Successful transition planning: the future of a family business
According to the Family Firm Institute, only 30 percent of family businesses survive into the second generation, and by the third generation, only 12 percent remain viable. There are many reasons family businesses fail, but all too often they succumb because the owners are overwhelmed and “too busy” to deal with the prospect of transitioning their businesses. Therefore they do not do the steps required for effective planning. As a result, the options that once may have been available to them shrink to a few.
Family businesses are different
Family businesses face unique transition challenges because, unlike many non-family businesses, the relationship between predecessors and successors continues after the business changes hands, and these relationships can be strained if the transition isn’t handled smoothly. Completing a successful ownership and leadership transition involves balancing the needs of the lead generation with those of the next generation who will continue to operate the business. The needs of both generations have to be further aligned with keeping the business in good financial health so as not to “kill the golden goose.”
Older and younger generations often have conflicting interests. Owners may be reluctant to hand over the reins, while their children are anxious to take charge. Family members may disagree about a successor’s readiness and fit for the job.
The parties also may have conflicting financial needs. Owners may depend on the business’s value to fund their retirement, while their children hope to minimize any up-front investment.
Selling the business to the younger generation creates a source of cash flow for retiring owners, but it can also place a significant burden on the children. This may be complicated further by multiple owners (including family members who are not active in the business) who may have a different plan than transitioning to selected family members who are active in the business.
In non-family businesses, ownership and management succession often go hand-in-hand. But in family businesses, special considerations may cause them to diverge. For example, a parent may wish to transfer business ownership to their children but also move non-family members into key management or ownership roles. Or a family member who is not qualified may take on responsibilities for which they are not well suited or which does not benefit the organization. This may create conflict or resentment.
Succession planning also raises estate-planning issues. It is not unusual for a business to be an owner’s largest, most illiquid asset (often up to 80-90 percent of an individual’s total assets). This can make estate planning a challenge, particularly for children who are not involved in the business.
What if the owner lacks sufficient non-business assets to provide for children who aren’t active in the business? What communication and “promises” have occurred or have been assumed? In addition, children who have spent years growing the business may object to sharing control or the equity they helped build with inactive siblings.
There are many ways to plan and be “fair” in the transition. One solution is to give voting stock to children working in the business and non-voting stock to others. Another solution is to use life insurance to create liquidity to provide for inactive heirs. A different solution is to provide cash or other non-business property such as a vacation home to a non-business family member.
Start planning early
Each family business is different, so there is not a single solution to these issues. But there is one powerful tool of which every family business should take advantage: time.
Starting early allows owners to make the transition over a period of time, which can help defuse the tensions and emotions associated with succession-planning decisions. It also enables them to relinquish control gradually over time, which can make it easier to “let go” and feel good about the process.
A gradual transition allows family members to have an open, honest discussion about their goals and concerns, and gives owners the time to educate family members on the reasoning behind their decisions. It also provides time for successors to gain the training and experience they need to be successful. In addition, it creates opportunity to build value and efficiency in the operations and leadership of the future entity so when the transition does occur, both the individuals and the organization are prepared.
In preparation for the transition, owners may have their children rotate among departments to learn all aspects of the operations. Some families require children who are interested in working in the business to work for another company in the industry or a similar position before returning to the family business.
Starting to plan early also facilitates an orderly sale or gift of the business to the next generation. A sale provides outgoing owners with a source of liquid assets for retirement and estate planning. It also helps the younger generation feel they’ve earned their place in the business rather than received it “on a silver platter.”
Spreading the payments over several years eases the burden on new owners and improves the chances of funding the purchase with cash flows from the business. In addition, so long as the sale is for fair market value and its terms are comparable to arm’s-length transactions, the transaction will not trigger gift taxes.
If a business owner prefers to hand down the business by gift or bequest, however, starting early gives the owner time to implement tax-efficient business structures and transfer techniques.
Work with professionals
For a family business, succession planning is closely intertwined with retirement planning, estate planning, tax planning, leadership development and wealth management. To improve the chances of success, owners should work with a team of advisors such as a transition specialist, a CPA tax advisor, attorney, investment advisor, banker and insurance agent. Not only can qualified, independent advisors help with the technical aspects of succession planning, but they can also provide an objective voice regarding difficult, emotional issues. Business advisors collaborate with business owners to successfully lead their organization to the next structure of ownership and leadership — and to the next stage of their lives.
Mary Van Skiver, CPA/CEPA/MBA/PHR, is a senior manager at Rehmann and can be reached at Mary.VanSkiver@Rehmann.com or (616) 975-4100.