How to Succeed in Succession Planning

According to the Family Firm Institute, only 30 percent of family businesses survive into the second generation, and by the third generation, only 12 percent remain viable.

There are many reasons why family businesses fail, but all too often, they succumb because the owners neglect to plan for an orderly transition from one generation to the next.

Family Businesses are Different

Family businesses face unique succession challenges. Unlike nonfamily businesses, relationships between predecessors and successors continue after the business changes hands, and these relationships can be strained if the transition isn't handled smoothly.

It doesn't help that the older and younger generations often have conflicting interests. Owners may be reluctant to hand over the reins, while their children are anxious to take charge. Family members may even disagree about a successor's readiness for the job.

The parties may also have conflicting financial needs. Owners may depend on the business' value to fund their retirement, while their children hope to minimize any up-front investment. Selling the business to the younger generation creates a source of cash flow for retiring owners, but it can also place a significant burden on the children.

In nonfamily businesses, ownership and management succession often go hand-in-hand. But in family businesses, special considerations may cause them to diverge. For example, a parent may wish to transfer business ownership to their children but also move nonfamily members into key management roles. This can create conflict or resentment.

Succession planning also raises estate-planning issues. It's not unusual for a business to be an owner's largest, most illiquid asset. This can make estate planning a challenge, particularly for children not involved in the business. What if the owner lacks sufficient nonbusiness assets to provide for children who aren't active in the business? Children who have spent years helping grow the business may object to sharing control with inactive siblings.

One solution is to give voting stock to children working in the business and nonvoting stock to others. But children in the business may still resist sharing the equity they helped build. Another solution is to use life insurance to create liquidity to provide for inactive heirs.

Start Planning Early

Each family business is different, so there's no single solution to these issues. But there's one powerful tool that every family business should take advantage of: time. Starting early allows you to make the transition over many years, which can help defuse the tensions and emotions associated with succession-planning decisions. It also enables you to relinquish control gradually over time, which can make it easier to "let go."

A gradual transition allows family members to have an open, honest discussion about their goals and concerns, and gives owners time to educate family members on the reasoning behind their decisions. It also provides time for successors to gain the training and experience they need to be successful.

Some owners have their children rotate among various departments to learn all aspects of the company's operations. Some even require their children to work for another company in the industry before returning to the family business fold.

Starting early also facilitates an orderly sale of the business to the next generation. A sale provides outgoing owners with a source of liquid assets for retirement and estate planning. It also helps the younger generation feel that they've earned their place in the business rather than received it on a silver platter.

Spreading the payments over several years eases the burden on new owners and improves the chances of funding the purchase with cash flows from the business. In addition, so long as the sale is for fair market value and its terms are comparable to arm's length transactions, the transaction will not trigger gift taxes.

If you prefer to hand down the business by gift or bequest, however, starting early gives you time to implement tax-efficient business structures and transfer techniques.

get professional help

For a family business, succession planning is closely intertwined with retirement planning, estate planning, tax planning, and wealth management. To improve your chances of success, you should work with a team of advisors, including an accountant, an attorney, an investment advisor, and possibly a banker and insurance agent.

Not only can qualified, independent advisors help you with the technical aspects of succession planning, but they can also provide an objective voice on difficult emotional issues.

Chris Morse is a principal for Rehmann and is located in the Traverse City office. His experience includes providing accounting, tax, financial planning and business consulting services to family-owned and closely held businesses, their shareholders and officers, as well as publicly held companies.