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Family Business Succession Planning

Date: Jun 6 2010
Author: Rob Adkin

With the leading edge of the baby boomer generation about to hit the age of sixty-five in the next year the issue of retirement and business succession is becoming a common topic of conversation. In the majority of cases the issue of “when to retire” is driven by the reality of “how much is enough to survive on comfortably.” For those working for the government or businesses with pension plans, the decision often comes down to a formula based on one’s age and the number of years worked. For most private business owners the issue can be much more complicated.

Succession planning is an issue that cannot be ignored. We all want to retire and enjoy a comfortable retirement. The longer one avoids dealing with the inevitable the greater the obstacles become. Ideally an individual should start planning an exit strategy ten to fifteen years before their planned date of retirement. Unfortunately most business owners are still too occupied with growing their business at that point to focus much of their energies on retirement.

The simple answer is that you have to start your planning sooner than later. The following are a few of the basic matters that you should be considering. The list is by no means exhaustive.

  1. You must seriously evaluate if there is anyone in the family that is capable of taking over the operation of the business. Your family members have grown up with the business and would presumably have significant insight into how it is run. This is not always the case however. Statistically, family succession does not have a very good track record. Most family businesses do not survive through two generations. You need to consider the immediate members of your family and determine if they have the aptitude, skills and, perhaps most importantly, the desire necessary to run the business.
  2. In the event one of your children has the ability to take over the business you must then decide how to deal with the other children. Most parents attempt to deal with their children equally unless there are very strong reasons to the contrary. If the family business is the major asset of the parents’ estate it would be very unfair to leave the entire value of the business to one child. Unfortunately the business, while successful, may not be capable of supporting the financing required to pay out the other siblings. One solution might be to separate the real property or capital assets of the business from the operational end of the business. The business could lease the real property or equipment from the family company and leave the business income in the hands of the child actually operating the business. This likely would involve a reorganization of the business structure. It takes a great deal of forethought to set up a system that rewards the hard work and initiative of the child that works in the business but is still fair to the other siblings.
  3. You must be prepared at some point to actually turn over the operation of your company to one or several of your children. It is often difficult for a parent to relinquish control of the business that they have built. It is possible to transfer control of the business gradually. The parents can transfer the future growth of the business to one’s children but still retain voting control of the business. Over a period of several years control of the operation and management can be shifted to the next generation. This obviously requires planning and an agenda. Once again it is important to start this thinking process sooner rather than later.
  4. If you do not have a child capable of taking over the business you are faced with the dilemma of finding a buyer. One cannot assume that when you finally decide to retire a willing purchaser is suddenly going to materialize. Finding a buyer, the right buyer, is going to take some time, particularly if your business has a significant value. You may have to be creative in order to find the right party. It is possible that the answer might be right before your eyes. Your employee base could very well contain your best candidate. Likely there is someone in your organization who has the skills necessary to run your business. With good planning you can nurture your successor. The main problem an employee is likely to face is raising the capital necessary to buy you out. If you start the process soon enough you can bring that person into the management of the business and eventually the ownership of the business. This might start out as a profit sharing structure and then gradually develop into an equity position. Again you could separate some of the more costly assets of the business into a separate company and lease these back to the operating company. This would reduce the amount of capital necessary to buy the business initially. You could consider vendor financing as well with terms that are more attractive than those provided by a financial institution. You could also grant the individual a right of first refusal or an option to purchase the real property or equipment at some later date.
  5. To paraphrase an old adage “time waits for no person”. There is no time like the present to start preparing for your retirement and business succession. The first thing to do is to get some good legal, accounting and financial advice. No matter what steps you take there will be income tax ramifications. You have to know these consequences before you make any decisions. You have less time than you think so best to start planning today – even if you think that retirement is twenty years away.