Family Business Ownership Succession

Unlike large businesses, family owned and managed businesses are less structured and generally heavily reliant upon the experience and drive of just a few or even one person. Most of America’s family business successes are the result of first generation dedicated people that devote extraordinary effort and energy toward their owned / operated company, often to the exclusion of most other interests. Operator focus is generally determined by immediate concerns of the numerous aspects of the business that ultimately fall on the desk of the owners.

For reasons of expense containment and family company culture practices, there are rarely internal specialization departments to handle issues relating to human recourses, risk management, legal department, marketing/ advertising, purchasing and more such needed areas in the ordinary conduct of business utilized by large companies. By avoiding the financial cost of internal support specialists, profit margins increase while risk exposure to “trial and error” style management also increases. If the business thrives from embryonic to mature stages, the owner has likely accumulated a vast amount of skills and knowledge from the experiences of “hands on” involvement on a day-to-day basis.

It is not unusual to have no other employee that can step into the shoes of the owner without serious business interruption should a situation require it. If and when circumstances necessitate succession ownership/ management change, results can be chaotic and unpredictable. Incapacity due to disability, death, or the eventual desire to retire to other interests may diminish or even destroy a once successful family owned business.

What could happen?

In the event of apparent instability, long-standing key employees (non-owner) perceive a threat to their employment/ financial security and begin to consider alternative remedies. Key employees may form or join competitive business operations since they know the business well and have few better immediate options. Business creditors, suppliers, and customers may develop concerns as to the viability of the business continuing long term. Years of careful attention and dedication to build a thriving enterprise may erode as a result of an absent link in the management/ owner succession chain.

What can be done?

Closely held business operators may develop an outside team, or a board of skilled business succession advisors to surface risk concerns and recommend preventative/ remedial measures within the company’s budget and culture. Utilizing current employees as members of the advisory team is not practical since they are not experts in the field and cannot hold an objective view when their security and responsibilities are at issue. Planning usually is refined as the owner learns and experiences results of implemented plans while still active in the business. Sort of a test drive to see how things are likely to work out when they retire or unexpected health issues arise. Reconvening the team periodically to assess and modify programs is the surest way to fine tune a vital component of securing the continuation the family business that has supported and rewarded the owner family for years.

Key employee recruitment, retention, and retirement are critical to the success of any business. Programs can be instituted to recognize and reward the long-term value of such employees by structuring a stock award plan based on responsibilities and length of service. The stock need not have a vote or be negotiable anywhere other than back to the company. In so doing, management is showing key employees that a piece of the company they helped to build will ultimately belong to them. If the employee becomes disabled, dies, or retires, the stock would be redeemed at current value reflective of the key employee’s contribution. Such plans help to retain non-owner key employees and facilitate ownership succession with less likelihood of mutiny by those vital to the business.

Operational management: Careful consideration should be given to providing an incentive to promote continued devotion to the needs of the business rather than wrestling with siblings and other family members. By recruiting high potential junior employees and grooming them for eventual management over time, safeguards are created for emergencies and eventual succession. If the choice of employee was not a good one, others will be sought since time is not immediately critical. Often family members are not the best choice for successor management and should be avoided unless they are well suited, lest the business be placed in peril. This is easier to say than to do since younger generation may have come to expect to be placed in charge.

One of the benefits of an outside team of specialists is the ability to perceive an unbiased view without becoming entangled in family relationships. The owners can blame the team for being tough and unpopular with decisions that owners know are right but hate to deal with. A well-designed plan will recognize and reward the best-suited and most interested heirs for their efforts and successes as employees rather than by ownership of stock. Rewards for accomplishments reflect company values and keep employee heirs focused on continuing to add value to the enterprise. Heir ownership on the other hand is likely to be envied by those not so endowed, but feel entitled by birthright, or marriage.

Successor ownership is a looming problem for all family businesses since our family members are generally not selected as employees may be. Multiple objectives usually exist when designing successor ownership that need to be prioritized if the business is not to be sold to an outsider. The owner and spouse (if living) need to be provided with suitable income generation long term. If there are multiple second-generation heirs, there needs to be a sense of fairness to avoid lifetime disputes and acrimony among the heirs. Some heirs are better suited to decision making than others, but should not be placed in a position to control other’s income and rights.

Sometimes heirs need to be protected from themselves and have income provided to them on a discretionary basis by a trustee or other disinterested party. Ownership earnings, after expenses and salaries, are best distributed based on a sense of equality amongst the heirs the original owners feel is appropriate. There should be formal buy/ sell agreements between all owners so that the rights and stock value of a minority owner are not usurped by the business operating heirs.

Areas to consider:

Dispute resolution can be challenging when family and business interests collide. An arbitration process involving respected outside professionals familiar with the business can avoid acrimony and mutiny in events where conflicting interests surface.

Valuation of the business to determine the tax effect of a death, gift, or sale of the business. Once the estimates of tax implications are determined, plans can be drawn to minimize costs.

Entity containers such as limited partnerships can be utilized to reduce valuation for tax purposes without reducing the actual values.  

Creditor claims, legal liability suits which may attach to the family business, have the potential to destroy the value and threaten its very existence. Employee practices (harassment) divorce libel and other tort actions are difficult to predict. Certain entity options make it difficult or impossible to attach the assets of the family business and should be explored. Senior family members should decide whether to sell, gift or a combination in order to satisfy their personal income needs while reducing estate taxation. Funding for the purchase or tax ramification of death can generally be best achieved by the use of life insurance.

For the non-business involved heirs, non-voting shares can be bequeathed and tied into a purchase agreement with the operating heirs. This method assures the fair market value to all heirs while retaining voting and operational control by those best suited to contribute to the general well being of the company, and ultimately the financial fate of all the family members. Life insurance or an installment note can be used to facilitate the purchase among the heirs.

Smooth transition: It is generally easier to follow the lead of the elder generation when they are involved and instrumental in passing the “reins” to younger members rather than having the family or widow “work it out”. While there may still be resentment on the part of those not selected for key positions, the elder generation can see the effects of their actions and amend as needed. Lack of awareness begets little or no planning, which generally results in less than favorable results, including the possible loss of a family business to internal litigation, taxes and credit unavailability. B

ringing seasoned planning professionals together with the operating members of the family to produce a summary of likely scenarios under current circumstances is the place where many families begin. Reducing resolutions to written format and distributing to family members and advising professionals allows for feedback that may be useful and demonstrates openness and management thinking. Foreseeing and averting problems is the cornerstone of the planning process.