Most owners and patriarchs of family businesses want to see the business continue within the family long after they have hung up the reins. However, the statistics when it comes to family business succession aren’t encouraging.
Only about three out of 10 family-owned businesses make the transition from the first to the second generation and just 12% make it to the third generation, according to the Conway Center for Family Business.* Just a miniscule 3% are transferred to a fourth generation and beyond.
The biggest key to long-term family business succession is creating a formal family business succession plan. This plan will identify one or more successors who will assume leadership of the business after you step away. It will also lay out a timeline for when the transition will take place and a plan for how your ownership shares will be transferred to your heirs.
Management vs. Ownership: There is a Difference
If you’re considering transferring your business, it’s important to first realize that management and ownership are not one and the same. For example, you may decide that you’d like to transfer the management of your business to only one of your children while transferring equal shares of ownership to all of your children, whether or not they are actively involved in the operation of the business.
6 best practices to help you get started in creating a family business succession plan:
1. Start Planning Early. How early is early, you ask? Many experts say that family business succession planning should begin no later than two to three years before you plan to exit the business. In reality, it’s never too early to start thinking about your family business succession plan. The sooner you start, the more time you’ll have to identify and train new leadership, transition client and vendor relationships to your heirs and start easing yourself out of the picture.
2. Communicate Openly with Family Members. Things can get emotional and feelings can get hurt when it comes to transitioning a family business. For example, if two or more of your children are working in the family business, they all might want to be considered for the role of President or CEO. But you can only choose one, so open communication is critical to avoiding hurt feelings and unmet expectations.
On the flip side, some family members might not want to keep working for the family business after you step aside; instead, they might want to pursue other interests. Or, some might prefer to work in a certain department like sales or operations instead of leading the business. The best way to find these things out is for everyone to communicate openly and honestly about their desires and expectations.
3. Train Your Successor. Once you have identified your successor, it’s your responsibility to prepare him or her to assume the reins after you leave. In essence, you must teach your successor everything he or she will need to know to be ready to step into your leadership shoes. This includes not just your day-to-day management responsibilities but also how you go about big-picture strategic planning and decision making.
Get your successor’s input about strategic decisions you must make. Even better, let your successor make some of these decisions himself or herself. It might be tempting to override a decision if you disagree with it, but it’s better to let your successor learn from the consequences of decisions (whether good or bad) now instead of later after you’re gone.
4. Perform Tax and Estate Planning. This is one of the most important, but also most overlooked, aspects of family business succession planning. There are myriad potential tax liabilities and estate planning consequences that will arise for you and your heirs once the business transfer takes place. In a worst-case scenario, your heirs might have to partially liquidate company assets in order to pay taxes, which will negatively impact the business’ value. By planning early, you may be able to reduce taxes associated with the transfer of your business.
5. Assemble a Team of Advisors. The good news is that you don’t have to embark on the succession planning journey alone. A variety of professional advisors can help you create a family business succession plan that’s customized for your unique situation. They include your financial advisor, CPA, attorney, insurance agent and your company’s board of directors.
These professionals can offer an unbiased perspective and share tips they’ve learned working with other family businesses like yours. With their guidance, you might be able to consider options and strategies you wouldn’t have thought of otherwise.
6. Do What’s Best for the Business. Family business succession planning can be complicated and emotional because it requires you to make difficult decisions with your loved ones in mind. As you evaluate your future and the future of your business, it boils down to doing what is in the best interests of your business.
Challenges of Succession Planning in Family Business
There are unique challenges when it comes to succession planning in family businesses that aren’t usually present in non-family enterprises. Devising a plan ahead of time for how you will meet these challenges is critical to achieving your succession planning goals.
Here are seven unique challenges of succession planning in family business to think about as you devise your plan:
1. Determining if heirs want to take over the business. This is the first question you must answer if you want to transfer business ownership to a family member. If there isn’t a family member who desires to assume a business leadership role, then you probably won’t be able to keep ownership of your business in the family.
The answer might be obvious if one or more heirs is actively involved in the business and shows interest in and an aptitude for leadership. But if this isn’t the case, you may need to have a family meeting to discuss the future of the business and family members’ potential roles in it.
2. Identifying a capable heir to lead the business. This is similar to the first challenge, except instead of asking if an heir wants to take over the business, you must ask if an heir is qualified to take over and lead the business. Sometimes family business owners spend years planning to transfer their business to an heir only to find out that the heir isn’t ready for this responsibility when the time comes.
One solution to this dilemma is to promote or hire a non-relative employee to take over management of the company and oversee operations. Family members can then take ownership of the company in a non-decision-making role. However, this arrangement can create conflict if there are disagreements between the family owners and the non-family managers about expectations or philosophy.
3. Becoming sentimentally attached to the business. It’s not uncommon for family members to get emotional and sentimental about the business that bears their name. When this happens, they may perceive the business as being more valuable than non-family managers or outsiders do. In a worst-case scenario, this emotional connection can create tension between family heirs and non-family employees.
4. Conflict between siblings. This is often the biggest succession challenge faced by family businesses — especially if the owner hasn’t done a good job of communicating with family members about what their future roles and responsibilities will be. For example, an eldest child might assume that he is going to take over leadership of the company due to his age.
But if his younger sister is more qualified, she might be the one who is tapped to lead the business in the future. This may lead to hurt feelings and potential conflicts that can ripple throughout the business, negatively affecting performance.
5. Limited capital. Family businesses are accountable to shareholders just like non-family businesses are. Sometimes family owners want to leave the business after a period of time and have the company buy their shares. To avoid conflict, other family owners may agree to do this even if it isn’t in the best interest of the company. This is capital that could be used to help the company grow by rolling out new products or expanding into new markets.
6. Resistance to change and stagnation. The things that have made a family business successful in the past may not be the things that will lead to continued success in the future. But without a fresh infusion of new ideas from outside the family, the business can become stagnant and resistant to change. Heirs need to be flexible and open to new ideas from both family and non-family employees.
7. Failure to perform tax and estate planning. The transfer of a family business will lead to many tax and estate planning consequences for both owners and their heirs. That’s why extensive tax and estate planning is crucial well in advance of the transfer date. Otherwise, heirs may have to partially liquidate company assets in order to pay estate taxes, which will negatively impact the business’ value. Early planning can help reduce the taxes associated with the transfer of a family business.
Learn more about Succession Planning:
- Buy-Sell Agreements are Essential to Any Small Business Succession Plan
- The Role of Insurance in Your Succession Plan
- Know What Your Business is Worth. Four Common Business Valuation Methods
Succession Planning Consultants: How We Can Help Your Family Business
The team at C.W. O’Conner Wealth Advisors works with business owners and their families to create succession plans based on their unique goals and objectives. We can help with ownership transactions, liquidity events and buy-sell agreements, as well as provide other business advisory services. Call us directly at 770-368-9919 or email Cliff at firstname.lastname@example.org or Kevin at email@example.com to learn more.
Editors Note: This article was originally published June 2021, but has been updated with new information.