Succession Planning for the Next Generation

This particular post will deal with the challenge of transitioning a successful business to the next generation. It is designed for all those who face the challenge either as a business owner or as an adviser. It can ultimately have a sway in the type of M&A deal the various owners choose to take.

Here’s the situation. Mom and dad have labored a lifetime building a profitable business that services a market niche and regularly delivers a paycheck to many hardworking employees. On paper, most would consider them rich but they fully appreciate that the bulk of their wealth is tied up in a business that could be derailed by changing market conditions, a breakthrough technology, a new tenacious competitor, sloppy management, or a host of other factors. They have witnessed the demise of other businesses that were all considered rock solid at some point in their existence.

The time has come for mom and dad to slow down, to turn over the reins, and to enjoy their retirement. One child is immersed in the business, fully prepared and anxious to run the show, and two other children are off pursuing other careers. The family wants a plan that will ensure the parent’s financial security to treat all the children fairly, protect the business, promote family harmony, and minimize all tax bites. It’s a tall order.

Family business transition planning is big business. Family-dominated businesses comprise more than 80% of US enterprises, employ more than 50% of our nation’s workforce and account for the bulk some estimate as much as 64% of America’s gross domestic product.

According to a recent survey of family businesses with annual gross sales of at least $5 million, 60% of the majority shareholders in family businesses are 55 or older and 30% are at least age 65. It a scenario where the baby boomers are looking to move-on. Although more than 80% of the senior family owners claim that they want the business to stay in the family, less than 30% of them acknowledge having a transition plan.

Strategic transition planning takes time, energy, and a willingness to grapple with tough family tax and financial issues. It cannot make a weak business strong or provide any guarantees of survival, but it can trigger a valuable, analytical process that prompts a frank assessment of available options, facilitates better long-term decision-making and saves taxes.

The initial challenge in the planning process is the threshold “keep vs. sell” question. Should the business be sold or kept in the family? That issue is the focus of a separate Plain Talk Presentation.

This presentation focuses on the challenge of developing a transition plan once the decision has been made to keep the business in the family. The focus here is not whether, but how. The plan design process for each family necessarily must be detailed-oriented, strategic, and forward-focused. Care must be exercised to avoid planning traps and the temptation to tack on complicated strategies that offer little or nothing for the particular family. Each situation is unique and should be treated as such. There is no slam dunk solution.

Above all, the specific objectives of the family must drive the planning process. The objectives, once they’ve been identified, then need to be prioritized to facilitate an effective analysis of the trade-offs and the compromises that inevitably surface in the planning process. The ultimate goal is to design a plan that effective accomplishes the highest priority tax and non-tax objectives over a period of time and at a level of complexity that works for the family.

This presentation first briefly reviews 5 essential elements that must be wisely incorporated into any plan and various traps that must be avoided in connection with each of the elements. It then illustrates various strategies for transitioning value in the business to other family members, strategies that can be implemented at key points in time. The presentation wraps up with some observations about some of the more exotic estate planning strategies that are possible considerations but often don’t work so well when a private business is the main focus of the planning.

This presentation has only one purpose – to help educate couples of all ages who want and need more information. At the end of some of the questions, you may want to pause the presentation. Take a breather while you think about and discuss a specific point before moving forward, and you may want to go through the presentation in more than one sitting. The idea is to take it at your own pace.

A simple case study is used to help illustrate the key plan elements and strategies that we’re going to discuss.

The Wilson family owns a business that is going to be transitioned to the next generation. The sell-out option is off the table. Wilson Incorporated is a privately owned C Corporation that has been on in specialized distribution business for 26 years.

Steve Wilson, he is 65 years of age, is the founder and the president of the company, and historically has been the principal force behind the company. Steve and his wife, Betty, she is 60 years old. They collectively own 90% of the outstanding common stock of the company. Betty serves on the board but spends no significant time in the business.

The other 10% of the stock is owned by Dave Wilson. Now, Dave is Steve and Betty’s oldest son. He is married and he has been actively involved in the business for years. Dave is considered the second-in-command behind Steve. In addition to having a strong financial background, Dave has a proven act for sales and marketing and is really skilled in dealing with people. Dave is anxious to take over the reins and he wants to aggressively grow and expand the business.

Steve and Betty have 2 other children, Kathy and Paul. Both are grown and married but neither of them works in the business. Paul is a doctor. Kathy works in commercial real estate. Steve and Betty have 4 grand children and they hope that they’re going to have one or two more.

Steve estimates that the business is worth approximately $10 million. That’s the price that he believes the business could be sold for to date. Steve and Betty’s total estate inclusive with their share of the business is valued at about $18 million. Steve and Betty are anxious to move forward. They’re looking forward to their retirement. They would like to develop a plan that will accomplish a variety of objectives.

Number one, Steve would like to phase out of the business over the next year and continue to receive payments from the business that will enable him and Betty to ride off into the sunset and enjoy their retirement for the rest of their lives.

Two, Dave will take over the control and the management of the business. That is, of course, if it works. Steve wants some ongoing involvement as a hedge against the boredom of retirement and to ensure that the financial integrity of the business is protected for the sake of his retirement in Betty’s welfare.

Three, Dave will have the freedom to diversify and expand the business and ideally, the value of all future appreciation will be reflected in Dave’s estate and will not continue to build Steve and Betty’s estates or the estates of other family members, specifically Kathy and Paul.

Four, Steve and Betty want to make sure that at their passing, each child receives an equal share of their estate. They appreciate that the business represents the bulk of their estate right now. They want Dave to control and run the business but they want to make certain that Kathy and Paul are treated fairly.

Five, Steve and Betty want to minimize taxes consistent with their other objectives and their overriding desire to be financially secure and independent.

Finally, above all, Steve and Betty always want to make certain that they are financially secure. They never want to be placed in the position of having to depend on their children and they always want to know that their estate is sufficient to finance their lifestyle for the duration. They’re willing to pay some estate taxes for this peace of mind. As a hedge against future estate taxes, they would like to start transferring assets to other family members so long as it does not compromise their overriding goal of economic independence.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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