Roughly 90% of American small businesses are family-owned. But sadly, the majority of these businesses fail to continue on to the next generation.
In fact, only around one-third of all family-owned businesses survive into the second generation, and only a small fraction of those make it to the third generation or beyond. Sometimes, this is because the subsequent generations don’t have an interest in inheriting or running the family business. On other occasions, it’s because they don’t know how to run it.
The problem in either scenario is the same: a failure to plan.
In 1934, a man started a business in New York City to manufacturer children’s coats. He was very successful, but he died in 1972 without having properly planned how the business would continue on without him. His son, who had worked in the family business his entire adult life, was not prepared to take it over, nor did he have the requisite skill set.
So, 12 years after the original owner died, the business was finished, closing its doors in 1984. Estate taxes were not the culprit. Instead, neither the man nor his son ever created a business succession plan. Nor did either have an exit strategy.
Why Owners Don’t Plan
While many business owners have the intent of passing on the family business to one or more of their children, they are often too busy running day-to-day operations and simply do not have the time or energy to consider business succession planning. Moreover, the stress of identifying and then grooming a family member (or employee) you trust to take over your business is a potential hot potato for many families and is, therefore, often avoided.
However, procrastination can be disastrous. Aside from procrastinating, here are some other ways that owners unintentionally sabotage business succession.
• They mistake succession planning and exit strategies to be one in the same.
• They don’t obtain the proper valuation of the business.
• They fail to identify a succession team.
• They don’t integrate their business succession plan with their estate plan.
• They ignore the Four Ds: death, disability, divorce and departure.
• They treat the business like family, rather than a business involving family.
• They fail to diversify their net worth from the business as a whole.
• They don’t plan for all contingencies.
Strategies for Success
There is no quick or easy answer or solution to this issue. However, in most successful transitions to the next generation or the third-party desired successor, owners have taken the necessary business succession and estate planning steps to minimize the conflicts, minimize estate and income taxes, and ensure that the business is in the right hands to maximize the chances of its success.
Comprehensive business succession and estate planning is the best way to improve the odds that your company will continue when you are gone (and possibly to provide the funds for your retirement, if you want to stop work while you are living).
Moreover, if a family member is not going to run the business when you are gone, then plans must be made for the family business to be sold to a third party, either at your death or when you exit your business.
Remember that estates in excess of the amount that passes free of estate tax, currently $5,490,000, are subject to a 40% federal estate tax (plus state estate tax, if you live in D.C. or Maryland). Thus, when doing your business succession and estate planning, you must plan for the need to pay the estate tax.
Where is the source of funds to pay the estate tax? Do you need to plan for liquidity at death, through estate tax planning and/or purchasing life insurance?
The solution to these questions may be setting up a structure within the estate plan that assures that those in the business own and control as much of the business as you want them to — while giving those not in the business other assets (or just an income stream from the business), so they can control their financial destiny, without interfering with the day-to-day operations.
Other Things to Consider
How much is the company worth? This can fluctuate during the life of a business. Should you get an appraisal now?
How long do you want/need to stay involved in the business? Many times, entrepreneurs see themselves as the business and find it hard to let go. There are also cases in which the owner cannot step down because s/he cannot be without the salary, health and retirement benefits being received from the company.
There are ways to plan to allow the owner to continue to receive an income stream, as a part-time employee or consultant, as the family business transitions to the next generations. Another technique is a deferred compensation plan to provide income to the founder.
Alternatively, you can sell or give the business interest to a trust for family members that will pay an income stream to the original owner.
How will the business’s digital assets be managed or transferred? Much of today’s business operations are being run and stored online (financial accounts, passwords, social media content, etc.), so knowing who will receive the business’s digital assets is of utmost importance. How will that person gain access and for how long should s/he have it? In the event that the owner passes away, these details should be spelled out in advance.
General Planning Ideas
• Sell or give assets, possibly including interests in the business, to children (and others) while you are alive.
• Purchase life insurance to provide for liquidity and/or to equalize the estate (the life insurance must be owned by an irrevocable life insurance trust).
• Create voting and non-voting interests in the business to allow for control to be given to one set of family members, while non-voting interests are given to those who are outside of the business.
• Use one or more charitable techniques to minimize income taxes and maximize return.
• Create a buy-sell agreement between you and those children in the business (or with others).
• Create trusts or other structures that control the use of assets after your death or control how business succession is going to occur over successive generations.
You’ve spent too many hours creating and operating your business to allow for it to all fall apart at your death or in other circumstances. Business succession and estate planning is critically important to the future success of your business, as well as to your own personal financial health and wealth.
Gary Altman is the founder and principal attorney at Altman & Associates, in Rockville. He can be reached at 301-468-3220 and [email protected].