Passing a Family Business to the Next Generation

For many business owners, the family business is far more than a source of income. It reflects years of work, investment, business relationships, goodwill, and professional knowledge accumulated over time. When a business owner plans for retirement, it becomes necessary to consider how to transfer the business to the next generation in an orderly manner, without harming the business operations, the family fabric, or the tax planning.

 The Intergenerational Transfer of a family business to the next generation is a complex process. It involves business, family, legal, and tax aspects. Early planning makes it possible to examine alternatives, reduce disputes, preserve the stability of the business, and improve the chances of successful intergenerational continuity.

Family businesses play a significant role in economic activity in Israel and worldwide. Experience shows that not every family business succeeds in passing successfully from one generation to the next. For this reason, an intergenerational transfer should not be treated as a technical act of transferring shares only, but rather as a broader process that should be planned in advance. Many business owners begin addressing the transfer of the business only shortly before retirement. In many cases, this is a relatively late stage. When the process starts early, it is possible to prepare the next generation, review the ownership structure, arrange the legal documents, and plan the transfer gradually.

Early planning also has economic significance. In Israel, corporate tax is 23%. Capital gains tax for an individual is generally 25%, and in certain cases, for example in the case of a substantial shareholder, the tax rate may generally reach 30%. Therefore, even a difference of a few percentage points in the transfer structure may have a real financial impact.

The First Stage in an Intergenerational Transfer

An intergenerational transfer does not begin only with a lawyer or accountant. First, it is necessary to examine whether the business itself is ready for the transition.

It is advisable to review several basic questions:

• Is one of the children interested in joining the business
• Has that child gained suitable managerial or professional experience
• Are the customers, employees, and suppliers familiar with that child
• Is there management that can function without full dependence on the founder

If all decisions in the business pass through one person, even an orderly legal transfer will not always be sufficient. It is therefore important to transfer knowledge, delegate authority, integrate the next generation into management, and build an operating mechanism that will allow the business to continue functioning steadily.

The Planning Stage in Transferring a Family Business – Decisions That Will Affect the Family for Years to Come

Once the business and the next generation begin to be ready, the planning stage begins. This is the stage at which the family members and advisers make decisions that will affect the transfer structure, the tax aspects, and the way the business will be managed going forward.

Beyond the business and legal planning, this is also a family process. Questions of control, fairness, status among siblings, compensation for children who work in the business, and family members’ expectations may create difficulties. Clear communication and orderly planning are therefore an essential part of the process.

• Should the business be transferred as a gift or sold to the children?

The manner in which the shares or rights in the business are transferred may affect tax aspects, the cost basis of the assets or shares in the hands of the next generation, and future options. Sometimes a transfer for no consideration will suit the family’s objectives. In other cases, an intrafamily sale, on appropriate terms, may produce a better result. It is therefore not enough to examine the tax payable at the time of the transfer. It is also important to consider what will happen if, in the future, the children wish to sell the business, bring in a partner, or change the ownership structure.

• Is it better to transfer everything at once or gradually?

Even after choosing the transfer mechanism, it is necessary to decide whether to implement it all at once or over several years.

A gradual transfer allows the next generation to enter the role step by step. This makes it possible to assign responsibility, examine actual performance, and make adjustments as needed. For many families, this is a solution that reduces risk and makes the transition easier. The timing and spread of the transfer may also have tax and legal implications. It is therefore important to examine each case according to the business structure, the family composition, and the long-term objectives.

• Is the company’s structure suitable for an intergenerational transfer of a family business?

Businesses change over the years – new activities are added, additional companies are established, real estate assets are acquired, or activity outside Israel is created. Nevertheless, many business owners continue operating under the same legal structure for many years.

Before an intergenerational transfer, it is important to examine whether the existing structure is still suitable. It may be advisable to separate real estate assets from the ongoing business activity. It may also be advisable to consider a holding company, a change in the ownership structure, or other adjustments.

• Is equal distribution among the children always the right solution?

One of the most sensitive issues is the division of ownership. In many cases, not all children are involved in the business to the same extent. Sometimes one child leads the activity, others work on a part-time basis, and another child is not interested in taking part in management. In such a situation, an equal distribution of shares will not always serve the best interests of the business or the family. It may create disputes, difficulties in decision-making, and a gap between the person who actually manages the business and those who hold equal rights.

It is therefore advisable to consider tailored solutions, such as:

• Distinguishing between management rights and economic rights
• Different allocation of shares and other family assets
• Establishing decision-making mechanisms and arrangements among shareholders

The percentage of ownership also matters. A person who holds, directly or indirectly, at least 10% of the rights may be considered a substantial shareholder for tax purposes. This classification may affect, among other things, the tax rate that will apply upon a dividend distribution or a future realization of the shares.

Intergenerational Transfer of a Family Business with International Activity

When the business has connections to other countries, the planning becomes more complex. This is true where there is a foreign company, a subsidiary, real estate outside Israel, or family members who are tax residents in other countries.

In such situations, it is not enough to examine Israeli law alone. It is also necessary to review the tax laws of the relevant countries, double tax treaties, residency rules, and sometimes issues relating to trusts, control and management, or inheritance taxes in certain countries. An action that appears appropriate in Israel may create a different outcome in another country. Therefore, when transferring a family company to the next generation where international activity is involved, it is important to conduct a broad and coordinated review.

How to Align a Will, Articles of Association, and Shareholders’ Agreement in the Transfer of a Family Business

Even when the family has decided on the transfer structure, the work is still not complete. It is important to ensure that all legal documents work together.

In practice, it often turns out that the will provides one mechanism, the shareholders’ agreement provides another, and the company’s articles of association have not been updated to reflect changes that have occurred over the years. These contradictions sometimes come to light only when the transfer needs to be implemented, at which point correcting them becomes more complex.

It is therefore important to review and align the following:

• The will
• The company’s articles of association
• The shareholders’ agreement
• The actual ownership structure
• Relevant family understandings
• Trust documents, if available

In many families, it is also advisable to consider preparing a family charter or a principles document that will help regulate expectations, roles, decision-making mechanisms, and the course of action in the event of a dispute.

Comparison of Possible Transfer Methods