Family Business Succession Navigating Non-Tax Issues
Donald E. Fergus, Jr., Esq. and Steven D. Baker, Esq.
Currently, family businesses account for approximately 90 percent of all incorporated businesses. This means that these entities are controlled by members of the same family or a small number of families; in addition, about one-third of Fortune 500 companies are family controlled. Family businesses have accounted for 80 percent of all jobs over the last 20 years. Despite this number of family businesses, their failure often arises due to conflicts within the family structure. The conflicts in the relationship between generations, spouses and siblings often determine whether a business will succeed or fail. These conflicts can lead to power struggles, stress and poor business decisions. The advisor must be cognizant of these conflict possibilities when working in the area of business succession.
Understanding the Issues
When a family has expressed an interest in initiating business succession, the advisor’s approach should be to first determine if the clients understand the issues. Do they realize there is a difference between ownership versus management succession? Often times the owners do not distinguish these elements. It is critical that the planner advise that transferring ownership does not necessarily deal with the issues of day-to-day management and all that it entails.
Conflicts can easily arise concerning employee issues, long range planning, business projects and use of cash flow in the business.
It must also be determined if the business can even survive without the involvement of the older generation. If it is a personal service business, it may be dependent upon the client’s involvement. It may also be dependent upon contacts and relations that the client has developed over substantial time. These aspects need to be analyzed to determine if the client can help develop these relationships with the succession. If not, succession may not be an option.
The client must also determine if business succession is viable. The planner should determine the qualities of a successor to ensure suitability for the position of management and ownership. It is not unusual for children to be uninvolved in the business and have outside interests. In that case there may be opportunities for ownership transfer with key employees being involved in the process for management purposes and even an ownership interest.
Another factor that underlies the process is whether the controlling owner can actually let go. If this is the case, procrastination on the part of the owner is not unusual. The owner must be part of the transition and actively working towards it. If the owner is uncomfortable with retirement due to financial or control issues, these issues must be addressed and resolved. The family does not want a situation where the controlling owner changes his mind at the retirement party.
Thought must also be given on preserving family harmony. Acting with integrity at all times is paramount. Also recognizing potential conflicts may be easier for the advisor than the clients. If there are sibling rivals or hostility, they may not be apparent until discussions on transition commence. Economic goals are essential in resolving these types of conflicts. There must be a process where they can be addressed and hopefully resolved if there is a sufficient level of trust between the parties.
Implementing the Plan
Commitment between the family members is essential when beginning the actual process of transferring the business. Many families begin by creating a family mission statement. This statement may review the purpose and perhaps even the values of the business. It may state what the business does, what the expectations of the family members are, and even how the business can function with conflicts between the business interests and those of family members.
A family charter may also be useful and set forth agreements on many issues. The issues may include notes from participation in the business by family members, guidelines for performance, remaining in the business, distributing ownership interests, and even guidance for succession. Use of a charter may assist the family by encouraging consistent behavior which has been agreed upon by the members.
Another tool is use of a family council. This can be a forum for all members whether they are active in the business or not. The council can meet regarding to review and revise the mission statement and insure that the family charter is being implemented. It may be especially useful for members not participating in the business as it gives them a voice in business operations and ownership. A well-functioning family council should be comprised of more than one generation and create opportunities for planning and preparing all generations to work together effectively. It can also act as a governing body to oversee the business activities and family community activity. In order to be most effective, its members must be willing to give it both the time and the energy that it requires.
Overcoming the resistance to succession planning may be difficult. However, if the family members are willing to make necessary changes, the family business can continue to succeed. The controlling members must recognize that by planning, their business can last for several generations. It is lack of succession planning, not estate taxes, that causes most businesses to fail.
Utilizing a well-constructed succession plan should result in a successful business transition. It will develop family plans and procedures to handle the transition, manage family conflicts and ensure the business is being operated pursuant to the agreed upon family values. Only the family can develop principles and create procedures to resolve issues as they arise in the role of the advisor to guide them in maintaining regular communication. Continuing to address questions and keeping the process on track can create a family legacy. The advisor has then provided a service to the clients in which all parties can experience success.
Adequate planning involves a dialogue that includes disclosure and analysis of particular facts and circumstances. As such, this article may not be considered, or relied upon as, legal or tax advice or a substitute for the direct legal advice of counsel or consultation of a qualified professional.
Donald E. Fergus, Jr. and Steven D. Baker are attorneys in the
AZ CPA – March/April 2006
