Consider family and business when planning for the future

An effective family business succession plan is an essential part of an estate plan for business owners concerned about managing their family's wealth and sustaining their business. With the proper professional guidance, an effective plan can also be drafted for estate tax purposes. But many of these plans end up being a source of great contention among the family unit.

Business owners should ask themselves whether their current succession plan emphasizes what is best for them personally, as well as for their business. How can the family grow the business and take advantage of tax incentives? How can they ensure they're taking emotional issues into consideration?

The success of any business depends on management's ability to plan for continuity. Will the appearance of new management challenge existing company values and beliefs? How would other life-altering events, such as divorce and remarriage, factor into the equation?

The psychological barriers

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A number of emotional issues may cloud a family's judgment or cause them to delay succession planning.

• The mortality factor: Many people find it difficult to discuss mortality with their family. This makes succession planning a challenge, because one of its core objectives is the successful transition of the family business at a minimum transfer tax cost. If someone isn't ready to plan, or is in a rush to get through the process, you may end up with a less-than-ideal plan.

• Resistance to change: Change requires people to step outside their comfort zone. Some business owners are reluctant to plan and wait until they are nearing retirement before they start thinking about business transition. Unfortunately, at that point, it may be difficult to bring children into the business if they have already established careers.

• Fear of losing power and control: Control over business operations and decision making is very important to most business owners. The thought of losing control can be difficult for a founder to accept.

• Fear of losing identity: The business owner's sense of identity and self-worth is often tied to the business. The thought of no longer being a vital part of the business can be extremely threatening. This obstacle is hard to overcome.

• Family dynamics: The most tax-efficient estate plan can be defeated if family dynamics are not properly addressed at the beginning of planning discussions. While certain children will be expected to succeed to positions of power in the business, others may be left out. Without the proper planning, this can spell disaster for the business. Family infighting over interests in the business, both financial and managerial, has led to the demise of many viable businesses.

By way of illustration, consider the following: Dad, a self-made man, is in his early 60s. He usually made personal and business decisions alone. Now, Dad realizes he must bring his children into management because he can no longer manage the business himself. However, he still wants to make most, if not all, major decisions. The children want some say in management. They also want Dad to realize he cannot continue to function as the sole decision-maker.

There are two possible approaches to this situation:

• The “after the fact” meeting: No pre-planning meetings are held. The family is convened to review a formal business succession plan. The children are not consulted beforehand and instead are assigned to their future roles. Needless to say, this type of approach often causes deep-rooted resentment to surface. Consequently, a whole new set of problems arises and the succession plan is placed in jeopardy.

• The path of least resistance: Before calling a meeting and unveiling the transition plan to the children, the owner and his advisers schedule several pre-planning meetings to discuss family dynamics, identify issues that are potential sources of tension, and determine how to address those concerns. The owner needs to recognize that the children must be engaged in the decision-making process on an ongoing basis if they are to perform at an optimal level of efficiency. Joint decision making leads to informed decisions and sharper execution of strategy.

Success is dependent on the education of those involved. The earlier the family is educated about the business and involved in the decision-making process, the easier it will be to ultimately transition the business to the next generation. One popular tool that can help this transition is the formation of a junior board. This is a vehicle for next-generation members to express opinions, ask questions and participate in decision making. It also enables them to develop teamwork and networking skills while providing a forum for experimentation and exploration.

Succession planning best practices

1. Evaluate the current situation and determine what business plan adjustments are necessary. Periodic reviews of the business plan are critical. In today's business world, nothing is stagnant, so the business plan must be updated regularly. At a minimum, there should be an annual assessment of performance, measured by reference to specific benchmarks. Changes in the legal, tax, political, social, economic or personal environment may necessitate modification of the current plan. Competitor activity and industry outlook should also be assessed to see if the plan is in line with the market.

2. Analyze the overall picture to see how a change in the business plan would affect the family wealth plan. In all likelihood, the business plan is the largest and most important part of the family wealth plan. Therefore, a review of the business plan must be accompanied by a review of the family wealth plan. Ideally this involves ongoing dialogue among family members so all parties' interests are represented. The worst mistake is underestimating the role that emotion plays in the process. To promote fairness and impartiality, a disinterested third party should be engaged to facilitate family business meetings, keeping in mind the following:

• How will the wealth plan affect each family member?

• Where does each member fit into the business plan?

• What are the direct threats to the business and wealth plan?

• How can these threats be overcome?

An effective way to illustrate how all the pieces fit together is to design a flowchart to demonstrate each family member's role in the business and wealth plan.

3. Develop a viable strategy that capitalizes on tax benefits for both the business and the family. The strategy should be broken down into measurable action steps. It is important to be driven by process, rather than results, when looking at potential tax benefits for a family business. The solution is important, but execution of strategy is the critical part of the exercise. A thorough understanding of the process will allow you to formulate and implement a business transition plan.

Effective tax planning for both the individuals and the business must be carefully balanced. Remember to weigh each individual's tax savings against the overall tax savings of the family and the business.

4. Consider market alignment factors and how to grow the business. Is there a clear vision as to how the business is going to continue to grow and prosper? This is an area where succession planning is critical. The business plan, and by extension the family wealth plan, depend on the ability of management to successfully drive growth. If there are no strong leaders to take the business into the future, it will die. Profitable business succession planning can be accomplished only by identifying future leaders at an early stage and working closely with them to ensure their development.

The family legacy

Without proper planning, the legacy of the family business could be tarnished. No business transition can succeed without understanding of and attention to the various psychological barriers. The business owner must evaluate the current situation and formulate a strategy that focuses on people and processes. The key is to make sure all family members feel a sense of ownership and responsibility. That sense of ownership will not only invigorate and excite them, but also may result in each successive generation being more active participants in the family business, thereby helping to increase the family's wealth.

Terry Eyberg is senior manager of Ernst & Young LLP, Personal Financial Services in New York (terry.eyberg@ey.com).

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