Planning for Succession: Letting Go is Difficult

By Mary Dana Korman and Steve Swartz, McGladrey & Pullen

Seventy percent of family-owned businesses do not survive to be transferred to the second generation in a successful fashion. Some are sold to outsiders or employees; some are liquidated; and some are transferred to the younger generation. Too often because of internal conflict, less than fully competent management and poor decision making, the enterprise fails when the founder is no longer involved. As the founder, it is a depressing possibility to realize that you have spent a lifetime creating and nurturing an organization that has less than a fifty-fifty chance of surviving.

The remedy lies in early succession planning and preparation of future leaders. Often, owners of family businesses avoid planning for succession. Some fear the planning process will bring up some sensitive and uncomfortable issues. Some find it hard to let go. However, it is an imperative step if your company is going to survive.

The succession planning process is two-pronged. It involves management transition planning, and it involves transitioning the ownership of the company. The founder is usually both the owner and the manager of the business, but the generation that follows may have some family members who own but do not manage, some who manage but do not own, and some who are both owners and employees. Therefore, it is helpful during the planning process to divide the problem into two distinct but intertwined aspects.

Overlap of family and business

All too often in a family business, family issues and business issues become entangled. It is difficult to figure out where one begins and the other ends. The result is a hybrid where the stresses prevent either the family or the business from functioning effectively. Recognizing and understanding the complex interaction of the two arenas will help to defuse potential difficulties in the planning of transitions and succession.

In the non-family firm, family and business are two distinct organizations in which its members function. The values and objectives of these two areas are distinctly different.

The family is emotion-based with members bound together by emotional ties, both positive and negative. Everything that occurs impacts the feelings of the individuals. It focuses on concerns for the security and nurturing of its members, operation out of loyalty and protectiveness. Change is minimized to maintain stability over time and to provide continuity for the individuals.

On the other hand in a business, accomplishment of tasks is the bond between members. People work together to get things done and to produce goods and services for the marketplace. Efforts are oriented outward toward the larger community, and members are valued for their competency and productivity. Change is a constant and needs to be exploited as the business works to remain alive in a fast moving marketplace.

Overlapping of family and business factors is inevitable in the family business, making life complicated for the participants and their advisors. If expectations and values are unclear or conflicting, the different characteristics and objectives breed tension and uncertainty. The greater the overlap, the greater the hazards. That same overlap also allows the strengths of the family to service the business. Keeping family struggles to a minimum and out of the business environment requires constant attention. In this context of differing family and business factors, the two dimensions of succession planning must be addressed.

Management transition planning

Management succession is the first aspect that must be addressed. Future leadership requires two primary ingredients: competency and commitment. Providing for corporate longevity is accomplished only if succeeding management possesses both of these ingredients. The following steps will help in planning.

  • Determine critical skills necessary for future leaders.
  • Define job responsibilities and expectations.
  • Assess skills and level of commitment of the next generation.
  • Establish a development plan that includes on-the-job experience plus book and classroom training.
  • Examine performance in a regular and systematic fashion.
  • Establish routine management meetings to include team building

Assessing the potential of future leaders and training them is too important to postpone, leave to chance or approach haphazardly. Creating a training plan is essential for the future success of the company. This training begins with the entry of the younger generation into the business and continues throughout their career. Learning technical skills, human relations skills, management techniques and developing leadership qualities requires systematic attention.

A critical part of preparation requires devising ways to include future successors in the decision-making process. No one becomes a good decision maker if they do not get the opportunity to make decisions, to learn from mistakes and to enjoy the satisfaction of their successes. Thorugh involving the younger members, the senior generation gains confidence in their successors as they see successful, though perhaps different, leaders in action.

Founders face a major change by including others in making decisions. If they want to train a next generation, they cannot get away with being solo in their work style. They must begin to think of themselves as having partners, junior though they may be. Partnering implies talking things over, taking others' ideas and opinions into account and being open to the goals and dreams of others. This confronts the owner with starting the process of letting go of the control previously enjoyed. However, if the desire is for a competent future management team, the tough emotional task of letting go in small increments has to begin early.

Ownership transition planning

The ownership planning process begins with questions that are different from management planning. To begin with, the owner must make the success and safety of the business the first priority, because personal wealth, retirement comfort and job security for family and non-family are tied to the future well-being of the enterprise. Consideration of the needs of the corporation given growth and strategic goals must be foremost.

The owner needs to grapple with how the ownership will be allocated, and to whom. Will there be multiple owners or should the company be owned only by those who work in the company? Will key executives have ownership? Can several owners operate as a team? The answers to these questions will be unique in each situation.

The ownership plan must take into account the needs of the founder for future income to sustain a satisfying life style. How income is paid out and protected, how much is distributed and for how long it is paid are questions that must be faced. The easy situation would be to have ample assets separate from the businesses, allowing financial separateness. Too often this is not the case.

Ownership planning requires clarifying values and desires about equitable treatment in estate distribution to all the offspring. The owner who has only one child who is competent to run the business and committed to taking over has an easy solution. But almost no one is in this simple situation. Most parents want to treat their multiple offspring equitably. Many founders struggle to find an ownership plan that feels fair without undermining the family relationships and the future viability of the company.

When the above issues are dealt with and the tradeoffs between them are accepted by the owner, there is the need to look at the tax consequences. The price that must be paid to protect the company, provide for the future income of the senior generation and treat the offspring equitably is the tax bite. Only professional advisors can develop ways to do what you want to do with the least tax consequence.

Once the plan for ownership is fairly well ironed out, it is in the best interest of the business and the family that those who will be affected by it are informed by the owner in a way that allows discussion of the plan. Nothing makes for more dissension, confusion and distress than to have this aspect of business affairs remain unknown and undiscussed until the time when the owner is no longer present to help others understand the plan.

Ownership transition steps

  • Define your company's future needs. Decide if it will be perpetuated into the next generation or sold.
  • Establish the income requirements of the owner/entrepreneur. How much money do you and your spouse need to retire?
  • Provide for equitable treatment of all offspring. This is the hardest step of all, and it can be a major stumbling block in the process for succession. Often it is helpful to, at a family meeting, ask the next generation about their desires and concerns regarding ownership. This input is helpful when the owner makes decisions.
  • Consider the tax implications of your decisions. Before you take any action, look at all the different scenarios for passing on the business. How much can you give to your children without incurring substantial tax? Should you sell a piece of the business to the children? How about a gift/sale combination? Again, carefully examine each scenario to make the most tax-advantaged decision possible. There is no quick formula to determine to whom, when and how it should be structured.
  • Set a timetable for implementing the plan and stick to it. Nothing breeds stress faster than rolling delays, promises made and not kept. Commitment to a plan for inclusion of others in ownership is essential for the business, your successor and employees.
  • Communicate your plans to the entire family. After you determine the best course of action, it is important to inform all members of the family, including spouses, at one meeting. Everyone needs to hear your plans, which will help avoid misunderstandings and bad feelings if one child is privy to the information before another. This approach also gives family members a chance to discuss the plan and to ask questions.

Conclusion

Succession planning is a careful blend of the needs of the first and second generations, with a sharp eye on the tax implications. It is rarely too early to begin planning for the succession of your company. The worst thing to do is nothing. During the process, keep the lines of communication open with all who are concerned. Understand that there will be emotional reactions that need discussion. If needed, use professional advisors to assist with clarifying objectives and implementing your management and ownership plans. Planning succession will enhance the health of your company and maintain harmony in your family.


Korman Swartz

Mary Dana Korman and Steve Swartz are organizational consultants in the Family Business Group, a division of McGladrey & Pullen. For information on the services, please call (612) 376-9376.

CIRAS News, Vol. 29, No. 4, Summer 1995