There’s a lot of talk these days about sustainability and how a company’s processes impact the environment. Yet for family businesses, perhaps equally as important as the size of their carbon footprint is how they can sustain a transfer of leadership due to a death, retirement or family crisis.
This past year, Kostin, Ruffkess & Co., CBIA and the University of Connecticut Family Business Program sponsored the UConn Family Business Survey. The results indicated that most family-owned companies are simply unprepared for any type of an emergency or a planned transition.
Of the 500 Connecticut family-owned businesses surveyed, 51 percent had CEOs who were over 55 years old. Only 13 percent had a succession plan and 35 percent of them said they didn’t expect to develop one soon. These results are troubling for the future of family businesses.
Too often, leaders of family businesses get distracted by the day-to-day operations of their business, and succession planning gets relegated to the “I’ll get to it someday” category. Plus, people tend to avoid talking about things they dislike — like retirement, illness or death.
However, when it comes to ensuring the sustainability of a family-owned business, which for many families is their main source of income, it’s important to take action now to avoid financial disaster later.
Talk to your accountant and lawyer for help in drafting a succession plan. That process will likely involve these steps:
Start with the Results — Figure out what you want in the event of an unexpected transition. If the business is owned by a father or mother, do you want a child or children to assume the leadership role? Do you want to have a sibling lead the business? If the business is owned jointly between two siblings, what happens if one dies? Does the family of the deceased take their place, or do they receive a buyout? How is that buyout funded?
Now that you have identified what you want to happen, you need to determine if you can convert your wishes to action.
If you want to transfer ownership from a parent to a child, is the child ready to run the business? The UConn Family Business Survey indicated that 53 percent of the respondents were concerned that the next generation lacked the skills and motivation to run the business and 31 percent expressed doubts that the next generation had any desire to assume a leadership role. These are both problem scenarios that merit further discussion.
While most families envision maintaining control of their family business in the event of an unexpected transition, the Family Business Survey indicated that only 29 percent had a complete estate plan and 68 percent had not formally chosen a successor.
This is a recipe for disaster.
Writing a plan that outlines what will happen upon the death or incapacity of the owners and making it known who will take their place is good for business. Planning not only helps prevent family arguments, it also helps motivate the next generation to learn about the business and build the skills needed to keep the business operating smoothly.
Properly Value the Business — It’s important to know what your business is worth. By doing so, when it comes time to pass it to another generation, you’re prepared for estate taxes and you can divide the assets in a way that will not cause a family feud.
The Family Business Survey showed that 42 percent of the respondents were unaware of the true fair market value of their business and one-third of the respondents were completely unsure of how they wanted to divide the assets of the business. Surprisingly, 33 percent were also unsure how they would fund estate taxes in the event of a transition. Working with a business appraiser and your CPA can help minimize the impact of estate taxes.
Buy-Sell and Operating Agreements — These vital documents develop common understandings among a company’s management team as to the events that will occur when one family member wants to retire, sell their share of the company, or is injured, killed or dies.
To work as intended, these documents must be well written and kept updated.
Get Your Funding In Order — Without the proper planning and advice, the estate taxes and legal fees involved in transitioning a business can be costly. Life insurance is a tool that can help. Without the proceeds from a life insurance policy, a family member may not be able to afford the take the reins of the business during a transition, or the company may become saddled with debt that would hinder its performance and sustainability.
Run a Simulation — Most organizations have fire drills to practice evacuating a building in case of an emergency. Why not do the same for your business in the event of an unexpected transition? A simulation involves gathering all parties involved in the transition and putting your well-written plans into action. When you run a simulation, you can easily identify red flags and learn if what you have on paper translates to reality. In addition, the simulation will uncover possible areas of family friction that can be identified and resolved.
Keep an Up-to-Date Plan — It’s vitally important that any documentation you have regarding the transition of the business be kept current. It goes without saying that tax regulations change, and the details contained in a document today may no longer be accurate tomorrow, or a better way to preserve assets may be introduced. Having your lawyer and CPA review your documents on an annual basis helps to ensure the smooth transition of business ownership and the preservation of family assets.
When it comes to sustaining family ownership of a company, a little bit of planning now goes a long way to ensuring that the company continues to thrive in the event of a planned or unplanned transition.
Xhemil “John” Koliani is a member of Kostin, Ruffkess & Co. LLC’s Business Valuation Services Group in Farmington. He holds both the CPA and ABV distinctions. Reach him at jkoliani@kostin.com.