Succession Planning and the Family Owned Business

Furthermore, they represent 50 percent of employment and Gross National Product. As the rate of Baby Boomers entering retirement continues to accelerate, the owners of family owned businesses – and the millions of individuals they employ – are faced with the challenge of transitioning ownership; a process often referred to as succession planning.

The United States Small Business Administration reports the odds of surviving a transition from the founding generation to the next are a mere 30 percent. The figures are even more uninspiring for the third generation with survival rates at less than 20 percent. Given these odds, it makes sense for family business owners to begin treating the succession planning process much as they would treat retirement and estate planning. While each business succession is unique, there are some common misunderstandings that can bring added complexity to the transition of a family owned business. The following are indicative of more successful transitions in a family-owned business.

The child wants to run the business and is capable of running it
While the founder may assume his or her child wants to step into the family business, this assumption needs to be validated well before the owner steps aside. Likewise, the owner needs to ensure that the heir and possibly his/her spouse are capable of running the business. Without proper knowledge of the organization, shares can fall into the hands of individuals unfamiliar with the company but with the rights to vote their interests. Another misconception is that an equitable ownership arrangement between two siblings is an ideal situation. Economics can be equalized while giving control to one clear decision-maker. Family business counseling can help identify issues and provide coaching to the new owner, while estate planning can assist with wealth transfer and inheritance issues.

The family treats the succession like an arm's length transaction
Selling a business to a family member can be an awkward transaction. Heirs may assume the business is a “gift.” A business valuation can quantify the value of the business to an heir and his/her spouse. The business appraiser will analyze historical financial statements, projections, benchmarks and other market data for similar companies. An independent valuation provides an objective assessment of the business’ value. While it may be tempting to conduct the valuation process in-house, market data is often difficult for the average business owner to find; especially for privately-owned companies. Additionally, cash flow analysis and present value calculations require sophisticated modeling and expert analysis.

The heir has the liquidity to buy out the owner or the willingness and capability of borrowing from institutional lenders
Ensuring that the buyer has the capital or financing to acquire the agency is important. Structuring the deal requires several variables from the buyer and seller as well as careful forethought. Trusted third parties including attorneys, financial institutions and business valuation experts can assist with the structure of the purchase.

The transaction acknowledges parties beyond the seller and buyer
A business’s success is contingent upon the support of employees, board members and of course, clients and customers. Planning how each of these parties will be communicated to during the succession process should not be overlooked. The new owner will need the support of these constituents to prevent disruption to business operations and continue cash flow. Incentives for management may be critical. Likewise, the seller will need to ensure the continued support of clients to preserve the interest of the buyer.

Even though it’s in the family, the sale is a “business transaction”
When dealing with family, it’s sometimes easy to overlook that there are important tax and legal ramifications as well as the corresponding documentation that must be addressed. Common documents involved in the sale include employment agreements, confidentiality agreements, non-solicitation and non-competes, buy/sell agreements, shareholder agreements and possibly amendments to by-laws.

The seller’s involvement after the sale
Perhaps the most difficult part of the process is the seller’s involvement following the succession. A change in leadership presents a significant risk that a key shareholder or senior manager may leave prematurely. Employees may also find their loyalty lessened during the transition. Ideally, the seller’s personal desires and the heir’s ability to operate without the former owner’s presence will be in agreement. Proper planning should address the seller’s continued involvement early on, enabling the seller and buyer to focus on other transition issues.

Succession planning is a sophisticated process but it does not need to be daunting, even for family owned businesses. Every family-owned business is different and the process will be unique depending on the owners’ succession strategy. Succession planning does not take place in a vacuum, but is a process requiring time and the involvement of multiple parties including the owner, heir and advisors.