Pass on Your Legacy to the Next Generation
The importance of the family business to the United States economy continues to grow, and family businesses are beginning to reverse the trend of mega-businesses wiping mom-and-pop stores off the map. Family businesses now account for about half of the U.S. Gross Domestic Product (GDP), a measure of the economic productivity of a country.
Family-owned or family-run companies are responsible for 60 percent of the jobs in America and nearly 80 percent of new jobs created. However, research indicates around only 52 percent of these family businesses expect the next generation can handle the businesses on their own. The leading concern about keeping management in the hands of family members is uncertainty regarding their aptitude and experience.
Growth and Sustainability
Family businesses often have intimate histories and complex cultures that are difficult for outsiders to understand. Today’s families are often more complicated and less traditional due to geographical relocation of family members and alternative economic opportunities available to family members.
Family businesses also have several other issues may hinder the successful continuation of the business. Fortunately, with focus and planning, most of these can be overcome by paying attention to the details.
Five key issues include:
1. Generational transition: Only a third of all family businesses successfully make the transition to the second generation.
2. Alignment of family interests: Alignment of interests between current owners and others becomes more pronounced as members retire and turn over the reins to the new generation, while at the same time looking to the company for their retirement income.
3. Interfamily disputes: While the interest of one family member may not be aligned with another family member, these situations can become even more difficult where there is, for example, a divorce of a family owner or a death and the surviving spouse is holding at least partial ownership, but is not involved in the business.
4. Balancing of financial returns: Creating buyout agreements is challenging. When the retiring generation looks to the value of their interest, they may tend to look to a balance sheet number. However, the true value of a business should probably be based on an earnings capitalization model, a concept unfamiliar to many smaller family companies.
5. Estate and Inheritance issues: These include federal and state estate and inheritance taxes and probate delays upon the death of a family owner.
What to Do? A Five-Step Process
By following five key steps relevant to almost all family businesses, the business can create a viable succession plan, provide for the financial independence of the retiring owner(s) and position the business for continued success and growth:
Step 1: Establish Goals & Objectives
- Review any current succession plan and reasonableness of achieving desired goals.
- Develop a collective vision, goals and objectives for the business.
- Determine the importance of continued family involvement in leadership and ownership of the company, but consider the option to bring in professional management.
- Establish personal retirement goals and cash flow needs of retiring family owners.
- Identify goals of next generation management, both personal and business.
- Identify and retain a team of professional advisors.
Step 2: Establish a Decision-Making Process
- Identify and establish governance processes for involving family members in decision-making.
- Establish a method for dispute resolution if needed.
- Document the succession plan in writing.
- Communicate the succession plan to family/stakeholders.
Step 3: Establish the Succession Plan
- Identify successors – both managers of the company and owners of the business.
- Identify active and non-active roles for all family members.
- Identify required additional support for the successor from family members.
Step 4: Create a Business and Owner Estate Plan
- Address taxation implications to the owner/business upon sale or transfer of ownership, death or divorce.
- Review owner estate planning to minimize taxes and avoid delays in business transfer to remaining owners or spouse.
- Have an attorney draft a will and a revocable family trust agreement to assure that your business goes where you want it to go without excessive taxes or inheritance complexities.
- Create a buy/sell agreement that is fair, reflective of the value of the business and minimizes taxes.
- Consider some form of life insurance to provide funds to your spouse or to the family business in the event of your death.
Step 5: Create a Transition Plan
- Consider options: outright purchase, gift/bequest or a combination of these.
- If the business is to be purchased, consider financing options including financing from an external party or self-financed from the retiring owners on a deferred payout basis.
- Establish a timeline for implementation of the succession plan.
- Consider a partial sale of the business to a private equity firm or other investors to fund your exit from the business.
- Beware of unintentional “tax traps” – for instance, if the business buys your interest and you continue to serve in some capacity, you may inadvertently convert capital gains into ordinary income.
Not every family business will survive and many do fail, primarily because of differing family interests and the ability of the next generation to grow the business. Taking these five steps now will save money and time and will help assure the continued success of your business.
Michael L. Evans is the Managing Director for the Newport LLC