Passing the Torch

southern california business attorneys

Mergers and Acquisitions

Passing the Torch

Issues Concerning Business Succession for Family Owned Businesses

THE FAMILY OWNED BUSINESS

In the context of a closely held business, there are a number of practical considerations which, based upon our experience in advising clients, must be considered in planning for business succession. The most common issues are as follows:

• Procrastination. Many of the business succession issues involving a closely held business are very difficult for business owners to clarify, much less solve. This frequently leads to procrastination in addressing succession issues.

However, as is the case with most estate planning, having an imperfect plan in place is better than having no plan at all. A business succession plan can usually be modified as circumstances change. And if that is not the case, the exercise of drafting agreements which implement a formal succession plan will frequently crystallize the issues sufficiently for most entrepreneurs to determine the best solution.

• Management Capability. Typically, owners of closely held businesses believe their business succession plan will consist of their children or heirs “taking over the business.” Unfortunately, from a business standpoint, this solution may not make much sense and could endanger the business.

Although it is difficult for many parents, what is really required is an honest assessment of the management capability of one’s heirs. If one child shows a special skill and can best apply that skill to grow the business in the future, the best business succession plan may well be to leave that child with a larger stake in the business, and\or an opportunity to buy a larger stake in the business, rather than just “splitting the pie” equally.

This is especially true if there are other non-business assets in the estate, such as income property, cash, or real estate that can be used to equalize amounts to other heirs. Even if this is not possible, it may make sense to leave the most capable child or children with voting control. In short, a successful business succession plan must take management capability into account.

• Desire to Manage. Closely related to management ability is whether a particular child or heir has the desire to manage the business. They may very well be perfectly happy in their own business or career, and unwilling to devote the time and effort necessary to manage the business even though they have the skill set to do so.

• Interpersonal Relationships. Abilities and desire aside, another important issue is whether the projected future management of the closely-held company will be able to get along with other key personnel once the founder of the business is gone. Two equally capable children may mix like oil and water. Or, a capable heir may simply be unable to get along with key employees who will be crucial to the company’s future success.

• Summary. There are no easy answers to business succession issues. What is important to realize is that the lack of easy answers should not preclude some disciplined thought about what it will take, from a management standpoint, to permit the business to prosper. That means looking at the business as such, through a lens unclouded by the founder’s role as parent.

It may also involve changing certain actions in the present. My own belief is that one of the most valuable things successful parents can give their children is training and teaching in the skills that made the parent successful to begin with. For a founder, this may mean giving children or other heirs expanded responsibilities now, and having the self-control necessary to step back and let them do some “on the job” learning, when the founder is still around to help.

FINANCIAL ISSUES. There are also a number of financial issues in a business succession plan that are frequently overlooked. These issues include the following:

• Credit Lines and Bank Financing. If the business requires credit lines and bank financing to operate, consideration must be given to what will happen to such bank financing when the founder passes away or retires. Even though heirs are capable of learning the business, the company’s financing sources may restrict future credit simply because they are unacquainted with new management’s capabilities.

Planning in this area may be as simple as making sure those who will ultimately run the business build their own relationships with key customers and financing sources, or may go as far as having a funding program, such as life insurance, in place to provide the needed funds if bank financing is not an alternative.

• Loss of Key Personnel. The loss of a founder may have a severe financial impact on the business. However, even where it won’t, the loss of a founder may cause the future loss of other key people who have personal relationships with the founder, but not successor management. Again, this issue may cause changes in the operation of the business today, including introducing programs of key employee stock ownership which are designed to keep such key personnel on board for the long haul.

• Liquidity and Estate Planning. Finally, the impact of the business and its valuation on one’s overall estate plan must be considered. The smart money really isn’t betting on any repeal of the estate tax, so the integration of the business succession plan with other estate planning must be carefully considered. The utility and cost of life insurance should be formally assessed, as well as whether and how business succession issues will impact traditional estate planning techniques such as the gifting of fractional interests in the business to heirs.