Many business owners envision keeping the business within the family, perhaps for generations. A formal succession plan may seem unnecessary, but what happens when the next generation doesn’t share the same long-term vision for the family business? Establishing guidelines and expectations is important for a smooth transition and continued business success.
When I was a new lawyer, my former firm represented a gentleman who owned a manufacturing business. He did very well for himself, and his family led a comfortable, but not extravagant, lifestyle. Two of his children went to medical school, and a third was groomed to take over the family business. As his lawyers, we developed and implemented a plan to tax-effectively transfer ownership of the business to the one son through a series of gift and sale transactions. The plan worked marvelously. The son became the owner of the business, and mom and dad had enough wealth to continue their comfortable lifestyle. We patted ourselves on the back for a job well done.
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About three years later the son sold the business for a mint. Dad was furious. He spent his lifetime building that business. He transferred the business to his son so it would stay in the family. He expected the son to continue to own and operate the company as a family business, maybe eventually passing it on to the next generation. If Dad had known the son just wanted the money, he would have sold the business himself.
The son became very wealthy by selling the business his father built. He would never have to work again. The father remained economically comfortable. The other two children, the doctors, did not share in their brother’s wealth. They would get an inheritance later, but it would be much later, after the deaths of both parents. As far as I know, the father never talked to his son again.
Bringing a child into the business is risky. Over the years, I’ve developed some ideas and observations about the best ways to bring a child into the business. I’m setting forth a few of them here:
- Be sure you and your children share the same vision for the future of the family business. Even better, put that vision in writing as part of a family governance document.
- Working in the family business is a privilege, not a right. No family member is entitled to work in the business, and no family member is entitled to hold any particular position in the company.
- Accepting a job in the family business should not be viewed as the easy path in life.
- A family member who wishes to join the family business must have the requisite formal education for his or her position in the business.
- A family member should work professionally outside the family business for a few years before being allowed to work in the family business. The family member might be required to earn at least one promotion in his or her professional work outside the family business before being allowed to work in the family business.
- Family members should be paid market wages and benefits for their work in the business. Family member employees should have no greater benefits than other employees in similar positions and with similar tenure.
- After a child becomes an employee of the family business, he or she should be supervised by someone who is not a family member and who has the intestinal fortitude to provide an objective evaluation of the child’s performance. A board of advisors also can be helpful in evaluating a family member’s performance.
- A group of mentors could be established to assist the family member in his or her career progression.
- The senior generation should not try to force a family member into any particular position. Few people have the right combination of skills and personality traits to be chief executive. Most people are better suited to more focused positions, like sales, accounting or operations.
- A family member who is being groomed to become the chief executive should hold various positions within the business. This diversity of experience, however, is not always necessary for family members who intend to hold a specific job function.
- The company should have voting and non-voting shares. Only family members who are actively involved in the business, or who are retired from active involvement, may own voting shares.
- The business should have regular shareholder meetings. All shareholders, including voting and non-voting shareholders, should be presented with reports, plans, budgets and projections for the business.
- Family members who are not actively involved in the business tend to be interested in receiving dividends or distributions. Family members who are actively involved in the business might favor reinvestment of profits to expand the business. To address this natural conflict, active family members should have the right to buy the shares of inactive family members. The valuation and payment terms should be within the market range but restricted to prevent putting too great a burden on the company’s cash flow.
- Family members who do not work in the business should not expect to receive a salary, health benefits, company car, vacation accommodations or similar benefits from the company. This is a business, not a trust fund.
- The senior generation should make three promises. First, they will leave the business in good condition. Second, they will provide for their own financial security with resources other than the business’s future cash flow (except for seller financing). Third, after the senior generation exits, they will not continue to meddle in the business unless invited to do so.
- Whatever guidelines the family develops should be in writing and should be well-known by the family members. The guidelines should be part of the family’s DNA.
For more information about business succession planning, contact Kevin Alerding or another member of Ice Miller’s Trusts and Estates Group. Kevin is certified by the Indiana State Bar Association as an estate planning and probate specialist and by The Exit Planning Institute as a Certified Exit Planning Advisor (CEPA).
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.