Family businesses account for roughly half of the gross domestic product of the US. Yet far fewer than half of those businesses, as few as 25 percent depending on the study, have effective succession plans in place. Poor succession planning contributes significantly to the fact that only about 30 percent of family-owned business continue into the second generation and only slightly more than 10 percent make it to the third.
Transferring leadership of a business to the next generation is a complex process that takes time, often years, to complete effectively. When planning for that task is left undone or until unexpected events like the death or illness of an owner forces the issue, the odds of a successful transfer plummet. Consider the range of issues an effective succession plan must address:
Start early, plan continually
- Identifying and grooming a new leader
- Identifying an interim leader, if necessary
- Retaining, and clarifying the roles of, other key talent
- Addressing the needs of all family members, including those not involved in the business
- Addressing the retirement needs of the current owner
- Determining how the transfer of ownership will be structured and funded
- Managing estate, gift and income tax consequences
“Succession is a complex process and it takes time,” says Bruce Benesh, national managing partner of Human Capital Services for Grant Thornton. “It’s more than just addressing the business, tax and financing issues. It also means managing various and sometimes competing family dynamics.”
The first rule of effective succession planning? Start early. “By the time the current leader reaches 50, you should start to plan,” says Benesh. But a succession plan is never final until the new leader is in place. “People change, the business changes, the market changes. Your plan must constantly evolve to keep up.”
According to Benesh, the first step is a deep assessment of potential candidates. Look at their educational backgrounds, their current and previous roles in the business or elsewhere, their relationships with other key players in the organization, their leadership and interpersonal skills—the whole range of qualities necessary to run the business. Starting early allows time to evaluate candidates against those criteria over time and to groom potential leaders by rotating them through key areas of operation to help build their experience.
“Don’t forget to ensure that the candidate is actually interested in taking over the business,” says Benesh. “Too often, that interest is assumed and the mantel is pressed on a son or daughter that does not share their parent’s dream.”
Have a Plan B
Succession plans should have a target date. For example, the current owner may plan on retiring at 70. But targets can change. What if the owner dies, is disabled or otherwise wishes to leave the business early? “An effective succession plan deals with contingencies, including what would happen if the plan had to be implemented tomorrow,” says Benesh.
An interim leader may be a solution. Realize, however, that an interim leader requires more than the skills necessary to run the business. “An interim leader is part executive and part mentor,” says Benesh. “Their job is not only to run the business but also to continue preparing the next generation to do the same.”
Business often chose interim leaders from within their current management ranks, assuming that their familiarity with the business and family personalities make them the best fit. But that may not always be the right choice. “Bringing in an interim owner from the outside provides a fresh, objective set of eyes that is also independent of any agendas or relationships within the business or the family,” says Benesh. That set of eyes could spot opportunities to improve the business and also can provide an emotional buffer between a current parent-owner and the child being groomed to take over the enterprise. “There can be friction between generations or a pressure to do things the way they’ve always been done,” says Benesh. “Bringing in a mentor from the outside can provide the seasoned business guidance an heir needs while allowing them space to grow into their future role.”
The right board helps
Too many family businesses either don’t have boards or have boards stocked with family members or others whose agendas may prevent true objectivity about the business. “Establishing a solid independent board of directors with a broad set of business, financial and other backgrounds will help drive an effective succession planning process,” says Benesh. “The right board can also provide valuable guidance and governance on a wide variety of other issues.”
Remember and communicate with all constituencies
A business has a wide host of constituencies beyond the corner office. Your succession plan has to address all of them. For example, do family members or others who are not active in the business hold any ownership interest? Your plan will have to address their needs. Most businesses have a cadre of skilled executives or other professionals whose continuing enthusiasm and support will be vital to the enterprise. Their compensation and incentives should be part of your plan. The ongoing faith of your key suppliers and customers is vital. By communicating clearly with them, you can help ensure that they understand and support your succession strategy and new leadership.
“Succession can be an emotional issue both within the family and within the organization,” says Benesh. “Owners sometimes fail to address conflicts, leaving them to fester. That can not only complicate the succession, it can actually destroy the business and sometimes the family.”
Don’t forget taxes and funding
Last year’s tax reform legislation had good news for business owners. It doubled the estate and gift tax exclusion from $11.2 million to $22.4 million. The bad news? The increase in the exclusion is set to expire at the end of 2025. With the estate tax rate topping out at 40 percent for taxable estates of more than $1 million, succession planning still needs to ensure sufficient liquidity to pay any estate tax bill. State tax exposure also must be addressed. As this map
from the Tax Foundation shows, The District of Columbia and 12 states also have an estate tax and 6 have an inheritance tax. The estate tax exclusion in some of those states is lower than the federal exclusion.
Your plan also needs to address how transfer of ownership will be funded. There are a wide variety of ways for such transactions to be funded and structured. Choosing the right one will be driven by your facts and circumstances. “Funding and structuring ownership transfer involves an accurate assessment of everyone’s needs and circumstances, including complex tax considerations,” says Benesh. “Early and ongoing professional advice is vital.”
Succession planning is not easy. It requires facing difficult business and family issues honestly and directly. Without it, however, the business you have spent a lifetime building and the security that legacy provides for your family can be damaged or destroyed.
National Managing Partner
Human Capital Services
: +1 803-231-3099