- Protecting the Family-Owned Business
- February 3, 2014 | Author: Thomas D. Begley
- Law Firm: Capehart & Scatchard, P.A. - Mount Laurel Office
The most important asset for many individuals and families is their business. Whether it is a sole proprietorship, partnership, limited liability or corporation, it represents not just its present economic worth, but a reflection of substantial personal and emotional effort in developing the venture into the success it has become. Unfortunately, many businesses collapse upon the retirement or death of their founder.
A recent White Paper, published by Merrill Lynch Wealth Management, detailed that less than fifteen percent (15%) of family owned businesses make it to the second generation and even less make it to the third. It notes that three out of four companies actually claim to have a succession plan. However, fewer than forty percent (40%) of these plans have actually been implemented. According to the Merrill Lynch paper, most business owners are consumed with the task of building their businesses. In doing so, they are so focused on planning for the immediate needs and events of the business that they forget or neglect to consider how the business will run once they are gone.
Businesses can continue and thrive for multiple generations. However, prudent planning is required. This planning is centered on three areas: (1) the development of successors to run the business when the founder is no longer present; (2) preparation and execution of legal documentation to set forth the parameters of succession; and (3) establishing the financial measures to ensure the economic viability of an enterprise during periods of ownership transition.
The first step in this area is for the owner to devise an exit strategy. This involves deciding when the owner is going to depart and who is going to be left in charge. In some businesses, a successor emerges naturally. In other businesses, the owner has to rotate his children and/or other family members to see who is best qualified to assume the reins for the future.
The importance of this decision cannot be overstated. Many businesses collapse because of poor choices in this regard. Owners make emotional, rather than objective, decisions. A successor is chosen for frivolous reasons, such as being the oldest, of a particular gender, having served a particular amount of years in the venture, fear of hurting the feelings of one who expects to take over, or a combination of the foregoing. Such rationales constitute a recipe for disaster.
The appointment of a successor must be based upon three criteria. First, the proposed successor must have a solid aptitude for the business itself. Second, he or she must have, as many say, “a good head for business.” Many people fail in business because they know their company’s product or service, but not the first thing about management. Third, he or she must have solid people skills. A successor must not only be liked, but respected.
The second step is to have proper legal documents in place in order to put the business plan into effect. Many businesses have some form of buy-sell agreement; however, most of these are skeletal documents that state how surviving owners buy out, pro rata, the shares of a retired or deceased owner. These agreements need to value the business, but many do not do so adequately or consistently. Many focus on buying out a deceased owner’s share from his or her estate, yet, the insurance underlying the agreement is either woeful or nonexistent. Moreover, this focus neglects the proper way to purchase shares from a withdrawing owner. A withdrawing owner wants his or her price paid as soon as possible, but the remaining owners may not be able to make immediate payment without leveraging the business and creating a torrid financial strain upon it. Proper documentation serves to prevent potential conflict when an owner announces his or her retirement.
In the case of gifting, rather than selling, different obstacles need to be addressed. Inter-family transfers can be affected by estate and inheritance taxes, gift taxes and corporate taxes. Timely planning can allow for the transfer of business interests in a manner that minimizes these taxes. Many owners are reluctant to transfer business interests, as they wish to maintain control over their enterprise until their death or withdrawal. However, competent plans can maintain this control while divesting significant value from one’s estate prior to death.
The final ingredient is money. The best legal documents will not work unless there are assets to back them up. For lifetime transfers, there must be adequate liquidity to ensure viability if an owner withdraws. For post-mortem acquisitions, proper insurance must be in place. In either event, a sound financial structure must exist to ensure continued viability of a business while enriching the lives of all of its owners.