Family Businesses and Succession Planning

One of the most difficult issues to tackle with a business owner is the succession planning of the business.  The key concept for the business owner to understand is that succession planning takes time to develop (the business did not grow overnight).  Also the business owner must buy into the idea that a team approach with various professionals will be required.

According to a number of U.S. Small Business Administration reports, roughly 90 percent of U.S. businesses are family firms. Yet, only 30 percent of these companies successfully transition from the first to the second generation, and a mere 15 percent survive into the third.

In a recent article from Trust & Estates Magazine Charles A Redd discussed some of the challenges for passing the family business from one generation to the next. He mentioned that succession planning for a closely held business is difficult for two primary reasons: Equity in a family business is unique in that it often has substantial value but limited marketability; and family relationships often make dealing with that asset emotionally charged.
Non-tax matters often equal or exceed tax issues in determining a successful succession plan. So let's consider some key non-tax matters to see how planning might handle them effectively.

Know the Players.  First, the business owner must address several issues relating to the owner's children and their relationships with the family business. The planner will need to know the extent to which the children have the desire and the capability to be involved in the business and the extent to which one or more of them are already involved. It's also important to understand the relationships between the owner and his children; between the owner's spouse and the children; and among the children themselves.

A business succession plan can be derailed if there are hostilities among the children, if one or more of the children have unrealistic expectations, and/or if the owner and the owner's spouse disagree regarding the children's current and future roles in the business. Indeed, if such obstacles exist, the plan may not be initiated, completed or implemented.
During Owner's Life.  If the owner's predisposition is to keep the business in the family, the two issues of greatest importance to him will be: Who will succeed to ownership of equity in the business? Who will assume management and operational responsibilities? The essential characteristics of the succession plan and how it develops depend upon the owner's financial needs and whether, among members of the family, appropriate successor owners and managers exist.
Active vs. Non-Active Children. Many owners intend to transfer their business interests to particular children who will run and/or actively participate in the business's operation after the current owner dies or retires. Those children often already occupy positions of responsibility in the business and are being groomed for their eventual ownership roles. When the business is the largest single asset in the owner's estate and the owner has limited other resources with which to fund his children's inheritances, the owner may need to pass some ownership interests to his other children as well. Conflicts are inevitable between the children who are actively involved in the business's operations (the insiders) and the other children (the outsiders).

Planning Options.  Here are four possible methods for distributing the owner's estate among his active and non-active children:

1. Transfer the business equity to all of the children.
2. Transfer the business equity to the active children and make equalizing transfers of other assets to the inactive children.
3. Transfer business equity to the active children; make compensating transfers of certain assets or pecuniary amounts to the inactive children.
4. Transfer business equity to all of the children; include redemption provisions.

Business planning involves complex and intertwined legal, financial and emotional issues that can be understandably hard for business owners and their families to face. Frequently, the principal challenge for the professional advisors involved is to make the process palatable to their clients. With careful, cooperative planning, a successful transition of the ownership and management of the family business to the next generation can be accomplished.