If you are an owner in a family enterprise, you may not be aware that the chances of your business transitioning successfully to the next generation are not very good. This has not changed over the years. Statistics show a failure rate of 67% of businesses succeeding into the second generation and 90% by the time they reach the third. With 80% to 90% of all enterprises in North America being family owned, it is important to address the reasons why transition is difficult.
Family enterprises are often put at risk by the dynamics of the business family. In fact, it has been estimated that 65% of families have not had any meaningful discussion about the succession of their business. It is no wonder the statistics on inter-generational business succession are so dismal.
Family issues can often hijack or delay the planning process. Sibling rivalries, family disputes, health issues and other concerns certainly present challenges that need to be dealt with in order for the succession plan to proceed. Many times a founder of a family business looks to rely on the business to provide him or her with a comfortable retirement while the children view the shares of the company as their inheritance. Sometimes an appropriate family successor is not readily identifiable or not available at all. In these times a decision needs to be made as to whether or not ownership needs to be separated from management, at least until the second generation is willing or capable to assume the reigns of management. If the founder needs to receive value or future income from the business a proper decision as to who is running the company is vital. If this is not forthcoming, then there may be no other alternative but to sell the company and to enlist effective management of the family wealth created. It is for these and other reasons that the founding generation need to consider retaining experts to help them wade through the issues that arise with family business succession planning.
It is important to develop a structure for the following:
Tax Planning
When planning for the succession of the business either as a family succession plan or as a sale an objective is to reduce income tax on the disposition (sale or inheritance) of the enterprise. Some of the ways this can be accomplished include an estate freeze to pass on the future taxable growth to the next generation. The corporate and trust structure utilized in this strategy may also create multiple Small Business Gains Exemptions which can reduce or eliminate the income tax on capital gains. It is key for the business owner to understand that just as it is important to try and reduce taxes during his or her lifetime, it is equally critical to benefit his or her estate by reducing taxes payable on death.
Management and Shareholder Disputes
This often involves the implementation of a Shareholders’ Agreement. Often there are multiple parties that should be subject to the terms of the agreement, including any Holding Companies or Trusts that might be created in the structure created to deal with the tax planning issues. The Shareholders’ Agreement also will provide the process to deal with any shareholder disputes that may arise as well as confer rights and restrictions on the shareholders. The agreement will be instrumental in providing for the exit strategy that the business owners may wish to employ.
Estate Equalization
There are times that one or more children may be involved in the company while the other siblings are not. Often the family business represents the bulk of the family fortune. Proper planning is necessary to ensure that the children are treated fairly in the succession plan for the business when the founder dies. One method often employed in this regard is for the children active in the business to receive the shares as per the will or shareholders’ agreement while the non-business children receive other assets or the proceeds of a life insurance policy.
Founder’s Retirement Plan
It is problematic that often a business owner’s wealth may be represented by up to 80% of his or her company’s worth. It is important that the founder develop a retirement plan independent of the business so that his or retirement is not unduly affected by any business setback.
Protecting the Company’s Share Value
Risk management should be employed to provide for any unforeseen circumstances that would have the effect of reducing share value. As previously mentioned, if the bulk of a family’s wealth is represented by the shares the family holds in the business, a significant reduction in that share value could prove catastrophic to the family. These unforeseen circumstances include the death, disability or serious health issues of those vital to the success of the business, especially the founder. Proper risk management will help to ensure that the business will survive for the benefit of future generations and continue to provide for the security of the founder and/or his or her spouse.
Since the dynamics of family businesses differ from non-family firms, particular attention is required in the planning for the management and succession of these enterprises. This planning should not be left until it is too late – it is never too soon to begin.