Retirement Information

All parties involved in succession planning should ask a lot of questions early on. Generally, the most pressing queries involve finances, family relations, and management skills. Following are some questions that the parent-owners should ask themselves about their successors, and that children should ask their parents (and themselves) about the business very early in the planning stage.

Questions the parents/business owners should ask:

Financial. Does the child know how to buy [jewelry] and is he fiscally educated? If not, how can this be accomplished? If the family elects to hire a manager to run the business, are there adequate profits to maintain a steady income for the family? And, in the event of an owner's sudden death and an incomplete store succession, from what assets will the estate settlement costs and taxes be paid? What is the implied value of the business, and have we structured the transfer in a tax-efficient manner? Is the parent/business owner still personally liable for any financial aspects of the business after the transfer?

Family relations. Will one or more family members be active in the business? If so, who will have control? What structures are in place to define authority roles? If not, will all the children be treated the same financially? How will the parents provide for children not involved in the business?

Management skills. Is the child active in the business now? Does the child want to work in the business? Does the child have a passion for the business? Does the child have the skills necessary to run the business, and if not, where can he or she obtain them? How will the child work with the parents and existing employees? What independent ideas for improving the business has the child suggested? Does the child have any industry experience outside of the parents' store?

Questions the children/business heirs should ask:

Financial. What are the successes and failures of the business? Is the cash flow enough to live on while paying debt service to the parents and enlarging the business? What are the cash flow requirements of the business regarding vendors, advertising, rent, purchases, inventory management, and payroll? Should the value of any inventory or store assets be adjusted to market conditions at the time of transfer?

Family relations. Do you want to follow in your parents' footsteps? Will siblings work in the business? If so, who will be in charge and how and where are duties and titles clearly defined? Can you work with siblings? If not, are they satisfied with the non-business inheritance their parents are planning for them? If they're not satisfied with inheritance plans after the parents' death, will they embroil the business in a lawsuit and possibly tie up other assets for the duration of any legal proceedings? What can you do to prevent family upsets and potential legal proceedings resulting from jealousy?

Management skills. Do you need the parent-owner to serve as a liaison to customers and suppliers during the transition period? Do the parents have a written timeline defining how long they want the transition period to last? What are your goals for the business?

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.

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. Storeowners should keep merchandise moving. After jewelry has been in the store for eight months. 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. Some jewelers, too, see the wisdom in this advice: "Inventory gives me no deduction [for tax purposes].
* 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. 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 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.
* 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. 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.

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. Working for strangers puts a person on his best behavior, 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. 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].
Though not directly involved in his family's well-orchestrated succession plan. The second generation was constantly delegating new duties and taking on new responsibilities.
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.

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.