Making the Business Last Generations

What is the key to making a family business last beyond the first generation? If you are a business owner you likely are familiar with the statistics that only a small percentage of businesses last much beyond the first generation, and a tiny percentage make it through the second generation to the third. The fate of the average business does not have to happen to your business with proper estate planning.

To find the key to the survival of a family business, U.S. Trust commissioned a survey of owners of second- and third-generation family businesses in the U.S., Europe, and Asia. While the survey did not have a compelling answer to the question above, it did find a key difference between family-owned firms with higher values than those with lower values.

In the past we have discussed the difference between families that treat the business as a welfare agency and those that run it as a business. In the welfare agency model the family employs any family member who wants a job regardless of qualifications, and salary often is not related to qualifications and the work done.

In the business model, family members are treated largely the same as everyone else. They are hired only for jobs for which they qualify and at market rates. They have to earn their promotions. Family members receive a preference over non-family members. But the family members must be qualified to receive jobs and promotions and must perform to keep their positions and salaries. If a family member needs financial assistance, the parents provide it directly through their personal funds, not by putting them on the payroll.

The U.S. Trust survey found businesses that focus on the firm’s needs are worth more than businesses where decisions are based primarily on the family needs and goals. Another interesting finding was that owners and managers at the business-focused entities were more likely to create and use succession plans.

Succession estateplanning is considered key to a firm’s surviving past the first generation by most advisors. The survey found 76% of the family-owned businesses have plans, but only 38% follow the plans. Among the business-focused firms, 90% have plans and 54% implemented them.

A succession plan has several features. It establishes an estate planning sucession strategy and process for training the next generation to take over the business. Simply shifting ownership of a business is not enough to ensure the business’s survival. The future owners must learn the business and how to make decisions. The plan also sets out how the ownership and wealth will be transferred, how taxes will be minimized, and how any other issues related to the business will be handled.

Among business-focused firms, about 81% of owners say strategic business issues are extremely important in succession, while only 65% of owners of family-focused firms said those issues were extremely important.

Family succession is not always a goal. Some owners believe there are no viable successors in the family. Others believe new ownership is needed to take advantage of expansion opportunities. Many owners simply want to cash out of the business.

Business succession and continuation do not simply happen. They must be carefully planned, and the estate planning strategy must be implemented and adapted to changing circumstances. Otherwise, business survival is left to chance, and the chances of survival beyond the first generation without an estate planning strategy are not good.

May 2009. RW