The Retirement Corporation of America

The Special Rules For A Family Business

Planning So Your Family Business Can Survive

FEW FAMILY-OWNED businesses survive into the second generation and virtually none make it to the third generation. How come? Well, family businesses rarely develop succession plans early enough to be able to keep the venture going after the founder is gone. When planning does start, it seldom focuses broadly enough on covering all circumstances by which the business can change hands.

The day you start your business is the day you start succession planning. After all, what would happen to the business if you are hit by a bus tomorrow?

A succession plan doesn't just mean involving your kids in the business. Thinking broadly, a succession plan is an exit strategy that deals with all possible circumstances that could remove you from the business: not only retirement, but also death or disability, or a decision to sell the business instead of giving it to your children. Unless you evaluate every option, you're not going to make the best decision.

Your succession plan may call for Joe Jr. to take over the business when you reach 70. It also should include life and disability insurance to carry on the business, or "wind it down" if you die or are disabled before your child is ready to take over. It might include an Employee Stock Ownership Plan (ESOP) to share ownership with employees, or a strategic alliance in which another business would assume control of your business if circumstances made it necessary.

Succession planning should also include a strategy for liquidating or selling off the business if none of your children want to succeed you. That's the most common succession plan, and probably the most appropriate. The reality is that family members seldom want to go into the business, but frequently would rather use the inheritance to follow their own pursuits.

Who Does the Succession Planning

The key obstacle to succession planning is that most family-owned businesses tend to be one-person shows. The entrepreneurial founder wants to make all decisions—including who will succeed him and when.

The best decisions are made by a group composed of people whose skills you rely on in your business and personal life: your accountant, general counsel, estate planning counsel, insurance agent, financial advisor, bank or trust officer, and your family investment advisor or money manager. Each brings a different set of talents, plus a different perspective, to the table. Working together, they can provide the broad focus that is essential to sound succession planning.

Businesses that don't make the most of the available talent are penny-wise and pound-foolish, reasoning that they don't want to spend a couple of thousand dollars for everyone to sit around a table and talk. But by not doing so, they risk bruised feelings at best, and a once-thriving business dying at worst.

Succession issues really fall under estate planning. A competent estate planner will have tons of business succession planning experience—plus specific knowledge and experience in estate planning. One exception would be a highly specialized business like a dental practice. Then you would bring in someone who specializes in dental practice mergers and acquisitions. That type of person will have contacts with young dentists looking to buy practices and will have many years of experience structuring those specialized kinds of deals.

Making the Succession Plan Work

For the succession to work, two issues must be worked out well ahead of time among parents, children, and your expert advisers.

•  When and how the founder will extricate himself from the business.

•  How the succession plan handles dividing the business among several children, especially when not all plan to enter the business.

It's unrealistic to expect the founder of the business to suddenly walk away one day and never return. The best approach is for the founder to phase himself out of the business—with the succession plan spelling out the time over which the phaseout will occur.

During the phaseout period, the founder should push the successor increasingly into the limelight. Unless the parent tells people, "Go to Joe Jr.—now he's the boss," Joe Jr. will never develop into the leader.

How to Divide Up a Family Business

f there are many children, the path of least resistance is to sell the business and divide the proceeds among family members. One of the least workable things people do is to divide ownership equally among all children—those going into the business and those who are not. That doesn't work very often.

Segregate out the real estate or some other passive asset, and have that owned by the children not active in the business. Everyone shares in the benefits of the business, but you don't have non-working children trying to control children who are in the business.

Another approach involves the use of life insurance. One child inherits the business. Life insurance pays the other children an amount equal to what their share of the business would have been.

Succession plans can run aground when more than one child is given control of the business. Unless the issue is resolved ahead of time, it can lead to destructive infighting. That's why all succession plans should be detailed meticulously while you are still mentally alert. Talk out the succession plan with everyone involved: spouse, children, partners, and any non-family members who will play a key role in the business.

The more key points that are agreed to ahead of time, and the more your estate plan reflects everyone's needs and wishes, the more smoothly the transition will be when you are no longer there.