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Family Business Succession Planning

By Eric J. Pritchard

Here’s an incredible statistic in today’s 1% focused world — family-owned businesses account for somewhere between 80% and 90% of the American economy.  In 27 years of practicing law, I’ve been fortunate to represent a number of family-owned businesses. In my experience, the vast majority of family business owners want to keep their business in the family. At the same time, however, nearly one-third of all family businesses don’t make it to the next generation.  (Family business experts call this the “Rule of Thirds.”)

Family business succession planning is complicated and doesn’t happen on its own. A good family business succession plan is developed and put into action years in advance of the actual transition of the ownership or management of the business. The plan should consider the needs of senior family members and the incoming generation, including those who chose not to work in the family business. The plan should also consider the concerns of non-family managers and other key employees.

There are many ways to transfer ownership of a family business. Some are more efficient and more appropriate than others. Everyone wants to minimize taxes. What’s right for your family will depend on a number of factors, including your family’s priorities and needs. Failing to plan the succession of your family-owned business is the same as planning to fail. Consider the following:

Threshold Issue. Every succession plan must address a threshold issue: Should ownership of the business be transitioned to the next generation or sold to a third-party with the proceeds funding the owner’s retirement and the heirs’ eventual inheritance?  Just because the owners want to leave their business to the next generation doesn’t mean it’s a viable option or even the best option.

Navigate Charged Emotional Issues. Perhaps the most delicate and emotionally charged aspects of dealing with a family-owned business is that family business resides at the crossroads of family and business, two of the most super-charged emotional issues in anyone’s life. As a result, family business owners often focus on other issues not wanting to deal with their retirement or the transition away from the business. (All too familiar to second or third generation family business members.) Letting go isn’t easy for someone who has poured their life’s energy into building a successful business. The family business owner has to decide when and how to step away but they can’t make those decisions in a vacuum. It’s never too early to start the process.

Successful family succession planning takes a team. This means family members, including those not in the business and key business managers. They all have a need to know what is going on and why. Assemble a team of knowledgeable professionals, a lawyer, accountant, financial advisor, valuation expert, even a family systems therapist or professional facilitator. You also may want to consider a family advisory council, which has a similar function to a board of advisors on matters of family and family business.

Select a Successor. This can be the single most difficult and delicate challenge in succession planning. Are you really sure your son or daughter want to take over the reins? Have you actually asked the them if they want to or has it always just been an assumption? A successful successor must be groomed and that takes time, money and effort. Family businesses are often more effective when one person is in charge. Owners must put the designated successor in a position to control the company, which can be tricky with siblings, cousins or other family members involved in the business.

Is the Plan Fair?  Fairness is one of the most delicate issues facing family-owned businesses. If the business employs several family members, who is in charge after transition?  And what about compensation, perhaps the single most emotionally charged issue in family business? Keep in mind that the family succession plan is intertwined with the owner’s estate planning so you must consider how to most appropriately (and fairly) address the interest of family members who, for whatever reason, work outside the family business. If the business is to be sold to family members, the price (and deal structure) must be fair while also passing tax scrutiny. What may be fair in the eyes of family members may not be fair in the eyes of the IRS. Terms of financing must provide the owner and spouse sufficient retirement income and the company must be able to make the payments while having sufficient capital for business purposes.

There are other issues to consider as well. Family succession begins with the first step. It’s never too early to begin the journey.