You have spent a great deal of your lifetime building a business. Now you are ready to transfer the business to a younger generation. This Financial Guide discusses some of the unique issues in planning for and implementing the transfer of the family-owned business.
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In a small business the owner(s) typically develops a unique bond to the business, unlike the typical corporation/employee relationship. The owner is often interested in ensuring that the business remains intact after his or her retirement or death. Perhaps the business owner would like to pass the business on to family members or sell the business to valued employees.
At any given time, close to half of U.S. small businesses are facing the transfer-of-ownership issue. Founders are trying to decide what to do with their businesses; however, the options are few. The following is a list of options to consider:
- Retain family ownership and management control.
- Retain ownership but hire outside management.
- Sell to an outsider or employee.
- Close the doors.
Why Family Firms Fail to Transfer Successfully
To be one of the few family businesses that survive a transfer of ownership requires a good understanding of your business and your family. There are four basic reasons why family firms fail to transfer the business successfully from generation to generation:
- Lack of viability of the business.
- Lack of planning.
- Little desire on the owner's part to transfer the firm.
- Reluctance of offspring to join the firm.
These factors, alone or in combination, make transferring a family business difficult, if not impossible. The primary cause for failure, however, is the lack of planning. With the right plan in place, the business, in most cases, will remain healthy.
Key Planning Elements
Family/Business Strategic Plan
The family/business strategic plan is needed to maintain a healthy, viable business. This plan establishes policies for the family's role in the business. For example, it may include an entry and exit policy that outlines the criteria for working in the business. It should include the creed or mission statement that spells out your family's values and basic policies for the business.
Succession Plan
A succession plan will ease the founding or current generation's concerns about transferring the firm. It outlines how succession will occur and how to know when the successor is ready. Many founders do not want to let go of the company because they are afraid the successors are not prepared, or they are afraid to be without a job.
Estate Plan
An estate plan is critical for the family and the business. Without it, you will pay higher estate taxes than necessary. Taking the time to develop an estate plan ensures that your estate goes primarily to your heirs rather than to taxes.
First Rule for Success:
Share information with all family members, active and non-active. By doing this, you will eliminate problems that arise when decisions are made and implemented without the knowledge and counsel of all family members.
What Makes The Family Business Unique?
This section will explore the nature of the family business as a dual operating system and will identify issues of greatest concern to family business owners, as identified by family business owners across the United States. As you review these issues, you will see that, although you and your family are unique, the challenges you face are not, because almost every family business shares the same problems.
What Is a Family Business?
Defined simply, a family business is any business in which a majority of the ownership or control lies within a family and in which two or more family members are directly involved.
It is also a complex, dual system consisting of the family and the business. Family members involved in the business are part of a task system (the business) and part of a family system. This is where conflict may occur because each system has its own rules, roles, and requirements.
Family System
- Emotional system
- Stresses relationships
- Rewards loyalty with love and care
- Entry by birth
- Membership is permanent
- Specific family roles and responsibilities
Business System
- Unemotional and contractually based
- Entry based on experience and expertise
- Membership contingent upon performance
- Performance rewarded materially
- Specific business roles and responsibilities
- Formal communication and decision-making
Common Family Business Issues
- Participation - who can participate in the family business and under what circumstances
- Leadership and ownership - how to prepare the next generation to assume responsibility for the business
- Letting go - how to help the entrepreneur let go of the family business
- Liquidity and estate taxes
- Attracting and retaining non-family executives
- Compensation of family members - equality versus merit
- Successors - who chooses and how to choose among multiple successors
- Strengthening family harmony
Strategic Planning
When conflict occurs in the family business, it can be traced to a disparity in the goals of the individuals, the family or the business. Perhaps a family member works in the business out of economic necessity, not because he or she wants to. Or perhaps the potential successor has plans for the business that differ from current management plans-different generations usually have different goals. Whatever the cause, the conflict must be addressed and resolved to avoid and prevent more serious problems later.
Business Strategic Planning
Strategic planning for family-owned businesses requires that you integrate family issues, such as:
- What are the long-term personal and professional goals of family members?
- What is the family mission? Why are you committed to establishing and operating the business?
- How do you envision the firm in the future?
- Will family members be active in management or will they be passive members?
- How will issues such as compensation, benefits and performance evaluation be handled?
Family Strategic Planning
The entire family should develop a mission statement or creed that defines why it is committed to the business. By sharing priorities, strengths and weaknesses, and the contribution each member can make to the business, the family will begin to create a unified vision of the firm. This vision will include personal goals and career objectives.
An important issue to consider is how to set priorities for the family and the business, i.e., decide which will come first, the family or the business. How you answer this question will influence your planning.
The Family Retreat
Trying to plan a business strategy during normal office hours is almost impossible. Plan a family business retreat to discuss the goals of the individual family members and the goals of the business. The first retreat should focus on reviewing the firm's history, defining family and business values and missions, creating a statement about the future of the business and reviewing areas that need more attention.
Retreat Purpose
The purpose of the retreat is to provide a forum for introspection, problem-solving and policy-making. For some participants, this will be their first opportunity to talk about their concerns in a non-confrontational atmosphere. It is also a time to celebrate the family and enhance its inner strength.
A retreat usually lasts two days and is held far enough away so you won't be disturbed or tempted to go to the office. Every member of the family, including in-laws, should be invited. Begin planning your retreat about six weeks in advance.
Common Retreat Topics
- A family creed or mission statement
- Management succession
- Estate planning
- Strategic business planning
- The reward system
- Performance evaluation
- Communication within the family
- Preparing adult children to enter the business
- Transition timing
- Exit and entry policies
Succession Planning
Succession is the transferring of leadership to the next generation. It is a process rather than an event. While there is a time frame within which the transition will occur, the actual amount of time taken for the process is arbitrary. It will depend on you, your family and the type of business you are in.
Forces Against Succession Planning
For the Founder:
- Fear of death
- Reluctance to let go of power and control
- Personal loss of identity
- Fear of losing work activity
- Feelings of jealousy and rivalry toward successor
For the Family:
- Founder's spouse's reluctance to let go of role in firm
- Norms against discussing family's future beyond lifetime of parents
- Norms against "favoring" siblings
- Fear of parents' death
1. Initiation
The initiation phase is that period of time when the children learn about the family business. It occurs from the time the children are born. A child can receive either a positive or a negative impression of the family business. If parents bring home the negative aspects of the business, complaining about it and about employees and relatives, the children will view the business in a very poor light.
2. Selection
Selection is the process of choosing who will be the firm's leader in the next generation. Of the entire transition process, this can be the most difficult step, especially if you must choose among a number of children. Selecting a successor may be viewed by siblings as favoring one child over the others, a perception that can be disastrous to family well-being and sibling harmony.
3. Education
Training or educating the successor in the firm is a delicate process. Many times a parent finds it difficult to train a child to be a successor. If so, an alternative trainer may be found within the firm. A successful trainer will be logical, committed to the task, credible and action-oriented.
4. Transition
The actual transfer of control to the successor occurs when you retire. Research indicates that transitions are smoothest when they are timely, final and do not include the entrepreneur's participation in daily activities, and the entrepreneur is publicly committed to an orderly succession plan.
Letting Go
There are many reasons why entrepreneurs cannot let go of the family business. Primary among these are financial ones. As a business owner, you may be used to a large salary and benefits, such as a car or insurance. After working hard in the business most of your life, you want your retirement years to be comfortable, not filled with financial anxieties.
The Entrepreneur Who Successfully Lets Go Has:
- A sound financial plan for retirement
- Activities outside the business that can provide social contact and power
- Confidence in the successor
- A willingness to listen to outside advisors
Consider a Board of Directors
Most small businesses do not have a board of directors, but a board can be invaluable during the succession process. A board can help management determine objectives and strategies, provide specialized expertise and even arbitrate feuds among family members.
Board Composition
The board is usually composed of both insiders and outsiders. Although family businesses usually are operated in a very private manner, there are benefits to making outsiders board members. They come with different backgrounds and perspectives and provide checks and balances.
A board should have five to seven members, including three or four outsiders. Select them carefully. You can find them in civic and charitable organizations, among acquaintances and at local universities.
Making Succession Work
To make succession work, you must communicate. This is the key ingredient. Use the family retreat as well as family meetings. Family meetings can educate the family in discussions about the nature of the firm, the kinds of leadership skills needed, entry and exit conditions, decision-making policies and conflict resolution procedures.
Key Success Factors
- Anticipate problems with non-family members
- Address sibling rivalry issues
- Develop a code of conduct for sibling relations
- Meet problems head-on rather than avoiding them
Estate Planning
In the family business, the bulk of your assets are often tied up in the business. This can not only create a large estate tax bill, but it also means that the estate may not have sufficient liquidity to pay those taxes. Estate tax laws are continuously changing. It is critical that you discuss your estate with your financial advisors to assess the adequacy of your current estate plan.
2023 Estate Tax Exemption
In 2023, the exemption equivalent exempts up to $12.92 million ($12.06 million for persons dying 2022). This means that you can pass $12.92 million in assets to your heirs free of estate taxes in 2023.
The annual exclusion gift consists of gifts of cash or other property of $17,000 in 2023 ($16,000 in 2022) or less per recipient per year. These gifts are free of federal gift taxation.
Estate Planning Tools
- Living trusts
- Marital deduction trusts
- Unified credit/exemption equivalent trust
- Dynastic trust
- Annual exclusion gifts
- Unified credit/exemption equivalent gifts
- Statutory grantor retained interest trust
Implementation
There are a variety of techniques which can be used to transfer your family business to relatives, partners, employees or others. The technique which is best for you will vary depending upon the structural form of your business, your intentions and the nature of the transfer (e.g., sale or gift).
Transfer Techniques
- Outright gift - transfer ownership of all or a portion of your business to your heirs with no compensation
- Annual gifting - transfer a portion of your business annually to take advantage of the gift tax rules
- Outright sale - sell ownership in your business for cash or other assets
- Installment sale - sell ownership in the business in exchange for future interest and principal payments
- Combination gift/sale - a combination of the above which can be used in the case of transfers to heirs
- Buy/Sell agreement - an agreement, typically between co-owners, where one agrees to buy the business from another for a set amount
- Employee Stock Ownership Plan - establish a tax advantaged plan which can transfer ownership of the business to your employees over time
Planning Checklist
Transferring the family business requires the family to make a determined effort to do the following:
- Communicate.
- Create a business strategic plan, including (1) business mission, (2) business goals, and (3) a strategy to achieve goals.
- Create a family strategic plan, including (1) a unified vision of the family's role in the business, (2) a code of conduct for family members, (3) joint operating policies that serve the family and business, and (4) a family creed.
- Prepare a Succession Plan, including arranging for successor training and setting a retirement date.
- Prepare an Estate Plan.
- Championing your successor.
Summary
Succession is a process that may extend from three to six years, or longer depending on your age and on your successor's age. It occurs in phases. Over a period of time, you initiate or educate your children to the family business. After determining a successor, you develop a plan to transfer leadership in the family business. The decision to announce who the successor is and when the transition will occur depends on the family.
Benefits of Early Announcement
- Reassuring employees, suppliers, and customers
- Allowing siblings time to adjust to the decision and to make alternative career decisions, if necessary
- Enabling the entrepreneur to plan for retirement
Fundamental Goal
The fundamental goal should be to pass the family business successfully to the next generation. To do this you must feel financially secure, secure with the company's future goals and plans and secure with your successor.
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