Matters Column

Keeping the ‘family’ in family-owned business succession

December 11, 2015
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Family-owned businesses are a driving force in the United States’ economy, contributing more than 50 percent of the gross domestic product. It’s easy to name some of the prominent family-owned businesses founded in West Michigan. These businesses provide the founding families with opportunities for gainful employment, leadership, and a sense of pride and freedom.

Studies such as the one conducted in 2014 by the Family Owned Business Institute at the GVSU Seidman College of Business reveal the qualities of family-owned businesses, such as they are less inclined to lay off employees and more likely to have structured philanthropic initiatives.

Despite their worth to the families and value to the communities, surveys show a number of family-owned businesses do not have a business succession plan to ensure the success of the business for future generations. The transition of those businesses are often dictated by external, intervening events, such as the death or disability of a controlling shareholder, family disputes or divorces, and other distributive events.

To maintain the viability of the family-owned business and avoid the pitfalls of a reactive transition approach, we offer some considerations for a business succession plan.

Corporate governance

Many times the succession goal for a family-owned business is simple: to transfer control from the current family shareholders to the next generation. Often this involves the transfer from one or two family members to a larger and more fragmented group of family members, which can complicate the decision-making process. In some circumstances, the younger generation may not be prepared to assume such responsibility.

The formation of a formal board of directors or advisory board may be a useful vehicle to successfully manage the business during the transition to the younger generation. The board can be comprised solely of family members, outside directors and advisors, or a mix of both. It should be tailored to the specific purpose for which it is formed.

For example, if the board is intended to facilitate a family decision-making process, it may be comprised of only family members or include a minority number of independent advisors.

In determining the proper board structure, the following questions should be considered:

  • What is the purpose and function of the board?
  • What authority will the board possess? What company matters will be required to be approved by the board?
  • Who has the right to appoint and remove board members?
  • Is there a clear mechanism to resolve deadlocks or disputes?
  • How often will the board meet?
  • Is the board appropriately compensated and protected from liability risk?
  • The company’s organizational documents and other legal agreements will need to be prepared to implement and support the board structure as intended.

Management

The chief executive of a family-owned business is typically the founder or subsequent family member who has grown up in the business. Key to any business succession plan is identifying the next chief executive. The overwhelming preference is for the next chief executive to be selected from the younger family generation. However, there are cases where no one in the family is willing or equipped for that.

In this case, rather than pushing a family member to assume the role of chief executive and negatively affecting the family, the business and its employees, the family shareholders should seek a candidate outside the family.

Close attention should be made to screen and select the right candidate.

Key considerations for empowering the outside chief executive are ensuring he or she has sufficient authority to obtain the desired results, establishing long-term incentives to align the chief executive’s interest with the family business, and agreeing to appropriate protections for both the chief executive and the family business (i.e., employment agreement, non-compete, etc.).

Ownership

A business succession plan often includes a buyout or transfer of ownership interest in the business to the next generation.

Otherwise, it may be difficult to transfer control and management if the current generation continues to retain a majority of the equity risk/benefit.

There are a number of interconnected factors that need to be addressed in the transfer of ownership interests in the family business, such as estate planning, tax, corporate governance and funding considerations. For example, if the exiting family shareholders already have sufficient wealth and elect to gift ownership interests to the next generation, they will need to determine the best vehicle to effectuate such gifts and the estate-planning implications.

Alternatively, if the ownership interests are to be purchased by the next generation, the family members will need to determine the best structure to effectuate such buyout (driven heavily by tax and funding considerations). The buyout is typically funded by the business’ cash flows or debt secured by the business assets (which adds an element of risk to the viability of the business).

The transfer of a majority of the ownership interests to the younger generation may also affect any corporate governance and/or management structures that have been established, such as a formal or advisory board.

In short, a succession plan involving ownership transfers has a multitude of considerations and moving parts that all must be crafted to work together appropriately.

Sale of the business

For some family-owned businesses, the best succession plan may be to sell to a third party. This is true in circumstances in which the younger generation lacks the requisite leadership capabilities and the family owners are unable to implement a corporate structure that allows for an effective decision-making process.

In these circumstances, selling the business and securing the sale proceeds for the family’s benefit is often better than eroding business value due to ineffective leadership. Selling a business is a complicated process that is best maneuvered with a team of financial, tax and legal experts experienced in these types of transactions.

Family-owned businesses are not only important to the families that own them but also play a vital role in their communities. The goal should be to proactively develop a succession plan rather than allowing the business transition to be dictated by external, intervening events or circumstances.

Developing and implementing a succession plan is an important undertaking that can also be an emotional one. Many times, the ultimate effectiveness of the succession plan relies on open and honest communications and having trusted professionals experienced in structuring and implementing these succession plans.

Dustin J. Daniels is an attorney at Miller Johnson. He can be contacted with questions at danielsd@millerjohnson.com or (616) 831-1737.

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