Basic Guide to Family Business Succession Planning

Client Alerts

Mark Bosswick

4.20.22 | Berdon Vision

Succession plans are designed as either a planned exit strategy or a business strategy to ensure that a business survives and prospers when the current leader(s) is/are no longer in charge — due to retirement, untimely death, sudden incapacity, or some other unforeseen circumstance. Developing an effective plan is no easy task — evidenced by the notorious 30/13/3 statistic that plagues so many family and privately held businesses:

• 30% of businesses survive the second generation
• 13% make it to the third generation
• 3% succeed beyond the third generation

While these statistics may not apply in all situations, the trend is evident, and the cost of a poor succession plan can be quite high!

Succession lies at the heart of what a family business is and centers around the inter-generational, intra-family transfer of power. To develop a successful plan, it is essential to understand the succession process, avoid the potential pitfalls, and explore all transition options in order to meet the primary objectives of the family/business owner.

Understanding the Process

To begin, an effective succession plan needs to encompass both the business dynamics and the family dynamics. As such, understanding the planning process below is essential in developing a successful plan.

• Understand and acknowledge that a formal plan is necessary
• Identify the key players in the business, especially those being groomed for the future
• Obtain an independent business valuation
• Explore transition options and appropriate ownership transfer techniques
• Understand and address ownership and management succession issues
• Implement and communicate the plan to all parties

Avoiding the Pitfalls

Running a successful business in today’s complex economic environment is challenging. It is imperative that the succession plan properly addresses family dynamics and management transition to avoid pitfalls and mistakes that can hinder the future success of the business.

Some common planning errors include:

• Failing to consider the tax and legal impact of the various transition options
• Forcing children/relatives that are not actively involved in the business to take on roles as part of the transition
• Giving children/relatives grossly unequal shares – opening the possibility of hurtful disputes and potential litigation
• Punishing financially successful children/relatives by reducing/excluding them from the transfer of ownership
• Failing to communicate the formal succession plan to all stakeholders, including children/relatives and business management

Weighing Tax Savings Opportunities

Tax savings or reduction strategies can enhance the after-tax value of the business and protect family members and partners. Here are some strategies.

• Creating a holding company or family trust can:
  • Leverage tax deferrals and savings
  • Offer income splitting opportunities
  • Protect assets from creditors
• Place shares of the business in a spousal trust so that taxes are not immediately payable upon the death of the leader
• Leverage life insurance to pay capital gains tax when there’s a forced succession due to death or incapacity or to provide liquidity for estate taxes
• Transfer company assets over time to spread out and better manage the tax bill
• Explore the lifetime capital gains tax exemption on qualifying small business shares
• Gift or sell shares of the business to a successor who is a family member utilizing fractional ownership discounts

Exploring Transition Options

Every business is different, so it is essential to develop a plan that meets the unique needs of the owner, the management, and the family. Having a clear understanding of the following options and how they may work for your business will enhance the possibility of a successful transition. Additionally, knowing how each option impacts your overall tax positions will help preserve and transfer your wealth, not just your business.

• Keeping the business in the family
  • Buy-sell agreements
  • Sale of shares via promissory notes, to be paid with bonuses or after-tax distributions
  • Gifting shares
  • Trusts as shareholders
• Management buyouts
• Sale to employees through an Employee Stock Ownership (ESOP) or cooperative
• Sale to a 3rd Party
• Liquidation

Implementation and Review

Once the succession approach is identified and agreed upon, owners need to implement steps to ensure the transition’s success. These steps include:

• Work with attorneys, accountants, and other advisors and service providers to ensure that all the documents are drawn up, signed, and filed appropriately. It is critical that the plan is legally and financially sound
• Finalize and document the evolution/career paths of key employees, management, the board, owner, and successor
• Design a personal development and leadership plan for the successor
• Create a summary of what the succession plan will accomplish and what the business will look like after the transition
• Inform the important stakeholders of the particulars of the plan

Staying Vigilant

It is also important to note that it should not be simply forgotten once the succession plan has been developed. It is prudent to revisit the plan on an annual basis to ensure that tax law changes and/or important life events (death, disability, divorce, marriage) have not negatively impacted the plan and the ultimate future success of the business.

If you have questions, contact Mark Bosswick at 212-331-7619 | MBosswick@berdon.com or your Berdon advisor.