One of the most challenging aspects of estate planning is devising a plan for the owner of a family owned business. A family owned business is usually the most significant asset of the owner’s estate. The owner and other family members are often very dependent upon the business financially. As the owners age and younger family members become involved (or already are) thought is given as to how the family owned business will pass intact to the next generation. Lack of business succession planning results in the failure of a successful transfer in approximately thirty percent of the cases to the generation beyond the first owners, and failure in approximately fifty percent of cases to the second generation. This article will address the numerous issues to be considered in implementing a business succession plan for the family business owner.
Barriers to Succession Planning
Over the years I have identified barriers to the implementation of a succession plan. First, although the owner may have an emotional need or drive to see that the business is carried successfully to the next generation, they are ‘too busy being successful’ to address the problem. The day to day activities blind-side the owner to taking a longer view of his or her mortality. There is, after all, always tomorrow. Second, family conflicts pervade work and home life as a result of the overlap of business and personal lives. The owner is too paralyzed by these conflicts to address the long term considerations. An owner who thinks ‘Just what I need is more conflict in my life!’ is ripe for procrastination. Third, those unaware of the problem adopt a ‘head in the sand’ approach usually motivated by fear of facing the inevitable. Again, procrastination rules. Fourth, is the inadequate or ‘flawed’ plan. In this area I put people who may have attempted some form of succession planning on their own, or did not follow through with the initial plan. Also in this category are those who have relied upon advice from professionals that are not competent to be giving such advice.
Developing a Succession Plan
Defining the Objectives. As with any other planning the estate planner starts the process by defining the client’s objectives. We begin by exploring the nature of the business, the industry, whether rising or declining, competition, business structure, ownership, financial condition, tax basis, fair market value, written arrangements or agreements, family members involved, key persons to the operation, and the company as a ‘going concern’. Considerations of the owner(s) are typically as follows:
- His or her desire to continue participating in the business in one capacity or another
- Retirement plans
- Financial needs during retirement
- Ability to relinquish partial or full control
- Owners other assets besides the family owned business
- Owners ability to pay transfer costs
- Need for equalization of distributions among family members
Related to the owner’s issues are the owner’s family issues and may involve the following inquiries:
- Do the members of the client’s family participate in the business, if so whom?
- Are there family members not involved in the family business and how should they be benefited?
- Is the family desirous of continuing the business?
- Do other family members have the expertise to continue the business?
- What are the needs of the owner’s spouse?
Finally, the business owners should step back and consider his or her alternatives:
- Should a plan be implemented and carried through to the next generation?
- Should the family work the succession plan, but always be ready to sell to outsiders?
- If the business is ‘dying’ should it be liquidated and is liquidation the best result?
Based upon the answers to these questions and others the estate planner is able to redefine the goals and objectives of the business owner and family members.
Valuation. The next step is to obtain a fair market valuation of the business. This allows the estate planner to determine the estate tax and other ‘transfer’ costs, need for liquidity, buy-sell funding requirements, and the likelihood of sale of the business to outside parties. This latter objective must always be kept in mind as an alternative for the owner of the family business, since even the most meticulously planned succession may not work out.
Ownership and Control. The family owned business is often held and controlled by husband, wife, or both, or a number of siblings. With ownership goes control over compensation, benefits, hiring and firing, management, short and long term business goals. Ownership also allows for the creation and maintenance of a Board of Directors, necessary to the long term health of the organization. Many succession plans involve dividing ownership and control so that the business owner retains control but passes ownership to others.
Management Succession. The family business must be viewed in terms of the way in which management decisions are made. Non-family businesses make decisions according to performance of their employees and reward them accordingly. Those who are unproductive are terminated. The family owned business makes decisions based upon the value of family members as people whether their performance is satisfactory or not. Even if the business owner plans to retire one or more successors must be identified and trained to manage the business. There may also be key persons in the business who are not family members. A concerted effort must be made to groom the appropriate successors to run the business. In some cases short term successors are appointed while long term successors complete the necessary training. The relative strengths and weaknesses of the family members must be carefully considered in determining the management restructuring that must take place. In many cases the owners remain as advisors even into retirement years serving as CEO or as members of the Board of Directors.
Tax Planning. The cash flow consequences of succession planning are crucial to its success. This is an area where the team approach of professionals can really bring value to the process. In the area of estate and gift taxes questions need to be raised regarding life time transfers or transfers at death. Should there be ‘carry over’ basis (gifting) or ‘stepped up’ basis (transfers at death)? What will be the death tax cost to transfer the business and how will finances be arranged to meet the obligations? In the area of income tax planning what will the capital gains be if the entity is sold to outside parties? Are there ways that this gain can be deferred or eliminated perhaps with charitable tax planning? What income will the retiring owners need, and what income levels will successors expect in their new roles?
Team Approach. A strategic business succession plan usually consists of a team of professionals that may or may not consist of the ‘usual’ advisors for the company. It may be necessary to bring in a completely new set of advisors consisting of a succession planning attorney, a CPA, investment advisor, business appraiser, insurance broker, and professional trustee. Some plans do not require all members of the team and other plans even more members. A client must be motivated to implement a succession plan and carry it through. He or she must be willing to pay the cost of the value added by the professionals. The earlier a plan is put in place, the greater likelihood of success. Once a plan is implemented it must be tended periodically, in most cases at least annually.
Summary. In summary, the benefits of succession planning are first and foremost, peace of mind. The owner has clarified his or her objectives and devised a plan that has a reasonable chance of meeting those objectives. In the process family conflicts are often either resolved or minimized. Older family members are free to participate in the business at a level they determine to be comfortable, or they may choose an entirely different lifestyle with little involvement in the family business. The new managing members are now able to influence the family business in a new direction that may prove to be more productive and prosperous. A well designed plan greatly enhances the chances of successfully moving a business from one generation to the next.
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