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January 8, 2016
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I.          Introduction

The transition of a family owned or closely-held business involves a variety of legal and tax issues. This goals of this process, however, should be focused on issues that are just as important – if not more important – than the legal and tax issues. Specifically, while most business owners appreciate avoiding taxes and creditor protection strategies, business owners should be focused on preserving family harmony, furthering family values, and ensuring that future generations have the tools at their disposal that are needed to be successful. This White Paper will not focus on the legal and tax issues that permeate – and sometimes wrongfully dominate – a succession plan. Rather, this White Paper will address the important timing, family, and value based issues that must be addressed in order for a succession plan to be successful.

II.        Timing is Everything

An often repeated mantra in succession planning is that a business owner “cannot start too early”. While this is true, starting the process must be done with clear goals and objectives. These goals and objectives often include identifying managers who can succeed to the owner (family and non-family), setting rules for the involvement of family members in the business, and establishing values.

The transition of ownership and management in a business are not necessarily the same thing. Estate plans are structured to transfer ownership tax-efficiently between generations of a family. The identity of the managers of the business will change over time, and these managers may or may not be family members. The current owner or group of owners must identify the best managers to take over executive level responsibilities and not focus on the family member who will be the best manager. Many situations exist where members of the next generation who are employed in the family business are not best suited to manage the business. It is critical that the best manager – and not the best manager who happens to be a family member – be elevated. Family members may be suited for specific responsibilities, such as finance, sales, or operations, but may not be suited for senior executive positions.

III.       Goal Setting and Communication

Family discussions about succession planning are difficult. Various issues must be discussed – finances, mortality, children in the business, children not in the business, who will take over in management – and discussing these issues is not easy. Nonetheless, a succession plan has little chance of working if there is a lack of substantive discussion of these important issues.

The first step is for the family business owner to set clear goals and objectives and to establish time frames for achieving them. Among other things, the business owner should establish in writing:

• A set of values that family members should follow
• A set of rules for the hiring and promotion of family members
• A policy on distributions from the business and the transfer of ownership
• A policy on compensation of family members employed by the business
• A policy for conflict resolution

The values, goals, and objectives of a succession plan are often set forth in a “family constitution”. A family constitution generally is not legally binding (unlike, for example, a buy-sell agreement or a trust agreement). Rather, its purpose is to consolidate values, goals, and objectives into one document to help guide the family. In addition, the construction of the family constitution often is a powerful tool to use to teach family members the owner’s values and objectives and to ensure that intra-family communication occurs in a productive and thoughtful manner.

IV.       Financial Planning

            Many estate planning techniques involved in succession planning involve the owner divesting himself or herself of assets, such as limited partnership interests or non-voting stock. An important (but often overlooked) part of any succession plan is ensuring that the owner who is transitioning ownership will be able to maintain his or her standard of living. The transitioning owner needs to properly compensate other owners and executives, particularly when those individuals are assuming more responsibility. You cannot attract and retain talented individuals without compensating them fairly. However, few business owners are willing to transition ownership if there is an unreasonable risk of financial insecurity as a result. Therefore, it is important that the transitioning owner, in consultation with his or her financial advisors and accountant, maps out income needs and has a financial plan in place. For example, rent paid by the business to the owner can be an important piece to this puzzle. Consideration should also be given to fringe benefits, particularly health insurance. Transferring ownership, if done properly, does not have to equate with a loss of income.

V.        Conclusion

The “success” of a succession plan will be defined by the goals and objectives established at the outset of planning. As explained above, establishing goals and objectives in a timely manner is the foundation of any successful plan, and whether the goals and objectives are met should determine whether the plan was a success.

No two family business are alike. Each family and each family business will have its owns set of challenges, goals, and values and therefore each succession plan will take on a life of its own. Nevertheless, a family business succession plan has a better chance of succeeding if the plan is implemented in a timely manner with clear and realistic goals and objectives.

Vance E. Antonacci is a member of the law firm of McNees Wallace & Nurick LLC and chair of the firm’s Estate Planning practice group. He practices out of the firm’s offices in Lancaster and Harrisburg.