AMBRECHT & BRITTAIN, LLP
Family Enterprise Planning:
Succession planning for family-held businesses when the owners wish to retain ownership and/or control within the family involves a complicated and time-consuming process that requires a multifaceted approach not fully understood by most professionals.(1) Family businesses are unique because, in addition to the usual technical business and estate planning issues, the business is interrelated to a multitude of family factors. As discussed by Peter Leach in his book The BDO Story Hayward Guide to the Family Business:
Family businesses differ in a variety of critically important ways from non-family businesses.(2)
If a family business is to achieve its full potential, it is vital that its management understands that business families function quite differently from non-business families and the challenges they create. As well as making the right decisions on the commercial problems which beset all enterprises, family businesses have to be able to analyze the special dynamics that surround the founder, the family, the firm and the future. They need to develop special skills that enable them to identify and resolve the unique difficulties which these dynamics introduce, and to adopt constructive strategies to foster growth of the business and the transfer of power and control within it.(3)
Yet, how much importance do the professional and the family business owner place on family factors in family business succession planning? Typically, not very much! Most professionals and family business owners minimize or even dismiss the family factors in the family business succession planning process. Often the attorney hears from the family business owners, in more or less the following words: "Tell me the tax law; our family does not have any problems!"
However, it is not uncommon for the attorney, while involved in the estate planning process for that same "problem-free" family, to be "side tracked" because the business owner makes some negative comment about a family member that sabotages the process, such as:
Or, the son or daughter assigned to give certain information to the attorney or accountant for processing never produces the information! Or, worse, the question whether the next generation really wants the business never comes up!
After becoming aware that there are some family problems, the estate planning lawyer often leaves the business owner(s) to solve the family issues unaided. Unfortunately, the business owner is all too often at a loss how to solve these complex family/ business concerns and instead immerses himself in the multitude of day-to-day demands of managing a closely held firm.
[A]s Yale University's Dr. Ivan Lansberg calls "the succession conspiracy," everyone involved may conclude it is in his or her best interests to avoid the issue altogether. Many entrepreneurs resist succession planning as a troublesome admission of mortality. Doing it means admitting that you won't live forever--a step they feel diminishes them.(5)
Statistics confirm that most family businesses, for whatever reason, do not properly plan succession.
As John Ward has stated in his book Keeping the Family Business Healthy:(6)
Keeping a family business alive is perhaps the toughest management job on earth. Only 13% of successful family businesses last through the third generation. Less than one-third survive into the second generation. And, as indicated by other studies, fewer than 5% of all businesses ever started actually become family businesses through appointment of a successor from the next generation.
The dying family business so permeates our business culture that is has become legendary. Expressions such as "shirt-sleeves to shirt-sleeves in three generations" and "rags to riches to rags" are common in the country.... All these phrases suggest the same story. The first generation builds the business, the second generation "milks" or "harvests" it, and the third generation must either auction what is left to the highest bidder or start all over again.
Ironically, there is an abundance of professionals with the technical skills necessary to plan the succession process.
It seems apparent, then, that if the estate planning attorney wants to effectively counsel businesses with family involvement, particularly during the business's transition planning from one generation to the next, the attorney should consider adding to his or her technical skills an understanding of the essential family factors in a family business. If the attorney at least recognizes that family factors are a second important component in the family business succession process, and if the attorney is able to convey their importance to the family business owner, such counsel may be more important to the client and his or her family business than a strong background in the technical issues, since that advice is so readily available.
The importance of convincing the client that family factors are as important as technical planning is underscored by the fact that the family business owner does not really recognize (at least overtly) or in many cases want to recognize that family factors are a critical succession planning component! It is incumbent upon the professional either to personally become familiar with the family factors in family business succession planning or to counsel the client to seek help from a qualified professional to help focus these important issues.In the classic book written by Mike Cohn, Passing The Torch,(7) the author states:
Attorneys, accountants, and financial advisors often focus exclusively on the tax and legal aspects of transfer strategies. They seldom address the underlying emotional and psychological issues that are involved. By addressing those (emotional) issues first, we strive to defuse emotionally intense situations and address important family issues. Only after those are resolved do we focus on the transfer strategies: the technical, legal, or tax aspects. This approach sets the stage for a successful transfer.(8) [Emphasis added.]
As Mr. Cohn indicates, there are two critical factors or steps involved in proper family business succession planning, namely:
The traditional technical (analytical) approach to succession planning suggests that the professional follow these steps:
This approach focuses on how to minimize the transfer taxes with little planning or discussion of the family issues. The plan as finally developed in most instances involves solving the division of the assets (fair or following some form of family justice), avoiding probate, and minimizing transfer taxes. Unfortunately, as one author has stated:
What often passes for family (business planning) involves either implementing the wishes of the dominant family members or persuading the family to adopt the (planner's) sense of fairness under the circumstances.(9)
To enhance the chances that the family business succession plan will succeed, the estate planning attorney and the family business owner should consider modifying the traditional approach in order to begin the process of integrating the family issues with the technical side of estate planning. The authors suggest the following integrated approach:
1. Develop, analyze, and understand the facts. Consider expanding this inquiry as follows:
A. Obtain the necessary family information to prepare a family tree (genogram);
B. Possibly during the second meeting, expand the discussion to include the complex family issues involved in the interrelationship of a family in a closely held family business;(10)
C. Given the complex family and technical issues involved in a family business, help the business owner face a difficult pivotal question that will form the basis upon which all of the planning decisions will spring:
Should the family business be kept in the family or sold?
In determining the proper response to this deceivingly simple question, the attorney should be aware that the answer involves significant emotional issues for the founder, his or her spouse, the remainder of the family, and others involved in the business. In many cases, the founder will be realistic about the business's future and give a reasoned response. However, a founder may automatically respond to this question by stating rather indignantly that the business will be kept in the family notwithstanding that the planner may have already observed many family issues that could lead to the business's destruction in the future. Additionally, the founder may have responded without actually knowing what the next generation really wants or needs!
D. Consider suggesting to the founder that a letter be sent to each member of the next generation soliciting his or her views on the future for the family business.(11)
Assuming that the founder agrees to this suggestion, the next steps are:
(i) Review the responses from letters mailed to the next generation. (Be sure the next generation's views coordinate with the estate planning objectives of the founder.)
(ii) Determine if the family and/or the estate planning attorney could benefit from including a family business psychologist or other professional to address family issues in the business. If yes, consult such a professional and discuss the next steps; if no, proceed to organize a family meeting.
E. Assuming that the majority of the family wants to retain the enterprise in the family, there are certain basic precepts in family business succession planning that the estate planner needs to keep in mind with regard to the family-issues informed technical point of view:
2. Determine which of the various planning tools are applicable.
3. Suggest to the clients which of the tools are the most appropriate tools for their unique family enterprise.
4. Engage in a dialogue with the clients to select the estate planning approach to be taken.
5. Begin implementation. Consider expanding this step as follows:
A. Plan a family meeting with all of the next generation in attendance(12) (including those working in the family business and those who may not be a part of the business).
B. Develop the agenda for the family meeting; for example:
(i) Establish family communication rules;
(ii) Review family assets and family business issues;
(iii) Review the expected death tax situation;
(iv) Review the proposed estate planning approach (asset distribution and classic estate planning tools);
(v) Determine if unresolved issues exist. If yes, determine an approach to solve or face the issues; and
(vi) Consider determining if additional family meetings would be appropriate. If yes, appoint a person responsible for organizing the next meeting.(13)
It takes work by the attorney (with the possible help of a family business psychologist), the business owner, and the owner's family to effectively plan the succession of the family business to the next generation. It does not just happen!!
(1) See Bork, et al., Working with Family Businesses, Jossey-Bass Publishers (1996), p. xi.
(2) See Peter Leach, The BDO Story Hayward Guide to the Family Business, Revised Second Edition, Kogan (1996), p. 3.
(4) "One of the axioms of family business is that there is an understandable natural reluctance for the family business owner to voluntarily surrender control or net worth." Goodman, The Expanded Role of the Attorney in Planning for the Continuity of the Family Business Enterprise, AFHE, Family Business Practice Series, Family Business Resources Publishing (1995).
(5) See Craig E. Aronoff, et al., Family Business Succession: The Final Test of Greatness, Family Business Leadership Series, Marietta, Georgia, No. 1, p. 7.
(6) See John L. Ward, Keeping the Family Business Healthy, Jossey-Bass Publishers (1987).
(7) See Mike Cohn, Passing the Torch, McGraw-Hill, Inc. (1990).
(8) Id., at p. 9.
(9) See LeVan, "Transforming Business Families," Gerald LeVan (1993), p. 243.
(10) See, for example, Bork, et al., Working with Family Businesses, supra.
(11) When faced with the fact that a founder does not really know what the next generation thinks with regard to keeping the business in the family, the authors will often suggest to the founder that a letter be addressed to each member of the next generation to ask his or her view about the family business in the future. The founder will usually agree to this request and may indicate some interest in the results.
(12) The authors usually find it helpful to include teenage family members as well as adults.
(13) The authors have found it to be more effective to have a family member other than the CEO or founder take on the responsibility of organizing the next meeting.
The contents of this publication are for information purposes only and are not meant nor should be construed to be legal advice. Note, also, the date of the document. Laws are constantly changing, and are subject to differing interpretations. We, therefore, urge you to do additional research or to contact your own legal or tax counsel before acting on the information contained herein.