. Parents’ plans can be unclear during this time because it’s “uncharted territory,” says Tom Hubler, president of Hubler Family Business Consultants, Minneapolis, Minn. “Kids become impatient for leadership responsibilities when parents are reluctant to change 30 or 40 years of habits. But they have to change when the job description changes.”

• Understand the cash flow requirements of the business regarding vendors, advertising, rent, purchases, inventory management, and payroll. Review the books with an accountant. “Children need an education in the return on investment based on what the parents expect from the sale,” observes Amy Bauman, marketing expert for Wilkerson’s.

• Understand aging parents’ need for financial security. As parents grow older, they often begin to feel vulnerable. “If they suffer a serious illness, it will drain their financial assets—and the ability to replace those assets will be limited by time and health,” Whitlock says. “If parents can retain an element of control, that eliminates their fear of running out of money.”

• Work with professionals—accountants, financial planners, lawyers, and others—who are experienced in succession planning. Jewelers who have undergone successions agree that working with professionals is key to reaching a mutually beneficial agreement. David Coll, owner of Montclair Jewelers, Oakland, Calif., was able to buy his father’s store in such a way that his dad wasn’t heavily taxed and Coll had ample time to pay off the business. Hayes even sought out non-traditional succession experts, calling on the business department of the nearby university for help in drafting his bank loan application.

Before the Sale

• Beware of old inventory. “The longer jewelers keep inventory, the more money they lose in the long run because it’s less desirable to the public and the recovery is less,” says Harry Stubbert, president of Optum Recovery Group, San Marcos, Calif. He urges storeowners to keep merchandise moving. After jewelry has been in the store for eight months, he says, “jewelers should be developing a plan to get rid of it, not banking it in the store and thinking it’s their retirement.”

• Remove all assets from the business prior to sale. This can be accomplished by hosting a jewelry retirement sale in your store. In this way, “the child assumes the business with minimal debt, and the parents have the majority of the assets out of the business to add to retirement accounts,” says Wilkerson. Some jewelers, too, see the wisdom in this advice: “Inventory gives me no deduction [for tax purposes],” notes Coll.

• Parents should buy life insurance to help defray the costs of estate taxes. “Life insurance provides an immediate death benefit that is generally received income-tax-free at the precise time it is needed,” says Donna Phelan, G.G., MBA, FA, a financial advisor with Prudential Securities, Rolling Hills, Calif. “Policy cash value, if any, may be available to provide some of the funds necessary to purchase an owner’s interest at retirement or withdrawal.”
  A jeweler in Southfield, Mich., got an immediate personal benefit from his life insurance policy: peace of mind. Lew Silver, owner of Lew Silver Diamond Broker, is now worry free knowing that in addition to a well-drafted succession plan, a life insurance policy is in place to assist his wife and children with estate taxes after his death. “Everything [and everyone] is taken care of, and nothing is in limbo,” he says.

• Incorporate the store. Many jewelers and succession experts recommend abandoning the sole proprietorship or partnership classification in favor of a limited liability company (LLC) or an S or C corporation. “Corporations help you make a budget for yourself and the business,” says Fred Couch Jr., owner of Couch’s Jewelers, Anniston, Ala. Other benefits of LLCs and corporations include tax savings and safeguarding the assets of the owner or owners against creditors. Sellers typically can limit their tax exposure more as an LLC than as a C corporation.

• Establish a buy-sell agreement. This is a contractual obligation created by the company or co-owners to purchase a departing or deceased owner’s share of the business. Benefits include setting a valuation formula on the business for estate tax purposes and predetermining who will run the business after the owner’s death. (See “The One Contract Every Jeweler Should Have,” JCK , June 2002, page 92.)

Ways to Conduct the Sale

• Create a non-qualified deferred compensation plan—a private pension plan—as opposed to a qualified plan that’s offered to all employees. This establishes a set lifetime salary for parents in exchange for working through a transition period. “The business takes a moral obligation and reduces it to a legal one,” says Whitlock. Also, when payment is made this way, the parents’ salaries are tax-deductible on the children’s income taxes.

• Establish a Grantor Retained Annuity Trust (GRAT). GRATs involve a transfer of the business to a trust, with the parent retaining an income stream for typically two to 10 years. At the end of the period, the business transfers directly to the successor or successors. For gift tax purposes, an independent valuation is advisable prior to transferring any shares to the successor, according to Joe Oliver III, director of mergers and acquisitions for group corporate finance, Davenport & Co LLC, Richmond, Va. “The IRS allows a seller to discount the value of the business because of the retained intervening income interest and other factors,” he says. “Make sure to speak with a valuation consultant to learn about currently accepted discount rates.”

• Buy out the company’s shares of stock. This move is typically made over a 10- to 25-year period, as is the case with jewelers like Wimmer and Eichhorn. To do this, however, a store must be structured as a corporation.

• Take out a loan to buy the business outright. The lump sum can be borrowed from a bank, as Hayes did, or from your parents, as was the case with Couch. As with any loan, of course, the child must be creditworthy and competent to handle the repayment schedule.

• Draft a contract. Negotiate your own unique terms, rates, and payment schedule with your parents or other sellers. This is the least formal means of purchasing a business. In later years, if parents want to forgive some debt—as Coll’s did—they can.

• Establish family limited partnerships or LLCs. These offer discounts and unique gifting strategies in exchange for allowing the senior owner to maintain control.

Business Entities Clarified

Issue	C Corp	S Corp	Partnership	Limited Liability Company (LLC)	Sole Proprietor
Source: www.clickandinc.com
Limited liability protection	yes	yes	no	yes	no
Continuity of life for entity	yes	yes, but stock ownership must be monitored	no	no	no
Free transferability of ownership	no	yes or no	no, but business can be sold	yes, with limits on who can own stock	yes, but may be contractually limited by a buy/sell agreement
Certainty of legal and tax outcomes	high	high to moderate	moderate	lowest	high
Double taxation of income	yes	no, unless former C Corp, built-in gains, and other taxes apply	no	no	no
Tax treatment of fringe benefits for owners	good	poor, if own more than 2% of stock	poor	poor	poor
Flexibility to select tax year	yes	limited	limited	limited	limited