If no one in your family will take your business over, you may want to consider passing it to directors or employees of your company.
Upside is that the person knows the business well. He has been working in the company for long. The education necessary to take over the business will be relatively mild.
The downside is money. He may not have enough money to buy out the business. Also, if your company has taken loans from banks, you are likely a guarantor of the loans too. The successor director/employee will be required to guarantee the loan instead of retiring you. That will be difficult for him to accept.
As to the money to buy out, if the company is performing well or has enough assets on its balance sheet and the successor seems capable, banks will be able to consider lending you money. Also, there are venture capitals or private funds that will provide you with fund to buy out the shares.
The company can also issues preferred shares without or limited voting rights to you so you will have right to receive dividends while the successor will have shares with voting right to control the company management. If the shares with voting right is only a small portion of the total shares, the money needed for buyout will be limited. According to the tax law, shares with voting right can be the same valuation as those without voting right. Therefore, if the majority of the existing shares are non voting shares, the valuation of the shares with voting right can be limited, based on the proportion.
But you still want to keep more than 1/3 shares that give you a veto, because the new management can issue new shares to dilute your shares and therefore reduce your right to receive dividends.
Points to consider
You should avoid giving shares to your employees for free. There will be gift tax. Gift tax can be higher than capital gain tax that you will have to pay in case you sell it. The gift tax can go up to 55% while the capital gain tax is flat 20.42%. Even if your intention is to give the shares for free, you will want to compare the both scenario carefully. You may be able to reduce the total tax amount paid by you and him by raising his salary for years and letting him buy your shares.
It is easier to get understanding of others such as employees but it is not always easy to find a right person within the family. Also, if the company is a major part of your estate, because the estate law guarantees that 50% of the default split should go to other heirs, the one to take over the business will likely not have 100% of the shares. For example, the default split for his spouse is 50%, and children 50% in total. If you have more than one child, say three children, each children will get 1/6 of your estate (50% * 1/3) by default. You can set a will to change the proportion but your spouse has right to take 1/4 (50% of 1/2) each children 1/12 (50% of 1/6) as minimum guaranteed.
But of course everybody know that it will be easier to run a company if you have bigger control by having more shares.
To solve this problem, there is a new law introduced recently called 承継円滑化法 or Smooth (Business) Succession Law.
By this law, you can choose two major benefits. (1) The first one is where you can exclude the valuation of the company from the computation of the minimum requirement. For example, if your estate in total is 300 million yen and the company valuation is 200 million yen, the minimum guaranteed estate will be based on 100 million (300mm – 200mm).
(2) The second option is you can fix the valuation of the company at the current situation. For example, the today’s valuation of the company is 50 million yen. By the time you pass away, your company valuation will be 500 million yen because your son worked so hard to grow the company bigger and healthier, your total estate is 600 million yen including the company. The minimum guaranteed estate will be based on 100 million yen (600mm – 500mm). This arrangement will not demotivate the person to take over the business and work harder.
We would think that the business succession of SMEs is usually to pass it to his next generation in his family. That is still the majority of the cases but it is not always true. These days, there are more successions to directors or employees who are not from his family or selling to a total third party.
If you would like to leave your business to your heir, you will have to worry about the inheritance tax. You would like to know how to lower the tax.
If you would like to pass it to your employees or directors who have been working in your company, he must know the business and its relations like important suppliers and clients. It will be easier to carry on the day to day operation than heirs who can be new to the business. The typical issue is cash he has. If your company is big enough, the valuation can be easily higher than the amount a normal personal can afford to buy its shares. In typical situation, the person will set up a company and borrow money through the company, with security of the company assets backing the loan. If you have been the guarantor of the company loan, the employee successor has to guarantee the loan to replace you. That can be very difficult for him and you may need to negotiate with banks.
These days, M&A is becoming more common. You will get cash in return and that will probably be the most important advantage. Also, buyers should know that business or they are already in the same business industry. They will benefit from a synergy. There are many private companies that provide M&A consultation and matching service such as Nihon M&A Center or Strike. There is also a public sector service provider such as 事業引継ぎ支援センター. Japanese government is interested in keeping SMEs running and operating.
If you own a business and you want to pass it to your children, you probably want to know how much tax you will have to pay for the transfer. It can be either a capital gain tax (if you take the form of selling), gift tax or inheritance tax.
Forms of succession
Some people just sell shares to her successor at market price. Some people set up a company with very little capital and borrow money from a bank to buy the shares. The successor (who can be her children or her relatives) will own the shares of the new company (holding company). If the existing business is profitable enough, banks will be willing to lend money to the new company.
Some people set up a trust that leaves its voting right to the current owner and gives benefits of dividends to her children etc.
How you maneuver the valuation of the shares
Once you decide when to transfer the shares, you will have some options to lower its share price such as:
- Retirement pay
- Realize losses by writing off non-performing assets
The point is to book as much as losses possible to lower the corporate income to lower the valuation. The valuation depends on its income, dividends, and its net assets (marked to market). I will write it more in details later in this blog.
I would like to provide a free consultation in a brief form as to how much the shares of your company is and how to reduce the cost of the transfer. There should be several options to transfer the ownership.