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Business Succession Planning: How to Pass The Torch Without getting Burned
Business succession planning for a family-owned business can be one of the most challenging and stressful tasks a family will ever encounter. Not only are there legal and technical issues to address but the emotional aspect of succession planning is one of the
biggest reasons the older generation fails to properly plan for succession. It is generally well accepted that only about 30% of all family-owned businesses are passed on to the next generation. Failure to properly plan for succession is certainly a contributing factor. While it may be a difficult process, it is an extremely important one because in many cases the family-owned business is a family’s biggest asset and the main source of income for family members. Therefore, failure to plan should not be an acceptable option.
What defines successful business succession planning and why is it so difficult for many families? The planning process consists of several components:
Ownership Succession Planning;
Management Succession Planning; and
PLANNING OWNERSHIP SUCCESSION
Like many types of planning, the answer to who should own the family business in subsequent generations is not one size fits all. Before making that decision there are many questions that need to be asked and answered. In many cases there is no perfect solution especially when there are children both in and out of the business and not enough other assets to spread around if you want to treat all children equally. Some important elements to consider:
Should family members not employed by the business have an ownership interest
Should in-laws have an ownership interest?
Should there be buy-sell agreements in place to provide for a smooth transition in the event of disability, death, divorce, termination of employment or claims by creditors? If the answer is yes, how will they be funded?
If a child is working in the business, should his or her share of the parents’ estate consist primarily of the business or should they be asked if this is what they want? The child may not want to continue working in the business or want his or her entire share of the estate dependent entirely upon the future success of the business.
Does every family member have a right to a job or should there be guidelines directing when a family member can come into the business?
If the older generation wants to equalize among all the children is there sufficient liquidity to accomplish this goal as well as to pay any estate tax and estate settlement costs due at death?
Can the business be divided between operating and non-operating assets? For example,should children working in the business receive the operating assets while those not in the business receive other assets such as the real estate used in the business subject to a long term lease? What is the downside to dividing the assets in this fashion?
Should ownership be transferred by gift during lifetime or at death of the older generation?
Is selling the business the best financial decision for the family?
If a shareholder is to be bought out upon death or disability, is there sufficient liquidity or cash flow to accomplish the buyout?
MANAGEMENT SUCCESSION PLANNING
This phase of succession planning concentrates on who will manage the family- business after the older generation passes the torch to the next generation. This could be a family member or members, a non-family professional manager or a caretaker to manage the business until the younger generation has enough maturity and experience to take over the reins. It may also require planning for the best means to keep key employees at the company after the transition to new management.
In some cases the heir apparent is obvious because one individual has clearly demonstrated he or she is not only capable but the only one interested in taking on the job. However, in other situations even though it may be obvious to some who the next leader should be, some or all of the other siblings may not agree. While there may never be complete consensus, the earlier the decision is made the more time the older generation has to smooth out the transition while still active in the business. Surprising the next generation with a new leader after the death of the founder is a recipe for disaster. It certainly could make for a very uncomfortable gathering around the dinner table.
One of the major obstacles to management succession is the older generation’s unwillingness to relinquish control of the business. Some of the more common reasons they won’t let go are:
The owner built the business and that’s all he or she has done for his or her entire life. They have no other interests;
The business is the major family asset and source of income and they are afraid to give up control and jeopardize that income;
They did not prepare by saving enough money for retirement and, therefore, need to work;
Planning is time consuming and can be divisive;
They cannot make the decision on a successor to run the business so it’s easier to do nothing;
There is no one else capable of running the business - in many cases this is a self-fulfilling prophecy because they won’t let anyone else make decisions; or
They never developed a successor or included him or her in the succession process.
You often hear the phrase, “He is a born leader.” While some people have certain characteristics that make them more likely to be successful leaders, developing leadership skills is still a process. In many cases the next generation of family-owned business leaders has been involved in the business in one capacity or another from an early age. Even when not working in the business it affected his or her childhood.
Some of the steps in the development process include:
Working part-time in the business in different capacities while still in school;
Ideally, having several years of outside work experience to bring in fresh perspectives;
If possible, coming into the business and taking on an existing and necessary job;
On-the-job education regarding the business’ history, strategy and philosophy;
In many situations a natural leader emerges. However, if there are multiple candidates a decision should be made sooner rather than later. The selection can be made by the current leader, a family executive committee or an outside board of directors;
The transition of authority and responsibility to the new leader. In other words turning over the keys to the kingdom to the kids; and then,
Start all over developing the next generation of leaders.
The process of creating a succession plan provides a blue print for the family business to follow and forces them to deal with many of the emotional issues that often lead to no action. The sooner a family begins the more likely it will result in a successful transition to the next generation.