Succession Planning for the Family Business
In many estates, a major portion of the assets of the estate is a family business. Family businesses can take many forms such an operating company like an automobile dealership, a restaurant or various other types of operating businesses. Family business can also be in the form of commercial real estate projects such as office buildings or shopping centers or even land for development. In some cases, family businesses consist of both, for example a retail business such as a hardware store (the operating company) and the land and building which is occupied by the hardware store (the commercial real estate). These two types will likely be held in different legal entities, possibly with different combinations of family member owners.
Often, the family business was started from scratch by the family patriarch and/or matriarch who through hard work and dedication over several decades has produced one or more very successful family businesses. In many cases, some or all of the children (and even possibly grandchildren) have grown up in or around the family business and have contributed to its success as well. Some of the children may have become involved in the family business as adults as a career while other children may have pursued independent careers of their own, not related to the family business.
As the founding parents of the family business age, the question arises as to what will be the future of the family business as the parents decide to slow down or retire and eventually upon their passing away. One answer for certain families may be an outright sale of the business to third parties such as a management team or outside investors while the founding parents are still alive. In such cases, a sale of the business is the succession plan and the proceeds of the sale become part of the founding parents’ estates to be addressed however they choose in their estate plans.
In other cases, rather than outright selling the business, the founding parents wish to pass the family business along to some or all members of the next generation of family and possibly on to a third generation in the future. This topic is what we typically refer to as “Family Succession Planning.”
Unfortunately, absent careful advance planning on the part of the founding parents and the other family members, statistically the chance of successfully passing the family business on to the next generation is not good, considerably less than a 50% success rate by some studies. Even worse, passing the family business on to the third generation faces even more dismal statistical odds.
Family politics and dynamics is a critical factor in whether or not a family business can be successfully passed on to the next generation. Members of the next generation may occupy different roles in the future of the family business. For example, some family members may be active, hands-on business managers. These family members are the operational family members. Other family members may have no active role in the management and operation of the business at all, but they will have ownership and economic stakes in the family business if they hold shares which are inherited from the founding parents. These are the family business ownership interests. Often, some family members hold both kinds of interests – that is operational interests as well as ownership interests. Not surprisingly, these two groups of interests within the family business are likely to have divergent goals, priorities and points of view, particularly when it comes to issues such as compensation, employment, allocation and/or distributions of earnings and risk appetite for such things as debt, expansion, and other kinds of business risks and potential future sale of some or all of the family business.
In order to plan for, address and try to resolve these kinds of future divergent interests and priorities, the founding parents need to carefully address in advance the nature and types of ownership in the family business. Some of these issues include for example, (1) voting vs. non-voting shares, (2) common vs. preferred shares, (3) buy-sell agreements restricting the rights of sales to outsiders or other non-family member and so on. Equally important, the corporate governance structures of management of the family business going forward after the founding parents have passed on needs to be carefully planned for in advance. Some of these issues include (1) membership on a board of directors, (2) officers of the family business, (3) who is in charge of the management of the family business, (4) how management can be changed as well as (5) what types of decisions (qualitative and quantitative) can be made by whom with or without the consent of those family members holding only ownership interests.
Usually as long as the founding parents are alive and hold at least majority stakes in the family business, the ownership and corporate governance structure of the family business will be more or less left up to the founding parents to dictate. But once they pass on, ownership and corporate governance decisions become very real and if they have not been addressed and resolved before the founding parents pass on, this failure may well be the fatal flaw in the hope for a successful family business transition to the next generations.
We recommend careful consultation by the founding parents with experienced advisers such as experienced legal counsel, accountants, bankers and other financial planners, in order to discuss and understand the nature of the family business, the nature of family dynamics of the next generation, the expected management versus ownership of the family business into the future, all with the goal of accomplishing a successful transition of the family business on to the next generation(s) of family members.