Tips for a Family Business Succession Plan

Family succession planning is like estate planning for a business. It prepares for what will happen to the family business if current leadership is no longer managing the day-to-day operations. The plan determines how the business can be sold and what will happen in the event of your death.

When starting or taking over a family business, you may not be thinking about how it will survive in the future. But succession planning is an important consideration at all stages of business development. In a family business, where relationships are more than professional and multiple family members can bring differing perspectives, this can be particularly critical.

“It’s good to have clients confront it, in a collaborative way,” says Miriam Hermann, a business attorney at Ferro Labella & Weiss in Hackensack, New Jersey. “I have a law partner who is an estate planning attorney, and often you want to look at these situations from both a business and an estate planning perspective and try to be creative.”

For legal help setting up your family business succession plan, speak with an experienced business and corporate lawyer.

Lifespan of Family-Owned Businesses and the Need for Succession Planning

Family-owned businesses, in which more than one member of a single family shares in small-business ownership and operations, continue to be a major part of the U.S. economy.

While it depends on how you define “family,” these business owners head companies that are thought to account for as much as 60% of U.S. gross domestic product and 19% of the Fortune Global 500, including 35% of Fortune 500 companies.

Where family is connected in this way, there’s often unique significance in sustaining a legacy. Equally, there may be a desire in younger generations to forge their own path, or to cash out through a sale.

Interestingly, only about a third of family businesses make it to the second generation. About 12% make it to the third. Succession planning can fix that, yet few family-owned businesses have a documented business succession plan.

Businesses of All Sizes Need Succession Planning

“In my practice, it really runs the gamut in sizes of family-owned companies I work with,” says Jennifer Vergilii, a business attorney at Calfee, Halter & Griswold in Cleveland, Ohio. She represents family business owners throughout their lifespan.

“For example, I just worked on the sale of a major lighting company that was held by the second generation and sold for $550 million. I also have a $12 million automotive business client, held by the father who has all of the voting power, and the second generation, who has non-voting power but a large percentage of the economics. Whatever the size, the issues that come up are the same.”

“One of the most important things I advise clients is to be very realistic about their specific situation, particularly whether their children are really the right individuals to take over the business,” adds Hermann.

Difficult Topics To Address in a Family Business Plan

As with any family, there can be topics that are hard to discuss. One of the more complicated aspects of deciding on the family business succession plan is how it overlaps with the distribution of the owners’ estates.

For example, “You may have siblings at the parent level who’ve been running the business but don’t always see eye to eye about their future plans. Or you may have a situation where one sibling’s family is local. They’ve brought their adult kids into the business and are interested in keeping it in the family. Meanwhile, the other sibling has kids who live across the country, with no interest at all in staying in business.”

When this happens, interests can diverge regarding the next generation of business operations. “You have to recognize that one child may have put their blood, sweat, and tears into the business and may be entitled to something more than other children. But that doesn’t mean it’s inevitable that your kids will have an all-out war on the death of the parent. Unfortunately, where money is concerned, it can get ugly,” Hermann says.

Creating a Long-Term Family Business Plan

In approaching succession planning, Vergilii recommends a foundation of thinking through long-term goals and putting agreements in place.

“The key is for the first generation that started the company to create what they envision the legacy being. If you leave it to the second generation, which is often when a sale happens, it’s much more difficult to navigate,” she says.

The best way to proceed is to maintain an ongoing discussion about goals and outcomes, while drafting documents to protect both individuals and the business.

In contemplating a successful transition, Vergilii and Hermann identify two primary protections:

1. Have a Good Buy-Sell Agreement

First, Vergilii advises that “getting a good buy-sell agreement in place between the generations is absolutely, positively vital. That will set forth who can control when a sale happens. The terms of the buy-sell agreement is the most important part of succession planning.

“An operating agreement setting forth who’s managing the business and what their roles are is an important planning tool,” adds Hermann. “There’s a mechanism for family members to be bought out on their parents’ death or retirement, as well as a basis for valuation.”

2. Have a Life Insurance Policy

“A close second is making sure that there is ‘key man’ life insurance in place,” says Vergilii. “If something happens, the funds are available to pursue a buyout. That money can also be used to hire a skilled CFO or president, so the business doesn’t fall apart.”

Alternative Planning Options: Is It Best for the Business To Remain in the Family?

It’s also possible that the best outcome is that the business not remain in the family. Hermann works with her clients to assess alternative planning options, such as identifying an internal succession candidate among key employees or pursuing a sale of the company to a third party.

Business planning attorneys like Vergilii and Hermann recommend that you consider these issues now and revisit them regularly.

“Just like an estate plan, your ownership and exit strategy should be a living document,” Vergilii says. “I tell my clients to think about this on an annual basis, because things do change. Just because something made sense five years ago, it may not still make sense.”

As with estate planning, there are definite advantages to planning ahead. “It is best while people are still alive and active in the business to amicably set up a plan,” says Hermann. “We encourage our clients to talk about this before it’s too late.”

Find Legal Help for Family Business Succession Planning

To put a plan in place for your family-owned business, seek legal advice from an experienced business planning attorney.