Jared Pilon
You have been planning for your children to take over your business. If your business is worth five million dollars today, how are your children supposed to buy it from you?
One planning tool we use to solve that problem is an estate freeze. I’ll lay out what it does for you, why we use it, and what you need to consider before bringing the next generation into ownership.
What an Estate Freeze Does
Today, you likely own common shares in your company. As your company has grown, the value tied to your shares has grown with it. You may have paid $100 for your shares years ago. Today, your business might be worth $3 million or more.
An estate freeze takes your business's current value and converts it into shares with a fixed value, typically redeemable preferred shares. Your company then issues new common shares, which might go to you, a holding company, or, in a family succession situation, to your children.
Your preferred shares represent the value you have already created. Your new common shares generally participate in future growth. We have not frozen your business. We have frozen your value in your business.
Why Family Businesses Use a Freeze to Bring in the Next Generation
Go back to the question I started with: if your business is worth five million dollars, how will your child buy it from you? You could sell shares to your child at fair market value, but that creates a taxable disposition for you and a financing obligation for them, which is often repaid out of your business's future salaries, bonuses, or dividends.
An estate freeze offers you another path. Instead of asking the next generation to purchase the value you have already built, it lets them buy in at the value created from this point forward. You freeze your existing value, your company issues new common shares from treasury, and your successor can purchase those new shares for a nominal amount. That preserves cash flow on both sides and lets you watch the next generation become owners while you're still there, including how they make decisions, handle your employees, and manage difficult years.
Value, Growth, and Control Are Three Different Things
Giving your children future growth does not mean giving them control of your company. The two do not have to go hand in hand. Some parents are comfortable handing voting shares to their children once they have been involved for years. Others are not ready to give up control of their business at all, even with significant value on the table.
You can address this directly through your share structure. Voting rights might stay attached to your preferred freeze shares, or you can create a separate class of shares designed to carry voting rights without meaningfully participating in your economic growth. Your economic succession and your control succession do not have to happen on the same day.
Plan for What Could Go Wrong
When you bring your children into ownership, you are not only facing a tax question, but a family one. I have seen situations where circumstances changed, and a family had to remove a child as both shareholder and director. It went smoothly, but it could easily have gone wrong. That's why a unanimous shareholders' agreement often becomes an essential part of your estate freeze. This agreement can include who makes decisions, what happens if someone wants to leave, how your shares are valued, and how a buyout gets funded.
Valuation matters as well. I have been involved in refreezing a structure after the assumptions behind an original valuation proved too optimistic. You don't complete an estate freeze once and file it away because your business, your family, and the tax rules will all keep changing.
An Estate Freeze Is Not the Plan
Completing an estate freeze does not mean you have completed your succession plan. You can have a technically flawless share structure and still have no idea who's running your business in five years. You still need to know who your successor is, whether they can run your company, and what your own life will look like after the transition. Your tax structure should support your succession plan; your succession plan should not be built around your tax structure.
If your company has accumulated value and your children are becoming involved, this is a conversation worth having years before you need the structure, not weeks before you want to transfer your business.
Legacy Accounting LLP helps business owners like you navigate this kind of succession planning, from understanding what an estate freeze accomplishes for you to building the shareholder agreements and tax structure around your business. Schedule a meeting with our knowledgeable accountants at or 403-343-7707 to talk through what a freeze could mean for your business.
Want to hear more about this topic? Check out Legacy: The Business Succession Podcast
Disclaimer
By using this website, blog or podcast, users agree as follows:
The information, services and/or products are for general information only and any reliance on the information provided therein is done at your own risk. If you make tax, accounting, investing or legal decisions after accessing this website, blog or podcast, it is recommended that you consult a qualified professional first.
The views and opinions expressed are those of the author, seller, guests or publisher and do not necessarily reflect the views of the organizations or businesses that these individuals are associated with.
Although we make strong efforts to make sure our information is accurate, we cannot always guarantee that the information on this website, blog or podcast is always correct, complete or up-to-date.
