Creating a business succession plan is important for any business, but it is particularly essential for a family-owned business. A well-thought-out succession plan is the most effective vehicle for making sure that a family business endures well into the future.
Family businesses have maintained their status as the backbone of the US economy. The Small Business Administration estimates that family businesses comprise 90 percent of all business enterprises in North America and 62 percent of total U.S. employment.
However, significant change is on the horizon: 27 percent of family-owned or family-managed businesses around the world expect to change hands in the next five years, according to a PricewaterhouseCoopers survey.
But are businesses ready to transition? Peakfamilybusiness.com estimates that only 30 percent of family businesses in the US have a plan for passing the reins to the next generation, even though close to 70 percent would like to keep the business in the family. The numbers don’t trend well with the passage of time. By the third generation, only 12 percent of family businesses in the US are still viable; and by the fourth generation and beyond, only 3 percent of family businesses continue to exist.
Transitioning a family business from one generation to the next can be emotionally trying. The viability of a succession plan often depends on how emotions are handled. Taking this into account, it clearly makes sense for the family business owner to treat the succession plan as seriously as retirement and estate planning. In other words, take the emotions out of it.
The primary challenge for many small business owners is formulating a plan for who should run the business in the future and how. While developing a plan may seem daunting, it should not discourage the owner from getting started. Once a well-thought-out plan is in place, transitioning owners can have peace of mind that comes from knowing they have done everything within their power to ensure the ongoing health of the business. The following eight tips can help current owners enact a smooth transition:
It is common for business owners to assign too high a monetary value to their businesses because of the emotional sweat equity they have expended, sometimes over the course of decades. This is known as “overestimation bias,” and it needs to be overcome. The best way to do so is to use external professionals to prepare an accurate business valuation report that does not overvalue or undervalue the business.
The best business valuation in the world will not help owners determine if the amount they receive from the transition is enough to take care of their lifestyle expenses, family, community obligations and plans for the future. Business owners often underestimate their lifestyle expenses by as much as 50 percent. It’s critical to identify how much is enough.
Careful tax and estate planning is essential if owners want to make sure various governmental agencies do not take a big slice of their future proceeds. Also, the owners need to make sure they have the requisite insurance coverage to mitigate any potential turmoil. Again, the proper use of outside professionals is crucial.
Deciding whether to use a family member or nonfamily member as the company’s new leader should be based on a single factor: Who is best qualified? All matters that involve family come with a complex set of emotions – family businesses are no different. To ensure a succession plan accomplishes all of its goals, owners need to stay emotionally detached and choose the most capable person.
Whether the person chosen to lead the business is internal or external, educate him/her early and often about the family business, as this will help to create an attitude of ownership. The successor probably thinks he/she understands what running the business entails, so now is the time to dispel any erroneous assumptions.
Develop a training program to mentor the next generation who will run the business. Clearly define roles, expectations and responsibilities. Empower the successor to make management decisions, and let the successor make mistakes – that’s how lessons are learned.
The timetable should include when control of the company will shift and the training period. Depending on the size of the business, it could take three to five years to implement the changes needed for a seamless transition.
As the successor takes on more responsibilities, the outgoing owner should spend less and less time at the office. This will demonstrate confidence in the new leader’s ability to manage the business, and when the transition takes place it won’t be abrupt. Make the outgoing owner’s level of involvement clear. It may be assumed that a long-time patriarch/matriarch of a business will always be available to offer advice. However, this may not be what a new successor wants and, in fact, could interfere with post-transition plans.
Research shows that 75 percent of business owners are not satisfied with the personal and financial outcomes achieved after they transition their businesses, with most of the dissatisfaction being attributed to poor planning and a lack of communication. This can be avoided by planning ahead, communicating plans with everyone involved and employing the proper professionals: CPA, financial advisor, estate planner and insurance professional. Proper planning (and keeping emotions out of it) can ensure the ongoing prosperity of the business while the outgoing owner rides off into the sunset – or on to whatever endeavor comes next.
Carl H. Bagell, CPA, is the managing partner for South Jersey for Friedman LLP. He is a member of the New Jersey Society of CPAs. Contact him at [email protected].