The transition of a family owned business involves a variety of legal and tax issues. While most business owners plan to avoid taxes and develop creditor protection strategies, business owners also should be focused on preserving family harmony, furthering family values, and ensuring that future generations have the skills needed to be successful. The timing of a plan, establishing goals, and determining values must be incorporated for a plan to be successful.
Goal Setting and Communication
Family discussions about succession planning are difficult. Various issues must be discussed - finances, mortality, children in the business, children not in the business, who will take over in management – and discussing these issues is not easy. Nonetheless, a succession plan has little chance of working if there is a lack of substantive discussion of these important issues.
The first step is for the family business owner to set clear goals and objectives and to establish time frames for achieving them. Among other things, the business owner should establish in writing:
• A set of values that family members are expected to follow
• A set of rules for the hiring, compensation, and promotion of family members
• A policy on distributions from the business and the transfer of ownership interests
• A policy for conflict resolution
The values, goals, and objectives of a succession plan are often set forth in a “family constitution.” The purpose of a family constitution is to consolidate values, goals, and objectives into one document to help guide the family. In addition, the development of the family constitution often is a tool to teach family members the owner’s values and objectives and to ensure that intra-family communication occurs in a productive, respectful, and thoughtful manner.
Timing is Everything
An often repeated phrase used in succession planning is that a business owner “cannot start too early.” Some of the important issues that typically require long-term planning are identifying managers who can succeed the owner and setting rules for the involvement of family members in the business.
The transition of ownership and management of a business are not necessarily the same thing. Succession plans are structured to transfer ownership tax-efficiently between generations of a family. The identity of the managers of the business will change over time and these managers may or may not be family members. The current owner or group of owners must identify the best managers to take over executive level responsibilities and not focus on the family member who will be the best manager. Many situations exist where members of the next generation who are employed in the family business are not best suited to manage the business. It is critical that the best manager – and not the best manager who happens to be a family member – be elevated. Family members may be suited for specific responsibilities, such as finance, sales, or operations, but may not be suited for senior executive positions.
In addition, it is important at an early stage to establish policies relating to the employment of family members and ownership by them. Clear, written rules setting forth what is expected of employed family members and of owners should avoid intra-family conflict and tension with non-family members employed by the business.
Many estate planning techniques involved in succession planning involve the owner divesting himself or herself of assets, such as limited partnership interests or non-voting stock. An important (but often overlooked) part of any succession plan is ensuring that the owner who is transitioning ownership has financial security. The transitioning owner needs to properly compensate other owners and executives, particularly when those individuals are assuming more responsibility. You cannot attract and retain talented individuals without compensating them fairly. However, few business owners are willing to transition ownership if there is an unreasonable risk of financial insecurity as a result. Therefore, it is important that the transitioning owner, in consultation with his or her financial advisors and accountant, maps out income needs and has a financial plan in place. For example, rent paid by the business to the owner can be an important piece to this puzzle. Consideration should also be given to fringe benefits, particularly health insurance. Transferring ownership, if done properly, does not have to result in a loss of financial security.
The “success” of a succession plan will be defined by the goals and objectives established at the outset of planning. As explained above, establishing goals and objectives in a timely manner is the foundation of any successful plan, and whether the goals and objectives are met should determine whether the plan was a success.
No two family businesses are alike. Each family and each family business will have its own set of challenges, goals, and values and therefore each succession plan will take on a life of its own. Nevertheless, a family business succession plan has a better chance of succeeding if the plan is implemented in a timely manner with clear and realistic goals and objectives.