Mark Kellogg
Fraser Trebilcock
Every day, for approximately the next 15 years, 10,000 baby boomers will reach age 65. This phenomenon is currently having, and will continue to have, a significant impact on our country in a number of areas, including on the family business and transition issues. Family-owned businesses are the backbone of the American economy. Family firms comprise 80 to 90 percent of all business enterprises in United States. In the next 5 years, 30 percent of family-owned businesses will experience a change in leadership due to retirement or semi-retirement.
Only 30 percent of all family-owned businesses survive into the second generation and only 12 percent will survive into the third generation. Ultimately, only 3 percent of all family businesses operate at the fourth generation and beyond. Therefore, making it to the 4th generation is very rare. Planning for the succession of the family business is crucial to the success of the transition of the family business to subsequent generations.
Based upon the research of Williams and Preisser (2003), of the 70 percent of businesses that fail to transition successfully, 60 percent fail due to problems with communication and trust; 25 percent fail due to lack of preparation from the next generation; and 15 percent fail from all other issues (for example, poor tax or financial planning, legal advice, etc.). Therefore, roughly 85 percent of business transitions fail due to a lack of communication, trust or next generation competency.
A family-business owner contemplating the fate of his or her business has essentially four distinct choices: (1) Business succession to the next generation; (2) Sale of the business to a third-party; (3) Merger or other reorganization of the business with a third-party; or (4) Termination of the business and liquidation of its assets. The rest of this Article will focus on option (1) above, the transition of the family business to the subsequent generation.
Most often, the family business constitutes the largest asset in the estate of a family-business owner, thus considerations regarding the business and the overall estate plan are inextricably related. Despite this, however, business succession planning and estate planning should be looked at as separate endeavors. However, the estate planning attorney is often confronted with the role of being the family-business adviser and the responsibility of beginning the succession planning process is frequently thrust upon him or her.
As you begin to engage in planning for the successful transition of the family business to the next generation, consider the following:
(1) Form a planning team. Business succession planning is complex and requires a team of advisors. The planning team may consist of one or more of the following: (A) the estate planning attorney; (B) the company CPA; (C) a financial adviser; (D) key members of the family business; (E) key members of the family, including representatives from the next generation; (F) an outside advisor or respected family friend, possibly someone whom the family trusts and who maintains a high degree of credibility; (G) given that per above, 60 percent of businesses fail to transition successfully due to problems with communication and trust, it may be beneficial to add an outside consultant who can assist with the psychological aspects of the succession planning process. Note further, that despite the importance and benefits associated with the planning team approach, the team should have someone who can serve as the "quarterback" to coordinate all the pieces and monitor and ensure continued progress.
(2) Conduct a Family/Business Assessment. Today there are a number of assessment tools that can assist in initiating the planning process. An assessment can assist the business owner and its advisers in (A) identifying issues and concerns that may impede the succession plan, such as uncovering potential land mines before they explode; (B) measure the strengths of the family as it relates to the family business and possible areas that need improvement; and (C) benchmark the family transition against best practices. The results of such an assessment will assist the business in developing it succession plan including specific action steps. In addition to the use of an assessment tool, it will also be beneficial to conduct individual interviews of key stakeholders to help provide a clear picture of the concerns and desires of those involved. The key stakeholders should include the business owner's spouse, key employees, children and even children's spouses. Although in-laws might not have direct involvement, undoubtedly they will have opinions, and those opinions may influence the success or failure of the planning process.
(3) Define the Desired Outcome. The ultimate goal of any succession plan is to achieve the desired outcome. Typically, the desired outcome is a plan that can be deemed successful by as many of those involved as possible. The success of any succession plan will be determined on a case-by-case basis, as the final succession plan will be as varied as the families and businesses involved in the planning process. There are, however, a few common factors in any effective succession plan:
- The business is managed by those who have the necessary skills to maintain the success of the business;
- Provide liquidity and sufficient income for the senior generation (former business owner);
- The business generates sufficient cash flow for all of its owners, which may include owners not directly involved in the business;
- Minimization of transfer taxes;
- There is an exit strategy in place for those who wish to exit the business;
- Obtain the buy-in of key stakeholders; and
- Ideally, the business is only a reasonable portion of each owner's overall financial picture.
(4) Implementation of the Succession Plan. The implementation of a business succession plan will typically be an ongoing process. The ultimate success or failure of the plan may not be known for years. Further, the family and other key stakeholders must be committed to the plan and remain diligent in carrying out the action steps necessary for implementation of the plan. Further, any business succession plan should be viewed as living document, which may require ongoing revisions and updates, as circumstances may change.
Estate planning for the family business requires the balancing of basic tensions between what may be fair for family members and ensuring the success of the family business. The objective of the estate planner should be to assist in finding that balance. This article outlines in very general terms, a process that can assist in developing a family business succession plan that can overcome the overwhelming odds of a successful business transition to one or more subsequent generations. As is most often the case, the devil is in the details.
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The author is an attorney with Fraser Trebilcock in Lansing.
Published: Mon, Oct 24, 2016
