The short answer is yes, if you want to increase the chances that your business survives. The statistics on family business transitioning to the next generation are somewhat surprising. Depending upon the source of the statistics, 30-40% turn into a second-generation business. Thirteen percent pass to a third generation and three percent to a fourth generation. There are many factors that contribute to these percentages. This article highlights some considerations and factors for planning.
Ownership succession plan
Have a plan for when you die, become disabled or retire. Think about who you want to own your business. There are business and personal considerations to this analysis. Set timelines for decisions. Perhaps the new owner and the manager are different people. Discussions with your family may be part of this analysis. A family meeting with key players and trusted advisors or consultants is often beneficial.
Management succession plan
Are you the current manager? If not, can the current management continue under a different owner? Review and embrace the strengths and recognize the weaknesses of possible successors, perhaps key employees.
Business transfer options
There are many business transfer options. You could sell your business during lifetime to one or more family members. The sale could be outright or to a trust and loans may be involved. Another option is a gift of a portion or all of your business during your lifetime. Or you could combine a sale and a gift. These alternatives each have estate and gift tax implications.
The sale of a business may be tied to a triggering event, such as your death, disability, divorce, desire to sell or need long-term care. This would prevent your business partners from being forced to going into business with your family. If this is the case, you want to make sure that there is a way to fund the buy-sell. Often, the funding is a life insurance policy on the owner who passes away. Other funding options would be necessary for other triggering events.
Coordinate with estate and financial plan
Your business succession planning should be coordinated with your estate and financial plan. Put simply, if you have a business partnership operating agreement, make sure that your will does not conflict with it. If you want, and are permitted under the operating agreement, to leave some or all of your business percentage to one of your children, how will you equalize that inheritance to your other children? Or do you believe that the sweat equity that your child put into the business to grow it obviates the need for any equalization?
Your financial plan is typically geared toward having sufficient income in retirement. After you determine your retirement income needs, that income and asset number will assist in the timing of your succession plan. Typically, you would not transition your business until your retirement income is secured. Also, if you have a spouse or significant other, his or her need for income if you would pass away first is normally considered. Alternatives that generate retirement income would be relying upon non-business assets, keeping preferred shares in the business, or negotiating contractual arrangements with the new owner such as a salary, consulting fee, deferred compensation package, or director fees for you.
If you do not want to give up control, then that could be an issue. Consider that relinquishing control now may prevent a collapse in the business later. You may opt to start a pattern of giving of shares of the business or positioning key employees to run the business later.
Perhaps you are ready to give up control too soon, without a plan. Successful transitions take time and many steps. You may choose to work part time or on a consulting basis while the new management gets settled.
Members of the next generation in a family business often exhibit entitlement issues. The business is not a personal ATM. You must set standards for education and work experience outside of the business. The oldest child or next longest standing employee status does not necessarily equate to the best choice for the next owner.
Start the thinking, talking and transition process early. Include your entire team of professionals, not just your accountant or business attorney. This is a process that evolves over time.