America’s business community is built on family-owned businesses. More than 90 percent of all businesses in the United States are family owned, and together they employ more than 62 percent of the private sector workforce. Two-thirds of the nation’s gross domestic product is produced by family-owned businesses. Further, over the last 20 years, more than 80 percent of the net new jobs created in the United Stated were created by family-owned businesses.
Most business owners want their businesses to survive them, and the vast majority, exceeding 80 percent, want to pass their businesses on to their children or other family members. Unfortunately, the statistics regarding the continuation of family-owned businesses are not very good. Around 70 percent to 80 percent of all businesses fail to survive to the second generation. Of those that do survive, only 12 percent make it to the third generation. These failures are detrimental to the family of the owner because more than 50 percent of the family’s net worth is commonly tied up in the business.
The number-one reason these family-owned business do not survive is the lack of a viable succession plan. A succession plan is the development of talent and leaders to meet the needs of the business now and in the future. A successful succession plan requires time and effort. Leadership continuity is critical to the continued success of a small business that is independently and family owned. As a lawyer representing these businesses and their owners, you can help ensure the continuity of family ownership by helping your clients develop and implement a succession plan.
Why a Succession Plan Is Needed
There are many reasons why the owner may not be able to continue to operate the business and needs to have a replacement waiting to take over. Owners never know when they may die, become physically incapacitated owing to an illness, or have some type of psychological breakdown. Owners might also become bored or tired, lose their excitement about the business, or want to do something different. Legal or financial problems can also arise that require the owner to be replaced immediately by a successor. There have even been cases where the owner has, without notice, walked away because they had had enough and wanted to go into immediate retirement. Whatever the cause, eventually a successor will take over for the original owner of the business. And the point is, one never knows when that successor will need to take over. If the owner of the business wants to maintain ownership as opposed to selling it to another, it is vital to have a succession plan in place.
There are several competing interests when the owner does need to retire. If members of the family are also employees, they might feel they should be the successors. Also, if the owner has several children, each of them may feel he or she should be put in charge of the business. Additionally, there may be non-family employees who, because of their length of service or importance to the business, want to become the successor to the owner, or at least obtain a stake in the business. Even when no family members of the owner are actively involved in the business, family members may still apply pressure because they want to ensure that they will end up owning the business if something should happen to the owner.
Nevertheless, many business owners never put a succession plan in place or give it much thought. They may believe they have plenty of time to do so, or they may fear they will offend family members if they pick one over another as successor. But the owner must early on determine whether there can be a successful transition to the next generation of the family and, if this is possible and desirable, how best to pick that family member or members. It is interesting to note that the average life span of a family-owned business is approximately 24 years, and this is also the average time the original owner is at the helm of the business.
Every business owner needs to implement an effective and complete succession plan. A succession plan is essential for knowledge and technology transfer, to develop leadership, to manage risks, and for the sustainability of the business. Without a succession plan, a thriving and growing business can go into a death spiral within weeks of the founding owner’s passing—the default plan might simply be that the family sells the business or liquidates it for its asset value.
The Succession Plan
Develop a team of advisors. The business owner needs to control the succession plan from beginning to end. After all, it is the owner’s company, and therefore he or she needs to control the management continuity strategy. The owner can select to do this in one of two ways. The owner might work only with selected family members to help decide on a successor. Alternatively, the owner might bring in professional advisors such as an attorney, CPA, business coach, transitional business consultant, and business experts in the industry who know what qualities are imperative for a successor to possess. Often the owner will find it beneficial to combine both strategies and select a successor based on input from both the immediate family members and professional advisors.
Identify the qualities a successor must possess. Once the owner has the team of advisors in place, he or she must identify those qualities that the successor must possess in order to successfully run and operate the business. Depending on the type of business, there could be some very specific and highly technical qualities that must be possessed by the chosen one. Such qualities would be ascertained by the owner and the advisors as part of the succession plan. However, there are many qualities that the successor must possess that are common to all businesses. For example, the successor must have a complete knowledge of the business he or she is to run and operate, or at least the ability to acquire this knowledge within an acceptable time frame. Further, the successor must possess the traits of enthusiasm, persistence, determination, willingness to learn, and basic intellectual capacity. Other qualities would include the ability to plan and organize and to solve problems, an eye for detail, good health, plenty of energy, and a gung ho attitude. And, without question, the successor should have a passion for and huge interest in the business and must want to ensure its continued success.
Identify the successor. Once the first and second steps of the succession plan have been completed, it is now time to identify potential successors. Often the owner will assume that his or her children will want to take over the business and be the successor. However, the owner of the business must identify the right successor for the business whether or not it is one of his or her children or another family member.
The owner should make it clear to each of the children and other family members that he or she is not required to join the business on a full-time basis. Also, it might be appropriate to give the potential family member successor the opportunity to work outside the business first to gain valuable skills in other business settings. (This was done with the grandchildren of the founder of the Chick-fil-A restaurant chain.) The owner must realize that the successor may or may not come from within his or her family. Further, if there are two strong contenders for successors, the owner could pick both of them to be the successor and make both responsible for the effective operation of the business upon the owner’s retirement.
Train the successor. Now that the successor has been picked, the owner must train the successor by transferring knowledge to him or her gradually over time. Depending on the business, the owner will need a transition period of one to three years to adequately train the successor. The successor must learn everything about the business—its most important customers, key suppliers and vendors, and other people who have contributed to its success. The owner must convey the key factors that led to the business’s success, along with the key factors that will lead to success in the future. As much as possible, the owner must document all his or her knowledge and processes so that the successor will know how things are done and why. Much of this knowledge should already be contained in the operations manual maintained by the business. However, the owner will still contribute much knowledge regarding the successful operation of the business that is not contained in the operations manual and other materials used to run the business.
Gradually the owner must show trust in the successor by delegating more and more responsibilities. The owner must realize that the successor may make mistakes from time to time, and that the owner will need to be there to assist in correcting these mistakes and turn them into learning experiences. Further, the owner must provide the successor with appropriate documents to efficiently operate the business. These documents include financial statements, insurance policies, key contracts, and corporate and/or other business documents that dictate how the business is to be run. The owner should also provide the successor with any and all documents dealing with local, state, and federal rules, regulations, and laws that must be adhered to in the proper, legal, and efficient operation of the business.
Initially the successor will shadow the owner and just watch the owner. Gradually the owner will delegate more and more responsibilities to the successor. This transition period also allows the business’s other employees and its customers, suppliers, and vendors to develop confidence in the successor as well. The end result is that all parties come to identify the business with the successor as opposed to the original owner.
Plan for legal and tax issues. Finally, the succession plan must be structured in such a way as to minimize the impact of estate, gift, and inheritance taxes on family members and the business. Business owners who fail to consider the potential impact of death taxes could easily force, upon their passing, their remaining family members to sell the business just to pay the estate’s tax bill. It is critical to involve a tax attorney and a CPA who specializes in valuation of businesses and taxes to determine which vehicles are best to minimize these taxes. Vehicles to consider include family limited partnerships, an estate freeze, various types of trusts, lifetime gifting, and buy/sell agreements. The owner must consider these issues with competent legal and tax counsel, and any further discussion of these types of legal options is beyond the scope of this article.
A business owner should already be implementing a succession plan upon the start or purchase of the business. We are not promised tomorrow. One never knows when a successor will have to take over in a pinch and long before expected. The only constant in life is its unpredictability, so one must be prepared with a written succession plan that can effectively meet the challenge. It is always better to be proactive than reactive. Developing a succession plan is involved and time consuming because there are many moving parts. The succession plan must be written down to ensure its success. It needs to be updated and adapted on a regular basis. This helps take emotion out of the decision-making process and in its implementation. Granted, not all business owners are looking to develop a succession plan—they might have already decided to sell the business to a third party (which could include a family member) or just to liquidate it. In this situation there is a whole host of other issues that must be addressed that are beyond the scope of this article. Yet, it is amazing how people always insure their large assets (house, car, etc.) from loss of value and/or destruction but seldom do business owners insure the value of their largest asset, their business, from loss of value and/or destruction. Perhaps the best form of such insurance is to put in place a viable succession plan.