My mother and I started a small business 10 years ago. We are 65/35 in ownership (I am majority) and my mother is ~5 years away from retirement. I've started thinking about a succession plan and would like to get some feedback on good/bad experiences in regards to this. One option of course is just a buy out of her percentage. Anyone have experience on long term % payouts to family members or founding members? pros/cons other ideas?
This isn't something needing to get done tomorrow and eventually we will get some professional help but just looking for some feedback.

Above is a good start. If you two can agree on a value you can save the time, hassel, and expense of a formal appraisal.

Not sure how you're structured, but be aware the you are related parties, so make sure it doesn't end up looking like a dividend. Review Section 302 of the Internal Revenue Code. Since you would be buying her out completely it shouldn't matter, but once she's out, she needs to stay out.

AggieT said:

---

Above is a good start. If you two can agree on a value you can save the time, hassel, and expense of a formal appraisal.

Not sure how you're structured, but be aware the you are related parties, so make sure it doesn't end up looking like a dividend. Review Section 302 of the Internal Revenue Code. Since you would be buying her out completely it shouldn't matter, but once she's out, she needs to stay out.

---

Yes, get some good estate planning tax advice also... non-taxable giving comes to mind here on her gain and your basis.

Definitely not something I'm too fond of given it's estate tax law but that's where I'd spend money.

An appraisal is going to be very esoteric for a small family business and still may not give you or her what she wants from a value standpoint.

Also try and consider, if necessary depending on your family dynamic, how this rolls into her estate and how that gets redistributed out later... will siblings come after you because you lowballed her and what you paid for 35% is unfair?

MS08 said:

---

Why does her stake need to be bought out or swallowed up just because she's retiring? If she has an active daily//weekly role and is compensated for that in the way of a wage, then replace her so that she can retire and her wage goes away. But, she can still get 35% profit distribution each year. That way She can retire and is now treated like an investor and she gets a passive income dividend every year.

If it is contentious, or she needs a lump sum of money, or she wants her stake to be bought out, those things create a different scenario.

Just peppering some thoughts.

---

I generally have no idea how these things work so want to ask a question around this not really sure how to frame it up.

Let's say I own 65% of the business and give myself a salary of $100k/yr. I have a partner that owns 35% of the business and also makes $100k/yr salary. There's $200k in profit each year. My minority partner retires and instead of hiring someone new I just say I'm going to take on increased workload and increase my salary to $300k/yr. Now there's only $100k in profit available each year. She goes from making $100k + ($200k*35%) per year to only $100k*35%.

Basically the question is as a majority owner how much can you really change things around to minimize the take of a non contributing minority owner? What's stopping me from paying myself $400k/yr salary and having no profit left in the business to distribute?

all depends on structuring.

In an LLC, you technically can't be an employee and an owner, so "salary" is really just distributions.

Typically, distributions need to be pro-rata based on ownership levels unless specifically specified for services provided and denoted in the operating agreement.

S-corps can be different.

AgDrone14 said:

---

MS08 said:

---

Why does her stake need to be bought out or swallowed up just because she's retiring? If she has an active daily//weekly role and is compensated for that in the way of a wage, then replace her so that she can retire and her wage goes away. But, she can still get 35% profit distribution each year. That way She can retire and is now treated like an investor and she gets a passive income dividend every year.

If it is contentious, or she needs a lump sum of money, or she wants her stake to be bought out, those things create a different scenario.

Just peppering some thoughts.

---

I generally have no idea how these things work so want to ask a question around this not really sure how to frame it up.

Let's say I own 65% of the business and give myself a salary of $100k/yr. I have a partner that owns 35% of the business and also makes $100k/yr salary. There's $200k in profit each year. My minority partner retires and instead of hiring someone new I just say I'm going to take on increased workload and increase my salary to $300k/yr. Now there's only $100k in profit available each year. She goes from making $100k + ($200k*35%) per year to only $100k*35%.

Basically the question is as a majority owner how much can you really change things around to minimize the take of a non contributing minority owner? What's stopping me from paying myself $400k/yr salary and having no profit left in the business to distribute?

---

Legal agreements. Written max / fair salary, rules of doing business, etc. Who has voting control as of today? What keeps you from slashing their salary in half and doubling yours today?

"Legal agreements. Written max / fair salary, rules of doing business, etc. Who has voting control as of today? What keeps you from slashing their salary in half and doubling yours today?"

Yes, this stuff, along with the overarching notion of being a good partner, and having reasonably good ethics. Hah. Also, if they are still a percentage owner in the company/business they still have a right to the financials and review of the books. Granted, if they don't have a majority stake they cannot really make decisions, but they can sure put the pressure on and make things uncomfortable. Why create that situation? Just be reasonable.
And, generally, I don't think it's incredibly likely that both "your" job and "their" job prior to their exit can be done as effectively as "you" were doing before and "they" were doing before. Thus, how can one be compensated double when the job performance of each job is probably sipping.

Just spitballing while I watch us in extra innings. All good. Beat Arkansas!

is the business a c corp, s corp, or a partnership?

I guess all the advice big4 firms have been giving private equity groups and how the structure their MIP members and shifted many to guaranteed payments is wrong?

woops. Maybe I should have specified, you can't be a W-2 employee and also be an owner of an LLC, technically.

With an LLC (taxed as a partnership), distributions do not need to be prorata, it is best if they are but there is no requirement that they be. And you are correct, the members should not take W-2 income.

Distributions from an S corporation must be prorata if you want to stay an S corporation.

MS08 said:

---

"Legal agreements. Written max / fair salary, rules of doing business, etc. Who has voting control as of today? What keeps you from slashing their salary in half and doubling yours today?"

Yes, this stuff, along with the overarching notion of being a good partner, and having reasonably good ethics. Hah. Also, if they are still a percentage owner in the company/business they still have a right to the financials and review of the books. Granted, if they don't have a majority stake they cannot really make decisions, but they can sure put the pressure on and make things uncomfortable. Why create that situation? Just be reasonable.
And, generally, I don't think it's incredibly likely that both "your" job and "their" job prior to their exit can be done as effectively as "you" were doing before and "they" were doing before. Thus, how can one be compensated double when the job performance of each job is probably sipping.

Just spitballing while I watch us in extra innings. All good. Beat Arkansas!

---

Thanks I'm just spitballing too as I was curious how things can go as small businesses change hands

another caveat I missed... LLC filing as a partnership which about 99% of the ones I work on are...

and yes, you can do unpro-rata distributions but it has to be denoted in the operating agreement and if it gets out of whack, must be true'd up at some point (usually in a sale).

Either way, from an advice to this guy... distributions need to be tracked very closely (especially if "personal" expenses start getting involved) to make sure everyone's capital accounts are legit.

When you start taking distributions and salaries, make sure you have a good handle on that from the beginning in these partnership type structures as things can get sideways or require amendments to the operating agreement down the road.

What we've done as a family on our 3rd generation of ownership
Set salary to cover health insurance until they're eligible for Medicare
Buyout their share with monthly payments over 10 years
It keeps them from pulling out of retirement or wasting money on insurance for a while and keeps the payments low so the business can survive if times get tough