How business owners can prepare themselves now for eventually handing over the reins to their successors.
Business founders typically devote years to building their companies. Many want their firms to continue beyond their lifetimes, managed by their children and possibly future generations. If this is your desire, then you will want to devote the same kind of energy, thought and planning that it took to build your business to help you successfully pass the baton and leave behind a sustainable legacy.
You'll need a well-thought-out plan to ensure all goals are accomplished: yours, your family's and your business's. A vital objective of making this multi-faceted plan is to set the stage for family harmony.
Developing a mission statement for the business is a great first step. This can cover the values of both the family and the business, providing a vision of what will be expected of the next generation of leadership. Knowing where you want to go helps you to get there eventually. It is therefore important to articulate what your goals are for your immediate family, for each extended family member and for the business. Only then can you assess where these various goals converge — and possibly diverge.
Businesses are more likely to succeed into the second, third, fourth and even fifth generations when they have prepared for these five critical issues:
• Sudden events: Successful legacy businesses have contingency plans for a sudden management change, just as they do for other catastrophic events. You must regularly review and revise these plans as circumstances evolve.
• Orderly transition: Even if the current owner's withdrawal from the business is not expected to occur for a decade or more, management needs to acknowledge and prepare for succession. This preparation entails having a formal succession plan, creating appropriate legal documents that can effectively make the succession plan a reality, formally training interested younger family members and integrating them into the business.
• Liquidity/estate taxes: The U.S. estate tax rate is 40%, and payment is usually due nine months after a person passes away. If that is not planned for, then this federal tax liability can be a tremendous burden on a business, severely limiting the possibility of reinvestment and distributions to shareholders. Even if the estate-tax payment can be deferred, the principal and interest due in later years can hamper a business's competitiveness. Many families are forced to liquidate a business to pay the estate taxes due on it — often in a hurry and for less than the business's full value. It's vital to take action now to help reduce the estate taxes that will be due.
• Concentration: One of the greatest threats to long-term shareholders of a business is concentration. For example, the business itself can be overly concentrated in a product, a select customer base or an individual supplier. Concentration of personal wealth in private company investments is an equally critical issue. Nothing better illustrates the potentially unfortunate consequences of this risk than the experiences of many closely held businesses during the financial crisis of 2008. Many businesses of all sizes were forced to dramatically reduce or stop distributions to shareholders or beneficiaries. Some were forced to shut down.
• Family involvement: Successful family businesses anticipate and work to defuse potential family discord long before it arises. They do so by proactively addressing typical, systemic causes of such discord, taking into account the potential complexity of family-business systems. These include policies on compensation, qualification to work in the business, minimum distributions and sale restrictions.
These are the five key elements that are essential to creating a business-succession plan that will help your family continue to thrive after you've retired. Make sure to establish and follow policies regarding distribution, control, advancement, entrepreneurial vitality and escape clauses.
Passing along control in a family business can be fraught with all of the various challenges that families and businesses face separately, complicating matters in unexpected ways. But with careful thought and planning, you can successfully pass the torch to family members and ensure that many successive generations will carry it.
Steve Faulkner is the head of private business advisory in the Advice Lab at J.P. Morgan Private Bank.
