9 key questions for an effective family business transition
Children following in their parents’ professional footsteps – or relatives following in other relatives’, as the case may be – is a grand tradition, but how prepared are you to vacate the path?
A panel of private wealth consultants offered their insights based on their experience supporting advisors with business owner clients through family transitions. Here, they offer nine questions aspiring exiters should be asking themselves if they plan to keep their life’s woin the family.
1. Does the person you plan to transfer your business to actually want to take over?
Family businesses are often discussed in the context of a couple of pervasive “rules” – the three-generation rule and the 30-13-3 rule. The former hinges on a finding that just 3% of family businesses made it beyond a third generation of ownership, while the latter prefixes that 3% with the 30% of family businesses that made it through a second generation and the 13% that made it through a third. Both seem to originate from a single 1980s study of manufacturing companies in Illinois.
They’re sobering, but imperfect, stats, and they obscure a more salient fact: most businesses fail; however, on average, family businesses are more likely to succeed. Family ventures tend to outlast other companies – and far outnumber them, accounting for 90% of American businesses according to the US Census Bureau.
But even with the odds in their favor, family businesses are still businesses. One of the keys to ensuring they last beyond a single generation is making sure those next generations want the job. As you plan for a transfer, it’s important to create a “line of succession” that has genuine affinity – and talent – for the work.
“The interest has to be there,” says Lauren Ahern, a director of private wealth premier solutions at Raymond James. “That’s where you start.”
2. Have you set the stage?
Of similar importance is choosing a successor or successors who are already involved in the business and helping to drive its direction. So, if you intend to see your business taken up by a family member who’s not yet an employee, now is the time to add them to the org chart.
3. Does everyone know their role?
When it comes to succession within the family, conflict could be twofold: family member vs. family member, and family member(s) vs. key employees. Heading off tensions starts with clearly defining roles and clearly communicating how those roles will – or won’t – evolve as the successor takes over.
4. Is your financial plan ready for your business's next step?
For Beth Dominguez, a private wealth consultant at Raymond James, step one in exit planning is ensuring a seller really understands their current financial position and factors it into their strategy.
“I once worked with a couple whose goal was to sell their business to their son in two years for $10 million. They didn’t have a plan beyond that, and their son didn’t have capital. But when we reviewed their finances, we found they didn’t actually need any money from a potential sale to more than maintain their lifestyle. That changed their whole view of the process, showed them they could take some time and be strategic.”
5. Who owns the business?
The scenarios Eric Kordsmeier, another private wealth consultant at Raymond James, sees most often are those where two spouses own 100% of the business or where parents own a majority and have gifted smaller percentages to their children. It’s in the latter scenario where things can get tricky.
“When it’s time to pass the business, let’s say, to the oldest child who’s an active employee, are they going to want to buy out their siblings? Are the siblings going to be OK with leaving their future income fate to the eldest? And if you do want to re-establish 100% ownership, how do you negotiate the pricing?”
6. How will you structure the transfer?
There’s no one way and no right way to transfer a business, but with privately held businesses in particular, the strategies can become quite complex.
More advanced approaches include things like transferring ownership interest to a grantor retained annuity trust (GRAT) or gifting company shares to an irrevocable trust or family limited partnership (FLP) and gradually gifting those shares to a successor.
Whatever the strategy, working with professionals to create and communicate a formal plan is key. “There are so many ways this can happen,” says Beth. “It’s really worth working with a professional advisor, particularly those with specialized experience in exit planning.”
7. Have you thought about fairness planning?
If you have more than one child, and you plan for just one or two of them to take over your business, what’s your plan for the others?
It can be hard to override the parental instinct to divide everything up equally. But too even a split can ignore tradeoffs like the ownership risk being assumed by the successor.
So, how do you compensate the children who aren’t taking over? You might explore giving them a larger stake in non-business assets or purchasing a life insurance policy and naming only those non-successor children as beneficiaries.
8. What is your timeline?
Many experts cite five to seven years from a business transition as the sweet spot to start planning. However, many experts advocate for beginning even earlier, up to 10 years out. “It gives you time to really define roles, drive value and create that timeline for relinquishing control,” Lauren says, “which is often the biggest hurdle.”
The other timely element to consider is the age at which you plan to step away. While it can be tempting to stay at the helm of a beloved business for as long as possible, if you want to realize tax efficiencies during your lifetime and leave fewer potential questions marks for heirs – business or otherwise – it’s good to exit with time on your side.
9. Who will you be after you exit?
Knowing how you’ll answer the first time someone asks, “What do you do?” post-exit is critical to ensuring the successful transfer of your business and your own future happiness.
According to Beth, “A very high percentage of business owners who sell and don’t know what they’re doing next, regret selling. So, you really need to look forward and decide who you’ll be when you aren’t the owner of this business.”
Raymond James does not provide tax or legal advice. Please discuss these matters with the appropriate professional.