Internal Barriers Threaten Succession

October 25, 2004
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GRAND RAPIDS — Some of the most recognizable companies in the region have retained their family heritage through generations. Benchmark family businesses like Meijer Inc. and Alticor have turned succession into an art form of sorts — an eager and talented second generation assumes day-to-day management duties, while the wealthy patriarch transitions into a life of leisure and philanthropy.

Most family businesses, however, will not be able to make succession look that easy, because a smooth transition will take years of careful planning and consideration.

The key to a successful transition is to plan for it far in advance,” explained Jeff Kane, a tax partner in the Grand Rapids office of BDO Seidman.

“And in doing that, I’ve found that for most businesses, the harder side business and tax type issues are not generally the most difficult decisions to make. The hardest challenges facing family-owned businesses are the softer side issues that so often seem to create problems.”

Agreeing is Mark Harder, a Warner Norcross & Judd partner and chairman of the firm’s Trusts and Estates Group. “The first thing you have to think about are the dynamics of the family.

“At the end of the day, when they all go home, it’s still family. You may talk about the business at the Thanksgiving dinner table, but they are still family and you are going to have to consider that with any good succession plan.”

Some of the worst family-related problems can arise out of an equity issue that may manifest itself in a variety of ways.

Many times, small and even large business owners do not have a great deal of liquid assets. According to Kane, the business will often represent over 90 percent of the family’s net worth. This raises some serious concerns for the retiring generation — how do they finance that retirement?

Likewise, the issue of equity appears when the business is transferred to the next generation.

“Most people say they want their children to be treated equally,” Harder said.

“But often times you will see one child chose to go into the business and have certain opportunities to accumulate wealth that is different from the opportunities available to the other children.”

He said the children that do not opt to continue the family business may find a gratifying career, but that career may not be as lucrative as that of the sibling involved in the business.

He explained that because of a parent’s lack of equity outside of business, the bulk of the family wealth transfers with the business, and there may be little left for the siblings not involved in the enterprise.

One solution is to have the second-generation owner purchase the business, providing the retiring generation financial security and allowing for an equal distribution of the estate.

Other options include dividing the business or allocating other income-producing assets to the siblings not active in the business, such as real estate.

Beyond financial security and inheritance, a succession plan must also take into account balancing family interests against those of shareholders and stakeholders within the company.

Family businesses can have other shareholders with an ownership stake, while even sole proprietorships will have obligations to management, customers, suppliers, employees and the community that will not change with the retirement or passing of the senior generation.

Although the first choice of nearly all family business owners is to have the next generation carry the torch, it cannot be done haphazardly.

“It’s a long-term process; it’s not something you can do overnight,” Harder said.

“The single biggest impediment to transferring a business to the next generation is finding and grooming qualified successors. Is the son or daughter interested in the company? Do they have a passion for it the way mom or dad did? Are they ready to take it over?

“So often,” he added, “when you hear about businesses that are family-held being sold outside of the community, it is because they are having difficulty with finding children interested in and capable of taking over the business.”

While not much can be done to draw an uninterested son or daughter into the business, a great deal can be done to ensure that a child with the desire to take over the business is qualified to do so.

Harder and Kane have both seen clients create structured training programs for family members with leadership potential.

They said many children are told to work outside of the company for a period of time. When they have proved themselves externally, most are rotated through different components of the company to gain a comprehensive knowledge of its operations.

Many companies establish a board of directors to mentor and evaluate the candidate.

“I have one client who put together a plan like this for his son,” Kane said. “I asked him how he thought his son was going to feel when he found out about it, and I remember him saying, ‘I don’t care how he feels about it. This is business.’”

In such situations, a new obligation is tacked onto senior management, to help groom and develop that individual and many times evaluate his or her progress.

If management has reservations about reporting failures to “dad,” a board can take up that burden, providing a dispassionate review and analysis of the candidate’s progress.

Kane added that in companies where an heir appears to be in place, difficulty can arise in attracting talent. Managers may fear being caught between the two generations, or fear being replaced by the family member.

“If someone enters the company knowing this already, it can be a mutually beneficial situation, and everyone should be pretty happy,” Kane said.

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