Business Succession Planning Part 1: What Happens When The Founder Dies?

By Thomas Fellhauer
Categories: Blog, Tax

Most successful family-owned small to medium sized businesses will run reasonably well and will continue to be reasonably profitable as long as the founder is directly involved. However, very few businesses thrive or even survive after the death of the founder.  Yet most business owners ignore this reality and fail to develop effective and realistic business succession plans.

Most of my practice involves advising business owners.  In my experience, in many families, the family business represents more than 50% of their total net worth. 

However, when it comes to making sure that the business continues to be successful after their death, business owners are frequently unprepared.  No person would willingly put more than 50% of their net worth at risk, yet this is in fact what happens with a family business due to no planning or poor planning.

If you are a business owner, ask yourself this: If you died tomorrow what would happen to your business?  Would it thrive and provide a long term source of financial support for your family?  Or would it gradually disintegrate amidst squabbling between family members and lawsuits and poor management until the remaining assets were sold for a fraction of their original value.

Passing the family business onto your children can be a minefield of risks.  Here is a list of suggestions which should help to reduce the risks that are inherent in the process:

1. Found out what your children think.  This isn’t easy.  In my experience, children will often give an answer like “It’s your business, do whatever you want”.  This is quite unhelpful as it rarely reflects what your children are really thinking.  Try to use a third party to assist in getting true wishes of each of your children.  Your children will often have strong preferences or fears but will be reluctant to express them.  They may find it easier to talk about these things to a lawyer or an accountant or a trained facilitator. 

2. Honestly and realistically assess the strengths and weaknesses of your children. Most parents are naturally proud of their children and will often overlook glaring flaws or deficiencies. When it comes to the business, ask yourself what roles and responsibilities could be fulfilled by your children and whether they are capable of running the business or whether they require outside assistance (e.g. professional managers).

3. Recognize differences and do not hide from them.  Your children are not identical.  They are unique individuals with their own strengths, weaknesses, and aspirations.  Recognize this but also recognize that not everyone is suited to run a business and running a business by committee is quite difficult. If it is clear to you that one of your children is more suited to running the business than another, have honest and frank discussions with all of them about this.  Give each one an opportunity to be heard and recognize that your own perceptions may be clouded by your personal relationships with your children.

4. If you believe the business can successfully operate with family ownership after your death, set out what the management structure will look like. Determine who will do what, define areas of responsibility and clarify decision-making authority.  Who will replace you?  Is there someone in the family who is ready to take your place?  Will other family members accept that person as their boss?

5. Once you determine the makeup of the management team that will take over after your death, with job descriptions etc., develop a plan to get there from where you are now. See if any training and development is needed.  Consider the role of key employees or if you need to hire to fill any gaps.

6. Make sure you have a proper compensation system in place.  If you have family members involved in your business, pay them the same as you would pay a non-family member for doing the same work. Make sure you separate ownership from management. The “owners” should evaluate the performance of management the same way they would evaluate the performance of any other employee.  If you have a different standard for family members, you will probably run into problems.

7. Get outside advice.  People outside of your family often see things more realistically than you do.  Get corporate, tax, accounting, and financial advice on the various options you are considering. 

8. Settle on a plan. Do not leave it to your children to decide. When you die, the business will be vulnerable and you don’t want to have the business paralyzed while your children try to work things out amongst themselves.  It’s your job to develop a plan based on the best information available but make it flexible enough so that it can be changed in the future if family circumstances change.

9. Communicate your plan to your family members and your professional advisors.  Be open to constructive criticism and suggestions for alternatives.

10. Start the implementation of your succession plan. This will likely involve formalizing matters that you didn’t need to put in writing before, such a written business succession plan will pull all the pieces together and describe the overall goals and the reasons and the roles and responsibilities of each person. This will be the most important document and yet is rarely done. You will also need to ensure that your legal documents such as your wills, trusts, insurance policies, shareholder’s agreements, powers of attorneys, and signing authorities are coordinated in support of your plan. 

11. Review your plan periodically.  Establish a small council of outside advisors and family members who you will periodically review your succession plan with. Be prepared to make adjustments.

12. Try a test run while you are alive and able to see the results.  Take a vacation and see how the management team works without you.  Step back from the business and let them handle the tough decisions that are normally left to you.

In my experience, if business owners follow the foregoing suggestions, the risk of failure in the business succession process is diminished considerably.

By Tom Fellhauer.  Tom heads up the Tax Group at Pushor Mitchell LLP.