When owners think about preserving the family business for the next generation, they think about estate taxes. You can do a lot to continue the family firm through tax strategies such as annual gifts, family limited partnerships, dynasty trusts, and the like. But tax planning is at most only half the job.
Half of all family business founders expect that two or more offspring will jointly manage the family enterprise. But reality is much different. About 70% of family businesses are sold before reaching the second generation. Only 15% last to the third generation. And 97% of inheritors blame neglect of the founders for problems continuing the business.
Business reasons usually are at the bottom of the list of why family enterprises don’t survive through the generations. Too often the founders have not carefully planned a succession. Lines of authority aren’t clear. Lifelong rivalries and disputes among siblings carry over into the business. There isn’t a clear line between business affairs and family affairs. Some view the business as a welfare program for the family
The list goes on. Whatever the cause, the problems with family business succession can be solved. Here’s a checklist to making the family business survive and succeed.
- You need a comprehensive plan, and you need to start early. The point of the plan is to anticipate the difficulties within your family and business and set up mechanisms ahead of time to deal with the potential problems. Most business successions fail because these issues are avoided until it is too late. Structuring the business for tax savings should be the last concern of this plan. The plan must provide for compensation, division of authority, transfers of ownership, and other key issues.
- Outside advisors are needed. A good family succession counselor will talk with each affected family member separately then lead group meetings at which potential problems are discussed and solutions proposed and hashed out. This expert might be an attorney, CPA, or a specialist in succession planning, and you might need more than one advisor.There are many issues that aren’t always discussed among family members, especially while the parents are alive, that the outside advisors can address. For example, children who don’t work in the business often are resentful of the decisions, priorities, and compensation of those who do. Some of those who don’t work in the business might believe they deserve equal treatment with others who work at the firm. Children might feel entitled to walk through the business and issue orders or make decisions simply because they are family members. Often a family business mixes both business and non-business goals, such as providing income to members regardless of their work load or quality. There also might be troubled family members, and the family has to decide what role they can play in the firm. The advisor should uncover these issues and help create solutions.
- Decision structures must be created and authority established. For example, you might set up a board of non-family members to set compensation and hiring policies for family members. A board of directors that excludes family members who do not work in the business might be created as final authority on business decisions, including distributions of net income. A family advisory council (which could include all family members) might be created to keep the family informed about the business and to get feedback from family members who are not in the business. Whatever structure is settled upon, you do need to establish a governing structure that will deal with potential conflicts and problems.
- Communication is a key. While you are alive and establishing the succession plan, your vision of the company, including its history and philosophy, should be communicated to all family members. You might want to do this in a way that can be referred back to or passed to new family members, such as a videotape or writing.Regular communication about the business also should occur. All family members who own an interest need to know what is happening in the business and why decisions are being made. You don’t want members who don’t work in the business to start rumors or misinformation that eventually build resentments. Monthly or quarterly meetings with two-way communication are important. Non-family members who are important to the business might make presentations at these meetings. For example, the outside CPA or chief financial officer might present the financial situation.
- A successor should be appointed. In some cases, rule-by-committee works. But most often, a business needs one individual who has unquestioned authority to make final decisions. Long-term decisions can be deferred to a committee. But day-to-day operating decisions need a clear final authority. You should decide who this will be and communicate that to everyone.
- Some advisors believe strongly that family members who don’t work in the business should not be owners. They believe a solution might be to split the business. The enterprise might be divisible into two or more separate entities. Or you might spin off the real estate the business occupies and give it to the members who don’t work in the business. They collect rent on the real estate and don’t interfere in the underlying business.
- Each child should have an opportunity to get out. A buy-sell agreement with clear, objective terms needs to be established. Then, if a family member wants to cash out, an independent source or formula will decide the price and terms well ahead of time.
There is no single formula for a successful succession plan. The details depend on the interaction of the members. In some cases, non-working and working family members harmoniously share ownership. In other cases, joint ownership leads to increasing acrimony. The only way to find the best plan is to start early, bring in outside help, and work to avoid potential problems.