Avoiding Common Pitfalls in Succession Planning
We are making headway in educating business owners and the general market on the differences between estate and succession planning, but we still have a very long way to go. I am constantly reminded of this in talking with business owners who repeatedly tell me “I’ve got it all done.” Upon further questioning, I realize what they mean is that they went through an estate planning exercise – they’ve got a will, a revocable trust, a buy-sell agreement, and some life insurance in a life insurance trust. Therefore, they believe that their succession planning is done. This couldn’t possibly be further from the truth.
I tell business owners all the time, “You can have the best estate planning money can afford, but if you have not dealt with the sibling rivalry that exists between your kids, your succession plan is vulnerable.” You see, estate planning is simply one component of about 30 components that make up a sound succession plan. So, what are some other common pitfalls to avoid in succession planning?
Succession planning axiom #1 is “never put yourself in a position of financial dependence upon your children.” Many business owners mistakenly believe that they will one day be able to rely on the proceeds of the sale of their business for their retirement and fail to build adequate liquidity apart from the operating business. Then, lo and behold, your children enter the business and, for estate planning reasons, it might make sense to transfer the business, or a portion of the business, to them through annual or lifetime gifting. But the senior generation controlling a family business is not going to get serious about turning over ownership and management of their business to their successors until they know that their personal financial security is not in doubt! Owning the real estate separately minimizes this concern by allowing a business owner to continue taking rent from the business. However, it is usually most beneficial to build adequate resources that are completely separated from the operation of the family business.
Another common pitfall to avoid is attempting to treat your children equally. A business owner may have more than one child in the business, or perhaps one or more children involved and one or more children not involved. Attempting to treat children equally with regard to management, leadership, and ultimately control of the business is a dangerous proposition. In most families, the decision to share and share alike does not work well because the career motivation and management capability cards are not divided equally among children.
Attempting to treat your children equally is often compounded by another – the inability to find balance in what I call the Family Business Oxymoron. Family and business are two diametrically opposing environments. Family is an environment of unconditional acceptance based upon who you are, a member of the family. Business, on the other hand, represents an environment of conditional acceptance based upon “what have you done for me lately.” Many business owners will either enable their children beyond their capability and allow them to progress in the business much too quickly, or will be so hard on them that they can never measure up to dad’s exacting standards in both personal and professional life. This usually leads to significant conflict in the father/son relationship in a family business environment. Very few families are able to strike the right balance without intervention.
Lacking depth in the management team is a significant pitfall in many family-owned companies. This is usually the result of a very strong entrepreneurial leader who has exhibited a “hub and spoke” management style for many years. It is very common for managers who are loyal to a founding business leader to have difficulty transferring their loyalty to the next generation of family leadership. The next generation of leadership during a succession transition is going to be in desperate need of a supportive management team. Seeking to build depth by developing people from within, along with the development of the next generation of family leadership, will significantly enhance this aspect of a succession plan. Remember, succession planning is not just about the CEO role, but about every significant leadership role that exists in your business.
Another pitfall in succession planning for family-owned companies is overlooking the impact of business structures and documentation on their long-term business continuity goals. I have met with many sibling partnerships that have shareholder agreements that represent a “survival of the fittest” approach. At one time, such a shareholder’s agreement might have made sense. But now, the siblings have children who are all active in the business; but, if one of the controlling shareholders dies, his family gets bought out, potentially losing their ability to become shareholders. Shareholder agreements rarely cover all the contingencies that exist. Most that I have seen only cover death or disability. What about divorce, bankruptcy, failure to comply with a lender directive, or other such contingencies? Another aspect of the impact business structuring has is when a business is set up as a C-Corp and the owner is financially dependent on the business. The only way to get money out of a C-Corp is through salary, dividends, or management contracts. When this aspect hasn’t been addressed, it will hinder the implementation of an effective exit strategy.
Controlling business owners remaining too close to the vest with planning considerations for too long is another common business succession pitfall. Due to fears of blowing the family apart and subsequent lack of effective, honest, and forthright family communication, family conflict becomes almost inevitable. A business owner needs to understand that he/she has a stewardship responsibility to family members, managers, employees, vendors, creditors, manufacturers, etc. This business represents so much more than what it does for you, the business owner. Communication among family members and seeking their input into your plans is the most effective way of keeping the business going and keeping the family happy in the process.
These are a few of the pitfalls that business owners could trip over in the succession of their businesses. Rest assured, there are a plethora of others, and my clients teach me new ones all the time. Succession Success is achieving a margin of success that is big enough, across these various factors, to empower a business to withstand the winds of change and the very predictable decline in productivity and profitability during a succession transition. The most important consideration is to come to the realization that there are a variety of pitfalls that can create unnecessary vulnerabilities in the perpetuation of your family business legacy and to make a decision to be pro-active in addressing these issues.
Jeff Faulkner, MS, is a partner with The Rawls Group specializing in family business succession planning. Jeff relies upon his background in family counseling to navigate the unique challenges of family dynamics in the succession planning process. Jeff’s private practice in the counseling industry, as well as his training in financial planning, has allowed him to gain specialized experience in working with families in achieving mutually satisfactory resolutions in succession planning issues. For additional information, contact him directly at 770-894-9056 or through The Rawls Group at 407-578-4455. www.rawlsgroup.com