Income to Support Retirement Lifestyle

In many situations involving the transition of business ownership to a family member, the owner is looking for continued income that will support a retirement lifestyle. It is important that the transitioning owner and the new owner discuss the income expectations of the current family business owner before any final transition agreement is made. This will reduce, but may not eliminate, the resentment from the next-generation owner of the business. Long-term acceptance of paying an income to the former owner is more of a problem when the owner is selling versus gifting the business.

Many sell their businesses to family members with a contractual structure providing that the selling family member will receive lifetime consulting income from the business, even if he or she no longer makes much contribution to the business. Zach explained that, 18 years earlier, he had bought the family business from his father at a price that was very attractive to Zach, but with a written contract between the business and his father that called for his father to receive an income for consulting services for as long as he lived stated t. He hat he both loved and respected his 85-year-old father.

Resentment directed at the parent who is still getting the same pay while no longer as active is not limited to transitions of ownership through selling the business to family members. Three years before Donald semi-retired from the company he founded, he met with his son, Bill, and daughter, Riley, to discuss his plans to start gifting to each the maximum amount of ownership in the family business that he could give them annually within the tax-free gift allowance amount. The distribution of profits from the company is based on their percentage of ownership. Donald’s percentage of ownership would decrease each year with the annual gift of ownership in the business to his children and Donald realized that his income from annual profit distributions would decrease unless company profits increased enough to offset his decreased percentage of ownership.

A few years after Donald semi-retired, his annual profit distributions actually increased because the company had tripled in profits. One of the older members of Riley’s TAB board said to Riley, “Did the stock your father gifted to you result in increased distributions to you from increased profits of the business?” Riley acknowledged that her increased percentage of the ownership in the business was already resulting in an increased portion of the annual profit distributions. Riley’s father’s attitude is not unlike many business owners who transition ownership little by little to their children and don’t see any reason for their income to support retirement lifestyle be reduced when they are no longer fully active in the business.

Over 90 percent of family business owners have little or no income diversification, deriving the majority of their income and security from their business. Based on this, it is not surprising that even if they have sold or gifted ownership of a family business, they expect to receive a salary or consulting income from the business. Often this ongoing income from the business is needed to provide them with their desired level of lifestyle.

So Bill started gifting his business to his daughter with an annual gift that has continued over many years. In case his death should happen before all the ownership is gifted to his daughter, Bill’s will provides that his daughter will inherit the remaining amount of ownership he has in the family business.

Under Bill’s agreement with his daughter, Bill is spending a limited amount of time working at the business and is working mostly out of an office in his home. Furthermore, he explained, his income is tax deductible for the business, so it is not really costing the business $100,000 after taxes. Bill proudly told me that since his daughter took over running the company, the business is “earning several times what it did when I was working six days a week running the business” and that his CEO income has increased from the original $100,000 so that it is much more now than it was when he worked full-time. As with the payments for seller financing, the selling or gifting family owner and the new family-member owner need to look at whether or not the business has the capability to generate the desired salary payments or consulting income to the former owner, the compensation desired by the new owner, and enough remaining cash flow to grow.