During a recent meeting, the topic of business succession planning was brought up by one of my colleagues. He mentioned that he recently oversaw the transition of a family business from the third generation of a family to the fourth generation. Given the poor odds that a business will successfully transition from the first generation to a second, I found this to be very impressive.
65% of family businesses fail to survive the transition from the first generation to the second and 90% fail to survive the transition from the second to the third. Fortunately, family businesses can increase their odds significantly by preparing a comprehensive succession plan. A succession plan lays out how the business will be owned and operated once the senior family member or members leave the business.
There are several key questions that a succession plan must answer. Among them:
1) Who will own the business?-One of the primary goals of succession planning is to preserve a family business within the family and not require a sale to outsiders. Beyond this, the original owner must decide if all family members will own the company or only certain family members who are involved in the business will become owners. Each choice has its own set of problems and challenges that must be addressed.
2) How will the business be owned?-If the original owner decides to transfer the business to a large group of new owners, they may wish to consider using a trust or another entity such as an LLC to own the business interests. This can provide both tax and asset protection benefits to the new owners and also allow the current owners to ease the owners into their new responsibilities.
3) Who will manage the business?-In many family businesses, the original owner will have controlled the business completely for many years and may be hesitant to name a successor. Nevertheless, picking a proper successor and training them before they take over the business are essential parts of administering a successful succession plan.
4) How will conflicts be handled? –When a single person controls a business, having a conflict policy is unnecessary. Once the ownership and management expand, a conflict policy allows both the original owner and his or her successors to prevent conflicts from growing beyond internal disputes. In businesses without conflict policies, it is not uncommon for disgruntled owners to bring legal action against the business and its owners for failing to protect the interests of the new owners.
5) How will the original owner be compensated for his interests? –It is common for the original owner’s interest in their company to be their primary asset. If the original owner retires or wishes to leave the business, he or she will rely on that interest to pay for their living expenses for the remainder of their lifetime. A succession plan should include a mechanism by which the original owner can be compensated for his or her ownership interests.
Transferring a business to family members is often the goal of the original owner, but in some instances, it is either not desired or not possible. In these situations, the original owner may instead sell the business for either a lump sum payment or a fixed series of payments. In these situations, it is important for the original owner to coordinate where the proceeds of the sale will go and how they will be held. Regardless of how a business is transitioned, it is essential that the business owner coordinate their succession planning with their estate planning to ensure that their assets and family members are properly protected.
A family business lasting four generations is a rarity, but it does not need to be an impossibility. As with all planning, starting early and working consistently with your advisors will yield the best results for you, your family and your business.
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