Succession plans critical to family-owned business

WASHINGTON (June 2, 2016) — Is the deck stacked against family-owned businesses? Statistics seem to bear out that harsh reality. Only a third of those entities successfully make the transition to a second generation.

By the third generation, 95 percent of family businesses are under new ownership.

This means that owners of family businesses — if they are truly serious about their businesses staying in the family — cannot begin soon enough to establish a succession plan, according to Michael Evans, national managing director of the Newport Board Group, a nationwide business strategy advisory firm.

Those family members must make sure a company's plan for the future is as airtight as possible, he said.

Sometimes the negatives in a family business doom a family succession plan at the start, according to Mr. Evans. The next generation may not be interested in continuing to operate the business, or capable of taking it over, or family disagreements can cripple attempts to maintain the business.

“You need to run the business as a business first, with appropriate family participation,” Mr. Evans told Tire Business.

“But there are examples both ways. Bill Ford still leads Ford (Motor Co.), while Warren Buffett took over (H. J. Heinz Co.)”

A well-run family business enjoys advantages that other businesses do not, according to Mr. Evans. It earns tremendous market advantages through the goodwill of customers, communities and employees, and it can establish a significant presence in industry segments across the U.S. economy.

But many family businesses also have issues, cultures and traditions that complicate the issue of succession, he said.

To ensure a smooth succession, family businesses must balance family and business values, with succession plans that take into consideration the overlapping roles and responsibilities of family members.

Hard to hate people you know

To be effective, a family succession plan must be one with a multiple yet unified vision, according to JoAnne Norton, consultant with the Irvine, Calif.-based Family Business Consulting Group.

“There must be a vision for the family, a vision for the business and a vision for the ownership,” she said. “And there should be alignment among all three.”

To simplify that idea for her clients, Ms. Norton often uses the analogy of a Thanksgiving dinner.

“The vision for the family at Thanksgiving is that you sit around the table and enjoy each other's company every year for generations,” she said. “If that's what you want, the business vision is that you can afford the turkey every year. And the ownership vision means that whatever you do in the business, you don't make people so angry that they don't show up.

“You've got to be very clear about your vision for all those areas,” she said.

To make such a vision for a family business come true, there is no substitute for strong family relationships, according to Ms. Norton.

“Liking each other is a huge part of working together,” she said. There should be the usual family get-togethers, but there also should be frequent meetings to talk about the business and keep everyone informed. These can be as informal as a family breakfast once a week, she said.

There should also be a meeting at least once a year to discuss ownership and succession.

“It can be a big family reunion,” she said. “You talk about how the business is doing, and the leader invites all the qualified family members to join the business.

“With the new electronic world, face-to-face communication has become undervalued,” she said.

Ms. Norton said she grew up as a second-generation member of a family business. “My father and his two brothers succeeded so well because they had such fun together,” she said. They had traditions such as a family band and regular pinochle games.

“The idea is that it's hard to hate people that you know,” she said.

Ongoing communication

In a recent presentation, Mr. Evans and his colleague Caleb White emphasized the need for family businesses to have well-functioning governance structures.

Family businesses, according to Messrs. Evans and White, must get consensus on the values, mission and long-term vision of the business, and communicate them to family and non-family stakeholders.

The governance structure must stress keeping family members—especially those who aren't executives—informed about the business' major accomplishments, challenges and options.

Any rules or decisions that affect family members' employment, dividends and other benefits must also be communicated, they said.

The governance structure must contain guidelines for electing family members to the company board of directors; for helping family members gain educational and professional training; and to help resolve conflicts between family members within a defined scope, Messrs. Evans and White said.

The governance structure should also build family consensus on fundamental issues, they said, such as:

• Principles for the best short- and long-term outcome for the business, the family and other stakeholders;

• Prospects for the business, including its viability in the market and its capital needs;

• The role of the family in company ownership and management, including the next generation;

• Whether to bring in management from outside the family; and

• How to grow the company while serving family interests.

Once the governance structure is established, family business owners must start the formal succession plan as early as possible, Messrs. Evans and White said, noting that as soon as a new CEO is appointed plans to identify the company's next succeeding CEO should begin.

Business owners should seek objective advice from independent directors or non-family executives, and involve key stakeholders in the selection process, they said. They should also develop a clear transition plan between the current CEO and his successor, including the current CEO's level of involvement after he or she retires.

“Succession problems are the main reason family businesses fail to reach the third generation,” they said.

Selecting the board of directors is also crucial to governing and maintaining the business, Messrs. Evans and White said.

The board of directors must include a few outside, independent members, they advised, because independent members bring an outside perspective on strategy to the operation, as well as new skills, objectivity in resolving disagreements and connections that can help the business.

Tax tips

Today, companies have many choices in funding a CEO's exit and selling the business back to family members, according to Messrs. Evans and White. The forms of sale include installment sales, private annuities and family Employee Stock Ownership Plans (ESOPs).

However, family businesses must be mindful of income tax considerations in making those transfers. “Business interests transferred between family members must be fair market value, and conditions should be arm's length,” they said.

One major pitfall, Mr. Evans said, may occur if the corporation redeems its stock and the retiring CEO remains within the corporation as a director, officer or employee.

“If the retiring owner still has his foot in the door, the Internal Revenue Service (IRS) will treat the purchase price of his shares as a dividend instead of a capital gain,” Mr. Evans said in a telephone interview with Tire Business.

“That means the entire purchase price will be subject to tax.”

Estate taxes also can create problems in the transfer of a family business, according to Mr. Evans.

The current exemption threshold for estate taxes is $5,450,000, according to the IRS.

Further exemptions and deductions are available under IRS rules.

“The estate tax has never been a big revenue raiser, and only about 3,000 families in the entire United States are subject to it,” he said. “But both Hillary Clinton and Bernie Sanders are lobbying to raise the estate tax.” Congressional Republicans, he added, have shown little will to repeal the tax, as many small business associations have lobbied for.

However, family business owners can alleviate transfer taxes through various methods, he said. These include:

• Annual exclusion gifts of up to $14,000 each ($28,000 for married couples) to as many receipts as the business owner wants;

• Gift tax exemptions that remove the income and future appreciation on the gifted property from the business owner's estate; and

• Family business liability companies (FLLC) that can be valuable in transferring a business to children at a discount from the value of the underlying assets owned by the FLLCs.

According to Messrs. Evans and White, airtight shareholder wills and trusts are critical to family business succession. Creating a revocable trust to hold stocks avoids delays on ownership transfers and reduces costs, they said.

“Have clear provisions as to whom the stock will pass to upon death,” they said. “You will have done your family a great disservice without making your clear intentions known—and why.”

Best laid plans

Even the best, most carefully prepared succession plans can be derailed because family business owners haven't committed to a long-term strategy, according to Anne K. Smart, director of the Family Business Center at Loyola University's Quinlan School of Business in Chicago.

“The leap from believing one's own view is best, to including the family in planning for their shared future as owners/managers, requires a commitment to family business education and a belief that we can pass the business on to responsible shareholders and managers,” Ms. Smart told Tire Business.

While planning is essential, so is commitment to a process that includes input from the next generation, according to Ms. Smart.

“Research shows successful succession correlates with strategic planning and governance of the business, as well as a strong commitment to family meetings and family business education.”

Working with professional advisers who understand the current generation's commitment to sustained family ownership is crucial, she said.

“The oldest and strongest family businesses understand that family unity and cohesion is their greatest strategic advantage, and they invest consistently in building and sustaining both their business and their families,” Ms. Smart said.

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