Will Your Family Business Survive to the Next Generation?
The wealth of the
Why Do Family Businesses Fail?
Despite the
posturing by politicians advocating “tax relief” and the elimination of the
death tax, the reality is that by changing the rules and moving the goal posts
so frequently, Congress has created a tax
environment that results in taxpayer paralysis. Estate planning should be a thoughtful
process designed to work over many years, but a sense of impermanence and
capriciousness in tax laws fosters inaction.
While business owners acknowledge the risks of neglecting their transition
problems, they doom their business to failure because they will not take the
necessary steps to minimize the “easiest tax to avoid” with just a little
planning. Even if there is no federal
estate tax concern, there will still be taxes on income and capital gains, and
newly imposed state inheritance taxes to deal with. However, the tax tail must not wag the
dog. Once the tax issues are addressed, it
may be more important to find a way to pass down a value system and maintain
continuity. These are critical steps in
the planning process, but too many advisors are not helping matters by ignoring
the non-tax conflicts in their hurry to complete an estate plan and push their
clients out the door with cookie cutter plans.
The estate
planning process can be confusing and highly technical, contributing to the 66%
of family business that fail to make it to the second generation. Try to pass the business on to the third
generation and fewer than 14% make the grade.
(Keeping the Family Business
Healthy, John L. Ward, 1987). Among many of the other reasons for such high
failure rates is the “founder's syndrome”, or the inability to let go. For some owners with unhappy marriages, they
have taken refuge in the business, while other owners dislike dealing with
personally traumatic issues like mortality or disability. All of this contributes to a revolving door of
quasi-retirement for the founder who has little else in life other than work,
and who keeps showing up at the office without relinquishing control of the
reins.
Many of the founder’s
business interests are closely intertwined with their driven personalities. This determination to succeed is the foundation
for their many achievements, and the source of future conflicts. Since control concerns are such a major part
of their life’s work, acknowledging any loss of mental acuity or mortality is a
real struggle. Additionally, many
founders have made some bad decisions along the way and they worry about disrupting family relationships in the process of
getting the situation back under control. How so?
They may have ignored some family members by favoring just a few select
heirs, or minimized the advice from non-family key employees. Too often, business founders put heirs on the
payroll with no-show jobs or with limited responsibilities. By setting family members up in executive
roles for which they have little training or aptitude, the founder creates
unrealistic expectations for heirs. Add
to the mix an heir who really works in the business and there will often be a
festering sense of inequity where one heir is working and the other heirs are
not; yet all draw a paycheck.
In the classic
estate planning process, owners pass value down to heirs in the form of stock
in corporations or partnership units in family entities. The problem is that owners will not
voluntarily give up control of a business in which they have invested a good
part of their lives, and such workaholics
will not accept the concept of a life in retirement or the need for a family
forum in which a fair and open exchange of information is necessary. For retirement to succeed, the energies and
priorities of the founder have to be channeled into something other than work,
but that is very hard when the founder fears becoming irrelevant and
unappreciated by succeeding heirs.
Since
the principals constantly interact with each other outside the business, family
entities are often in turmoil because problems are brought home and the
management stresses are not easily set aside.
When children marry
and have families of their own, the in-laws and third generation all want
input. Getting all the players to focus
on problems and achieve a unified management system is a lot like herding cats,
not an easy situation under the best of circumstances. Besides conflicting goals, intergenerational
conflict, and sibling rivalry, tension in the
office is a foregone conclusion. Add to that volatile mix a history of poor
communication and a failure to enact meaningful changes
in management and frustration will build.
Thus, it should be no surprise that few businesses maintain
operations far beyond the founder’s life.
In addition, it should shock no one that
the founder may be the worst teacher for heirs as he tries to integrate them
into the family business—he has spent his life fixated on control, not on
sharing information or techniques. Sometimes a non-family key employee or mentor
can be a buffer and may be a better choice to interface between the generations
to make sure everyone is prepared to assume his or her rightful place in the
business.
Not all is lost. Some families manage to make the business work
down through the years. The best example
in the
The Plan
Generally, for a
succession plan to work, the main concerns about death, disability and
retirement must be addressed early and often.
In the post 9/11 world, it would be terribly imprudent to ignore the
potential for catastrophic loss of principal family members. Therefore, create
a plan that addresses these questions:
- How can institutional memory be enhanced and
senior family members achieve a sense of validation.
- Who is going to own the business, and in what
format?
- What steps must be taken to ensure continuity,
and which advisors need to be brought into the transition team to make
sure it happens?
- Who is going to operate the business, make day-to-day
decisions, pay bills, sign checks?
- Has the business buy-sell agreement been updated,
and are realistic valuation techniques in place?
- Will there be adequate liquidity to continue to
operate the business when the founder steps out of the picture and still
provide for an equitable distribution of ownership interests?
- Will non-operating heirs be satisfied with
reinvesting the profits back into the business to expand? If not, managers face a shortsighted
process of carving out value for income. Or will heirs
take the first good offer for the business and head to warm and gentle
climates?
- Can the operating heirs buy out the others in a
fair exchange of value for control?
- Can all of this planning be done in a tax
efficient manner without disrupting the business?
- If there is a family heir anointed as successor,
does this person have a grasp on the business operation, its employees,
suppliers, credit worthiness, and customers?
- Do the heirs have the capacity and training to
make decisions and keep the company moving forward with the full
confidence of the other family members?
Alternatively, is there a key employee or outside manager available
to hold the business together?
Most companies
fail within a short time of their inception. Family owned business have a tradition
of being more durable, but it takes special care and a lot of extra effort to
overcome these hurdles and succeed for the next generation. Start the process early and preserve a
lifetime of family work for the future.
©2003 - Vaughn
W. Henry
Henry & Associates
Gift and Estate Planning Resources
vwhenry@aol.com – www.gift-estate.com
