How to Ensure a Smooth Transition When It’s Time
Giving Them the Business
By Gina M. Barry, Esq.
More often than not, a family business is doomed by the failure of the owners to plan for its continuation. Currently, only 30% of family-run companies succeed into the second generation, and only 15% percent survive into the third generation. Fortunately, with proper planning, most business owners can ensure the continued operation of their business should they become incapacitated or pass away.
Contemplating one’s mortality is not a pleasant activity. Most believe they have plenty of time to plan. Some business owners identify so closely with their business that they simply cannot comprehend the idea of their business being operated by anyone other than themselves. However, when a business owner becomes incapacitated or passes away without a plan in place, the business always falters and often fails.
“Currently, only 30% of family-run companies succeed into the second generation, and only 15% percent survive into the third generation.”
The general recommended time to plan for business succession is between the ages of 55 and 65. This timeframe is recommended because most successful business-succession plans include several steps carried out over time. Some succession consultants recommend a three- to five-year plan, while others advocate a five- to 10-year plan. Adequate planning time allows a business owner to test potential successors in different roles and to evaluate their maturity, commitment, business acumen, and leadership abilities. Further, once a successor is chosen, adequate lead time allows the successor to gain expertise so that the business does not falter when the former business owner leaves the business.
More often than not, the head of a family-owned operation chooses a child as a successor. Commonly, more than one child is competent to step into the parent’s shoes, which makes the selection process even more difficult. When a family member is not available, a key employee often fits the bill. Typically, these employees have already displayed the abilities necessary for operating the business.
The business owner should begin by determining three things: when they want to step away from the business, for how long they want to remain active in the company thereafter, and in what capacity they wish to remain involved. Next, the business owner needs to discuss their ideas about the future with their family, senior management team, and key employees. Thereafter, the business owner should begin working with the successor to revise their business plan, thereby allowing them to include any future new products, plans for expansion, growth, or new investment, as well as a candid assessment of the company’s current environment and competitive positioning.
The business owner will also want to develop a financial strategy for actually stepping fully away from the business. A financial strategy, which is perhaps the most significant activity associated with succession planning, protects the company, the family, and the employees against a monetary burden that could doom the entire process to failure. For example, if a business owner intends to leave the business to their children, they must consider any estate taxes their estate may face upon their passing that may require the liquidation of the business, despite best intentions.
It is also critical to obtain an accurate valuation of the business regardless of who will take over or inherit the enterprise. Such a valuation encompasses tangible assets, such as real estate, buildings, machinery, and equipment, as well as intangible assets, such as employee loyalty, manufacturing processes, customer base, business reputation, patents on products, and new technologies. Employing a professional valuation company is recommended, as there are many different factors that affect the value of a business.
Once the business has been valued, it is necessary to determine the method of transferring the business. Some options for transferring a business include gifting, the use of a trust, buy-sell agreements, and life-insurance-funded plans. The choice of successor will strongly influence this decision. Surely, a plan that gives the business to children or family members would differ greatly from a plan that requires a third party to purchase the business owner’s interest. When transferring to a child or related party, the business owner may gift some of the company’s value, whereas, when transferring to an independent third party, the business owner would most likely want to be paid the full fair market value of the business.
As various plans may be established and the specifics of the business must be considered, each different plan must be reviewed on its own merits. The process of choosing a succession plan involves numerous factors, and there are many pitfalls along the way. Thus, it is best to consult with the necessary professionals, such as attorneys, financial advisors, and accountants, to assist with the transition and to allow as much time as possible to plan and make the transition. By doing so, business owners can ensure the vitality of their business for many years to come.
Gina M. Barry is a partner with the law firm of Bacon Wilson, P.C. She is a member of the National Academy of Elder Law Attorneys, the Estate Planning Council, and the Western Massachusetts Elder Care Professionals Assoc., and concentrates her practice in the areas of estate and asset-protection planning, probate and trust administration, guardianships, conservatorships, and residential real estate; (413) 781-0560; [email protected]