From the very beginning, entrepreneurs have a plan for their business to succeed. They set goals and develope approaches to accomplish those objectives. Their business has stood the test of time because they anticipated difficulties and resolved them. But if they plan for success does not include how to pass the family business on when it is time for them to step away, their future generations will not be in the best position to carry on their successful legacy.
For small family businesses that survived the pandemic and are now grappling with a tough economy, succession planning may not seem like a top priority. And if lack a succession plan for business, are not alone. Yet the closer you are to retirement, the more pressing the need is to not only talk about business succession with your family, but to have a written plan in place.
Succession Planning Is One of the Biggest Issues Facing Family Businesses
Finding and retaining good employees, fending off competition, high inflation, and labor shortages—small businesses face a lot of challenges. On top of that, there is another challenge that some do not see coming: how will the business continue to thrive once the founding generation is no longer involved?
Business succession planning is a strategy for passing on control of your company. For many family-owned businesses, this means transferring management and ownership to the next generation. In fact, roughly seven out of ten family businesses say they would like to pass their company on to their heirs.
Maybe it was your plan from the beginning to create a multigenerational enterprise. Or perhaps keeping things in the family rather than selling is a more recent goal. In either case, your vision may be lacking a key component: a practical plan to successfully achieve your goal.
The percentage of small businesses that lack a succession plan varies from source to source and from year to year. For example, a 2016 PwC family business survey found that 43 percent of family business owners lacked a succession plan. The Dayton Daily News reported in 2021 that 75 percent of small businesses did not have a succession plan.
Accordingly, many small businesses are not prepared for a handoff—either because they have not thought about it, have not properly documented it, or both. Many of us have seen the daunting statistic that only about 30 to 40 percent of family-owned firms survive to become second-generation businesses. The key to beating the odds and successfully passing down your business is to create a plan and act on it.
Steps for Family Business Succession
We are in the midst of the greatest wealth transfer in American history. The Wall Street Journal notes that older generations will pass on around $70 trillion between 2018 and 2042. As Baby Boomers reach retirement age and step away from their businesses, they are facing the realities associated with business succession.
Some realize too late that they do not have a legitimate succession plan. The earlier you start planning, the better. Your business was not built overnight, and ensuring it survives after you step down also will not be done in a day. Whether you are getting an early jump on succession planning or are making up for lost time, here are some considerations to help guide a smooth transition.
Have a Multiyear Plan
The best time to start thinking about succession planning for your family business is when you start the business. The next best time is now. Ideally, you should prepare for succession at least five to ten years before your retirement. That should give you enough time to identify who in your family will take over particular roles, train them for the job, and make sure that you have the correct documentation.
Ownership Track versus Management Track
Part of succession planning is having a realistic outlook about which individuals are best suited for certain roles. Good managers do not always make good owners, and vice versa. Some family members who may have an ownership interest may not be well-suited to manage the business. Also, some may be great at running the business day-to-day but lack the knowledge and foresight needed for long-term growth strategizing.
Ideally, the family members you have in mind for future management and ownership are currently working for the company, but you should not limit yourself to people already involved in the business. For example, you might have a grandchild earning an MBA from a top business school who has demonstrated wisdom and leadership beyond their years.
Also, do not rule out having nonfamily members, including current employees, take over key management roles in the business. The business can remain family-owned and operated even if people outside the family have important positions.
Separate Blood from Business
Loyalty is one aspect of a family business, but it should not come at the expense of competency. Businesses operate best when the best people are hired for the job. A person’s place in the family business should be earned—not given. A family member may feel it is their birthright to take over a particular role, but if another person is better suited, you might have to choose what is best for the business even if it results in hurt feelings.
Enter your succession planning with the understanding that you are not going to please everyone. One of the toughest parts of a family business is separating the personal and the professional, which is easier said than done. Consider bringing in outside advisers such as lawyers, tax experts, and wealth advisers to facilitate family discussions and provide a business-first perspective.
Plan for the Unexpected
A major component of planning for the future is expecting the unexpected. Your years in business have taught you that things rarely work out exactly as you expect. In addition to a plan, you need contingency plans, and this extends to your succession planning.
For example, suppose that the child that you hand chose and trained to take over a leadership role in the family business has a change of heart and accepts a job offer from another company. Or, maybe the person you first thought was right for the job is now showing qualities that give you pause. These scenarios show the importance of having backup plans and retaining the right to change your mind as succession planning unfolds.
And, it is not just others that you need to plan for. Succession planning includes planning for retirement, as well as death, injury, and illness. Let’s say that, upon your retirement, you plan to temporarily retain company ownership as the next generation of management steps into place, but you unexpectedly die or become incapacitated. What happens then? A succession plan that addresses multiple contingencies is stronger than one that relies on everything occurring without a hitch.
Document the Transition
You have spent years putting together the perfect succession plan. Management successors have been chosen and have been taking on more responsibilities with daily operations. You know who will take over company ownership and have identified when the handoff will take place. You have thought extensively about integrating your business succession plan with your estate plan in the most tax-efficient manner. There is just one problem: none of it is in writing.
A succession plan that is not in writing is not really a plan. You would not dream of doing business deals without contracts and other supporting documentation. Treat your succession plan the same way by formalizing it through documents such as shareholder agreements, operating agreements, employment contracts, and buy-sell agreements (which can be used if one or more family members buy out the ownership stakes of other members). These documents should align with your estate plan to avoid any potential legal conflicts.
We Can Help with Your Business Succession Planning
As you plan for succession, keep in mind that you do not have to wash your hands of the business entirely. You could remain an owner in the company and help to ease the transition from one generation to the next while receiving business income. You could also serve as a paid company advisor or continue to invest in the company postretirement. It might be necessary to sell some company assets to fund your retirement.
Whatever your plan is, the earlier you start developing and acting on it, the higher the likelihood of a smooth transfer. No one plans for their business to fail. But without a succession plan, the next generation of leadership might not succeed in carrying on the family legacy.
Our business attorneys can help you beat the odds by advising you on every aspect of succession planning, from leadership grooming to documentation to tax considerations. Call or contact us to set up an appointment.