If you are an owner in a family enterprise, the likelihood of your business successfully transitioning to the next generations is not very good. This has not changed over the years. Statistics show a failure rate of:
- 67% of businesses fail to succeed into the second generation
- 90% fail by the third generation
With 80% to 90% of all enterprises in North America being family owned, it is important to address the reasons why transition is difficult.
Why does this happen and what can you do to prevent it?
Family enterprises are often put at risk by family dynamics. This can be especially true if the family has not had any meaningful dialogue on the succession of the business. And, while we are throwing around statistics, it has been estimated that 65% of families have not had any meaningful discussion about business succession.
- Family issues can often hijack or delay the planning process. Sibling rivalries, family disputes, health issues and other concerns certainly present challenges that need to be dealt with in order for the succession plan to move forward.
- Many times a founder of a family business looks to rely on the business to provide him or her with a comfortable retirement while the children view the shares of the company as their inheritance.
- Sometimes an appropriate family successor is not readily identifiable or not available at all.
- In these times a decision needs to be made as to whether or not ownership needs to be separated from management, at least until the second generation is willing or capable to assume the reigns of management.
- If the founder needs to receive value or future income from the business a proper decision as to who is running the company is vital. If this is not forthcoming, then there may be no other alternative but to sell the company.
When planning for the succession of the business an important objective is to reduce income tax on the disposition (sale or inheritance). One of the methods is to implement an estate freeze which transfers the future taxable growth to the next generation. The corporate and trust structure utilized in this strategy may also create multiple Small Business Gains Exemptions which can reduce or eliminate the income tax on capital gains.
Just as it is important for a business owner to plan to reduce taxes during his or her lifetime, it is also important to maximize the value of the estate by planning to reduce taxes at death.
Minimize Management and Shareholder Disputes
This can be accomplished with the implementation of a Shareholders’ Agreement. Often there are multiple parties that should be subject to the terms of the agreement, including any Holding Companies or Trusts that may be created to deal with the tax planning issues. The Shareholders’ Agreement will include the procedures to deal with any shareholder disputes as well as confer rights and restrictions on the shareholders.
The agreement should also define the exit strategy that the business owners may wish to employ.
Often the family business represents the bulk of the family fortune. There are times that one or more children may be involved in the company while the other siblings are not. Proper planning is necessary to ensure that the children are treated fairly in the succession plan for the business when the founder dies.
One method often employed in this regard is for the children active in the business to receive the shares as per the will or shareholders’ agreement while the non-business children receive other assets or the proceeds of a life insurance policy.
Founder’s Retirement Plan
It is problematic that often a business owner’s wealth may be represented by up to 80% of his or her company’s worth. It is important that the founder develop a retirement plan independent of the business so that his or retirement is not unduly affected by any business setback.
Protecting the Company’s Share Value
Risk management should be employed to provide for any unforeseen circumstances that would have the effect of reducing share value. As previously mentioned, if the bulk of a family’s wealth is represented by the shares the family holds in the business, a significant reduction in that share value could prove catastrophic to the family. These unforeseen circumstances include the death, disability or serious health issues of those vital to the success of the business, especially the founder. Proper risk management will help to ensure that the business will survive for the benefit of future generations and continue to provide for the security of the founder and/or his or her spouse.
Since the dynamics of family businesses differ from non-family firms, particular attention is required in the planning for the management and succession of these enterprises. This planning should not be left until it is too late – it is never too soon to begin.