Don’t underestimate the complexity of transferring family business ownership from one generation to the next. The most seamless transitions follow a comprehensive plan that ensures all legal aspects of the succession have been considered. Unfortunately, most business families lack a plan. This can lead to negative consequences for retiring business leaders and successors alike.
Succession plans generally detail how the transition will be executed while also including contingency arrangements should outcomes vary from initial expectations. The more detail that’s provided about each action, the better. Most senior-generation business owners do not adequately prepare for conflicts between members of the next generation. Questions to consider include:
• Is the business sufficiently financed?
• Does the business depend on the owners' contacts?
• If several successors will co-own the business, are they capable of working together?
• Should one successor be the majority owner? If not, will conflicts prevent the business from thriving?
Be sure that the plan includes documentation that properly transfers the owner’s interest. It’s also essential to provide satisfactory funding for the plan. All too often, companies have a transition plan in place, but the capital needed to sustain it is not assured. If the financial foundation of the company is at risk, the departing leader should discuss this frankly with the potential successors.
The senior-generation leader must have enough liquidity to allow for the estate tax liability that may be incurred. Generally, business owners who transfer their companies to family members do so via a buy-sell agreement, a grantor retained annuity trust or an outright gift through a recapitalization of some sort.
In buy-sell agreements, financing issues are of paramount importance. Be sure you fully understand the different options. Optimally, the business owner’s share will be cashed out. If not, financing terms should be understood and, to the greatest extent possible, guaranteed. Will the owner fund his own buy-out through an insurance program or a gift to the next generation? Or will the next generation purchase some stake in the company? Remember, asking the right questions usually means less confusion down the road.
The plan should outline reasonable contingencies so you won’t be caught in a situation without alternative actions. For example, a parent may transition her business to her children. After a few years, some of the children may decide that an alternative career better suits them. The documentation should thus contemplate how those successors’ interests will be protected or purchased. The last thing a parent wants to do is create animosity among her children.
Especially if you are in a service business, communicate openly with your customers to help ensure that they remain with the company through the change. In some cases, this may mean making special (but reasonable) arrangements with them.
Put a competent legal and accounting team in place to guide the business into the future. Generally, a transition works best when the current team is left in place; however, the successors may prefer to work with their own advisers. The plan will not be adversely affected if the new team is kept abreast of all facets of the transition.
Of course, there is always the possibility that the successors will have to contend with industry changes, market oscillations and other extenuating circumstances. But having a well-thought-out ownership transition plan is the best way to avoid legal obstacles down the road.
Timothy Ridley is a partner with the law firm of Meagher & Geer in Minneapolis. His practice focuses on wills, trusts and estates.