Business Succession Planning For Family Businesses
According to Family Business magazine, only 30% of family businesses survive to a second generation, 10% to a third, and 4% to a fourth.
Why don’t more family businesses survive? It is generally a combination of factors stemming from the original owner’s failure to plan for its future. If the original owner fails to take the proper steps, it is likely the family business will fail or be sold off after he or she dies. In order to survive, the owner must choose his/her replacement and put the replacement in the position to steer the company. For the new manager to succeed, the personal and financial needs of the family members must be taken into consideration. And of equal importance, the original owner must establish an estate plan that minimizes estate taxes. A good estate planning attorney can help the owner draft the proper agreements and trusts for a successful business transition.
MY OWN EXPERIENCE
I am a strong proponent of business succession planning because I saw first-hand what the failure to plan did to my mother’s family. My grandfather, although a very successful business man, failed to plan for replacement management and didn’t have any estate plan other than a will. The will provided that all four children were to share equally. However, with estate taxes due, most of his assets other than his company were sold to cover the estate taxes and all four children retained equal interests in the Company. His sons continued to run the company, but they fought over control and eventually ran the company into the ground. The end result was that his daughters received very little inheritance and family relationships were hurt.
A business succession plan must meet three goals: (1) determine who is the best person to take over management of the business and establish a means to affect this; (2) take into consideration all family members’ feelings about this plan and treat everyone fairly; and (3) minimize estate taxes.
WHAT COULD HAVE PREVENTED THIS SCENARIO?
One son was best suited to run the company. If my grandfather had planned ahead, he could have set up a plan whereby the most qualified son took over management. The other son could have been bought out. To assure this transfer of power, the managing son and my grandfather should have drafted a buy/sell agreement that would state that upon my grandfather’s death, the managing son has the right to buy a managing portion of the stock.
AVOIDING CONTENTIOUS FEELINGS
It’s also important to deal with the feelings of the other family members regarding the family business and to consider which person will take over management? What is an equitable division of the overall estate? The owner of the company should look at the feelings of the other family to think through what seems fair and reasonable for all. If it is a fairly contentious matter, a therapist or a business consultant may be of help. The key here is to separate personal issues from the issue of what is best for the business and what is fair for the family members. This counsel is exactly the role of a good estate attorney and can guide decision-making by outlining options or providing education of tax consequences.
After agreement is obtained, there needs to be an estate plan that treats all family members equally. This is not to say that everyone obtains an equal share in all assets. Ideally, the focus is on fairness and equalizing values.
MINIMIZE ESTATE TAXES
The last goal is to minimize estate taxes. So, in addition to using insurance to provide for these taxes, the owner may want to establish entities such as family limited partnerships (FLP) or limited liability companies. Then the owner could start transferring small interests in the FLP to the family members while still maintaining control of the company. In doing so, the whole of the company is not owned by him at his death. This division of ownership, depending on the situation, will allow his estate to take a discount on the value of the company upon his death which can range from 20% to 35% of the overall value.
A good business succession plan supported by the appropriate estate planning documents can save a family business, but more importantly can save a family. For estate plans with special expertise in tax law, call the Law Office Of Jane K. Penhaligen : 925-464-1598.