Organization of Transfers of Small and Medium-Sized Enterprises Within the Family: Tax Law Considerations

Abstract

The succession process of small to medium enterprises (SMEs) creates lifelong dilem‐ mas for entrepreneurs. Who would like to be reminded of his or her imminent mortality by the children's claim on the family company? One way to enhance the value of an enterprise is to ensure that family ownership remains, since this will preserve idiosyncratic knowledge. However, there are several important considerations of a transaction‐cost character that hamper the transfer of ownership of the firm. Especially, considerations of tax consequences can make it very complicated to plan a transfer of the ownership of a SME during the lifetime of the owner. Sweden serves as an interesting illustration of the implications of different tax laws on the choice of succession arrangement since it recently decided to abolish the gift and inheritance tax starting January 1, 2005. This article reports on the tax‐induced contractual difficulties. These difficulties are compared with the relatively less complicated situation that occurs when a country such as Sweden abolishes taxes on inheritance and gifts. Case vignettes are used to illustrate the legal dimension of transfer of ownership. A number of recommendations are provided for how to enhance the family succession process of SMEs. A case study supports these findings.

Intergenerational ownership succession

“…One of the few exceptions is Gersick et al (1997), who depict the lifecycle of ownership succession as evolving from a controlling owner (first generation) to a sibling partnership (second generation) to a cousin consortium (third generation). Bjuggren and Sund (2005) differentiate among several stages of an ownership succession, including initiation, planning, carry-through and follow up. Lambrecht and Lievens (2008) contribute by elaborating on how the 'pruning of the family tree' is a form of ownership succession that in later stages, can move the business back into simpler forms when, for example, one branch of the family takes over.…”

“…3. Enhancing the possibility of running the business after ownership succession by avoiding financial constraints, such as those related to excessive taxes (Bjuggren & Sund, 2005). 4.…”

“…Management succession will not typically have tax implications, whereas ownership succession may be subject to gift tax and/or capital gains tax provisions. Thus, the tax authorities may be interested in ownership succession as a non-close stakeholder but can be expected to ignore management succession (Bjuggren & Sund, 2005). 4.…”

Impact of founder experience on exit intentions

“…This exit strategy is often desirable because it can enhance the value of the firm by preserving idiosyncratic knowledge held by family members (Bjuggren and Sund 2005). While not without risk (i.e., few firms make it into the third generation), family succession may be desirable because it allows the exiting entrepreneur to capture financial value and to remain engaged in the firm as the family ties remain.…”

Inter vivos transfers of ownership in family firms

“…There are substantial transaction costs associated with transferring ownership of a family firm (Bjuggren and Sund 2005). Rates of ownership transfers are likely to be sensitive to changes in estate, gift and inheritance taxes, such as the 2004 abolition of transfer taxes in Sweden.…”