By J. Benedict Hartman, published in the 2016 issue of The Advisor, a publication by Furman University
Family businesses drive the American economy. Forbes reports that 90 percent of all U.S. businesses are family-owned or controlled by a family, and these businesses generate more than half of the Gross National Product. However, of these thriving businesses, less than one-third survives the transition from first to second generation ownership. The reality is that family-run companies are prone to certain pitfalls regarding succession planning, but these can be remedied with proper foresight.
Simply put, a succession plan is a predefined procedure for transferring ownership and management of a business when the owner retires or otherwise ceases to manage the operation. According to Entrepreneur.com, more than half of all small business owners were 50 or older in 2015 — and it’s never too soon to establish plans for a smooth and equitable transition.
The first thing to consider when crafting a succession plan is the transfer of decision-making power. Who will assume the mantle when the current owner leaves? This can be a particularly difficult decision when family is involved. A dialogue with the Board of Directors, or assembling a designated committee on the topic, can help the decision-making process.
Ideally, a suitable family member will be able to take over the duties of running the company. If some, but not all, of the family will be involved in the management of the business, much thought must be given as to how to treat family members in disparate circumstances. It may be, however, that there is no relative with the requisite business savvy to do so, or that potential heirs lack a consistent involvement with the enterprise. If this is the case, a key trusted employee may be an alternative option, but getting levelheaded, outside input can be invaluable before making such an important and emotionally charged decision.
In addition to providing for the company’s future management, a succession plan must deal with the critical issue of the transfer of assets. If the business owner’s wealth primarily consists of an ownership stake in the company, the board may be expected to purchase that ownership from the owner or his or her estate. In such circumstances a buy-sell agreement, in which the board members agree to purchase another member’s ownership share upon the occurrence of a specified event, can be an invaluable document. Thought should be given as to how to fund this purchase.
If, however, the business owner wants to transfer ownership to a family member or other specified individual (whether or not this includes management responsibility), the tax ramifications of the transfer may be dauntingly complex. Consulting an authority in the field may be the best course of action. Gifts and sales should be analyzed with consideration to the tax consequences of each plan. However, it is important not to let tax concerns commandeer one’s decision making — the top consideration in succession planning is ensuring the smooth continuity of operations, and if/when this conflicts with the secondary goal of minimizing tax liabilities, it will be helpful to remember the big picture.
Another important consideration in succession planning is the retention of key employees. A company’s managers and officers can be the most vital component of its continued success, and if a business seems likely to collapse into chaos following a transfer of leadership, these employees may be tempted to seek greener (i.e., more stable) pastures. The knowledge that there is a procedure in place to deal with contingencies can help employees feel more comfortable taking the long view of the company’s future. Of course, there are many other elements of keeping one’s employees happy, but a fully thought-out succession plan that’s been discussed in person with key employees can provide a valuable sense of security.
In addition to the plans described above, it may be a good idea for the company to purchase life insurance on top-level decision makers. The business may insure the life of the owner, or it may take out “key man insurance” on the lives of its top officers, so that if one of the business’s principals should pass, the insurance proceeds can help keep things running smoothly while the company — and family — recover from the loss.
All of these options merit consideration when looking into succession planning for one’s business — particularly one that is family-owned. There is no one-size-fits-all approach to preparing for a seamless transfer of power, but careful consideration will smooth the transition and help ensure that the business thrives.