Joshua S. Miller, The Daily Record Newswire
Many a successful business owner has spent most of his life building the business. The business has been the owner’s primary income stream and may represent the vast majority of his net worth.
Inevitably, the owner comes to the proverbial fork in the road when he has to answer: “What next?” Retire and pass the business to the children? (Or acknowledge that the children are neither equipped nor interested in sustaining the business.) Stay on in a limited capacity? Sell to an outsider?
Rarely is the status quo the answer. Rather, the answer to “what next?” is thoughtful, long-term planning to address the many issues of family business succession. There are several key decision points business owners need to think about carefully.
According to the Family Business Institute, 88 percent of current family business owners believe the same family or families will control their business in five years. Succession statistics, however, undermine that belief. Only about 30 percent of family businesses survive into the second generation, 12 percent into the third generation, and 3 percent into the fourth generation or beyond.
Each family business is uniquely its own ecosystem, but all family businesses have one dominant characteristic in common: the overlap of family issues and business issues. This overlap involves unclear boundaries between the family and the business, deeply rooted and shared traditions (both business and family), and wealth transfer with a vision for both individuals and the company.
The owner of a successful family business faces significant challenges when the time comes to either transition the business to other members of the family, or sell to a third party. Numerous questions arise, such as:
• Do I distribute the business to all my children equitably? Or fairly? (There’s a big difference.)
• Do I transfer control to the one adult child who has been active in the business, with certain accommodations to the remaining children?
• How do I structure the decision for transferring ownership and control to one or more family members?
• How do I prevent family discord about my decision?
• How might I structure the sale to a third party in view of tax and estate planning issues?
• After a major liquidity event, how do I maintain that wealth to live on and preserve it for future generations?
In an effort to answer those questions, clients will turn to key advisors to think through the process of transitioning their business and their life following the sale or transfer.
Keeping it in the family
For many owners, the family business represents prestige, job security, control over financial destiny, a multi-generational legacy and the very thing that gives the family its sense of “who we are.”
For those who have a strong desire to see a business continue in the family for generations, the business represents the entire spectrum of human emotions. That, in turn, requires the owner to think through a series of questions regarding the family, including:
• Are your children really competent to run it? Are there other key employees who need to be retained?
• If they are not already, when do you want your children involved?
• How will you establish a “control” process to avoid family disagreements?
• Do you need to stay involved?
In addition to the above questions, the family also may have to engage in decision-making that will seek to preserve family harmony. The business owner may be tempted to solve the problem by simply making a decision, but an impulsive decision is likely to backfire in the long run.
It is far better to craft a decision that involves those most affected. This process might require outside facilitation, and the conversations may be difficult, but the results of coming to an agreement before the death of the founder can preserve both family harmony and financial value. And if the family can’t agree, the owner will have far more information to work with as he plans for transition.
Giving up and passing on a family business is a major, life-changing event with a whole host of complex issues and often-difficult decisions. While it can result in family strife, if done well, it also has the potential to be a golden opportunity to realize business, family, legacy and philanthropic goals after years of hard work and sacrifice.
Heading for the exit
Family business founders may come to the conclusion that transitioning the business to outsiders, not family members, is the best course for both the family’s future success and the company’s future success. Not only do the emotions of selling the business need to be worked through, but it is essential that the business itself be best positioned for sale.
The likely first step is to clean up the balance sheet. There may be expenses that were run through the business that really should not be, or loans to family members that have not been paid back. Receivables need to be kept as current as possible or written off.
Most important is the structure of the business. Are there valuable strategic alliances and long-term contracts with suppliers or vendors? If so, they need to be locked down. If the business requires real estate to operate, long-term leases need to be in place.
The business also needs to secure agreements with essential employees and key management. All these things add value to the business when the time comes to sell.
There are numerous ways to structure the sale of a closely held business: a lump sum sale, an installment sale, an earnout sale based on a percentage of future profits, or a sale to a charitable trust.
The owner may sell the business by transferring either the entire ownership interest (stock, partnership interest, membership interest) or just the assets of the business. The desired “end result” will help determine a sale’s structure.
What next?
The founding owner of a family business may have spent decades in the business and everything about it feels comfortable and controllable — the routine, the risks, the rewards. Even the fact that his individual wealth — and, by extension, the family’s wealth — is concentrated in the business feels comfortable.
And then one day the sale of the business is complete and gone is the comfort, the control and the concentration of wealth. That is why when developing a succession plan the business owner should explore his financial well-being after the sale or transfer of the business. Questions to contemplate include:
• Will you be able to retire when you want?
• Will your surviving spouse be able to enjoy his or her lifestyle independent of the business?
• Is there enough liquidity to pay estate taxes so the family won’t lose the business or see it financially crippled?
• What estate and trust options should you consider?
• If you sell, how will the assets you receive be invested?
• What means of support do your children have?
• What are your charitable objectives?
• What is your comfort zone on giving up control, when and to whom, and potentially paying gift taxes now to achieve your goals?
The traditional model of the matriarch and patriarch making all the estate planning decisions is breaking down rapidly. Increasingly, wealth holders are involving their children in the core questions of the estate planning process.
In that sense, estate planning is moving beyond a personal responsibility to a family responsibility. For those who say that their children couldn’t participate in that discussion and who fear the involvement of their children in such decisions, one has to ask: “If they can’t engage in even this simple discussion, what makes you think they will be able to be in business together over the course of the rest of their lives?”
As it turns out, many founders find this kind of conversation provides great insight into what life will be like for their children after the parents are gone and shapes the planning in ways that will likely avoid disaster.
The wise family leader will ensure that the children are educated and informed about the issues and then involve them in the solution to these dilemmas (after all, it is the children who will have to deal with the consequences, and the last thing most parents want is to sow the seeds of inevitable dissension).
The more enlightened path is to resolve these issues in family conference. If resolution cannot be reached while the parents are alive, it almost certainly will not magically be reached after the last parent dies.
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Joshua S. Miller is a managing director and senior wealth strategist in the Boston office of Atlantic Trust Private Wealth Management.
