Family Business Succession Planning: 5 Steps to Avoid a Worst-Case Transition

“Hope for the best, prepare for the worst”. An old proverb that you likely have heard before. When you’re approaching major business decisions, imagining the worst-case scenario often helps you prepare most effectively for the best case. The transition of a family or closely-held business is one of those situations where this approach is especially important.

Small and medium-size businesses employ nearly 46% of Americans and with the baby boomer generation reaching retirement age there are 6 million small businesses expected to go through an ownership transition by 2035.

Research highlights that most small and medium family-owned businesses hope to transfer ownership to future generations, but at the same time, a survey from PwC (PricewaterhouseCoopers) of family-owned business owners around the world revealed only about 30% had a documented succession plan.

This gap between intent and documented planning is a common pitfall we have seen among many business owners. Without an up-to-date documented succession plan, “bad” can quickly intensify to “worst case” scenarios.

Worst Case Scenarios

If you’re looking for a blueprint on how not to handle the generational transition of a family business, HBO’s Succession puts on display some of the potential consequences. Without a clear succession plan, the 4 Roy family children engage in a prolonged, messy, muddled battle for control of the family business as their father’s health begins to decline.

But you do not need to look to Hollywood for unhappy examples. Imagine the impact of any of the following all-too common situations on your own small business and family.

• The current 40-something year-old second generation business leader is suddenly given a life-threatening diagnosis or serious illness, making it too late to purchase disability income or life insurance that could provide funds to hire a seasoned manager or support their immediate family.

• Your top salesperson is a member of the family business through marriage, then there is an ugly divorce that leaves the business without the industry contacts and relationships to sustain your sales pipeline.

• After the unexpected death of a key investor, you discover this business partner’s heir is a 17-year-old with a full-blown substance abuse problem.

Over the years, we have seen each of these situations unfold.

Common Barriers to Planning

We've also see over and over again, the same common obstacles to planning for a business transition.

• Founder-itis. In contrast to publicly owned firms where the average CEO tenure is six years, many family businesses have the same leaders for 20 or 25 years, and these extended tenures can increase the difficulties of coping with shifts in technology, business models, and consumer behavior. Being a leader for so long can also lead to silo’s of knowledge that need to be shared with someone else before they can fully step away. While the founder of the business may officially ‘retire,’ actually letting go on a daily basis can be difficult.

• Avoidance. Your life is full. Family dynamics are complicated. At the end of a long day, it can be easier to convince yourself that nothing bad will happen than it is to raise difficult issues with family members, especially across multiple generations.

• Culture versus business myth. Many small business owners seem to believe in an either/or approach to management and business operations. Either the business culture maintains a warm, informal approach to day-to-day operations with a tightly knit group of long-time employees (like a ‘family’) — or, there are formal processes, procedures and a chain of command in place (like a ‘business’). Yet there is nothing inherently antithetical to sustaining a positive and unique business culture in having a clearly defined chain of command, SOPs (standard operating procedures), or investor clauses in your bylaws. For evidence, look at the consistent winners in the annual “Best Places to Work” lists.

• The plenty of time myth. Business transitions take longer than you may think. After you have decided where you are headed, it will take another 2-5 years to prepare a small business for transition either to the next generation, or for sale to an outside buyer. Sales to a third party are usually less complicated than intergenerational sales.

• Next Generation Not Willing or Prepared. It’s growing more common, especially in certain business types, for the next generation to be unprepared or simply unwilling to inherit a family business. In those cases, it’s better to start planning even earlier to explore the other options available.

Five Steps to Take

A five-step approach can help to avoid a nightmare family business transition. Involving multiple generations and maintaining open communication throughout the process is the ideal, however some families find success with one internal champion who takes the lead on doing the ‘homework’ and presents findings to other business family members for decision-making at scheduled planning retreats.

• Step 1: Scenario Planning
  Spend some time imagining the unexpected, worst-case scenarios for your extended family, business and industry. Ask yourself, for example:

  • What if, one of the founders or next-generation managers suddenly fell gravely ill?

  • What if, this or that major investor or partner needed cash and pulled out of the business quickly?

  • What if, this or that key employee decided to leave the organization?

• Step 2: Rank Your Risks
  Rank in order the impact of each scenario risk or outcome for your family, your business, and key non-family member employees. A ranking helps to clearly prioritize risks and set clear goals.

• Step 3: Explore Available Tools
  Explore the business transition planning tools and options available for you, the business and your family with your financial advisor, an attorney, and other professionals on your team. Estate planning, tax planning and leadership development need to be in sync. You want to understand the time frame and the cost to implement each.

• Step 4: Set Your Work Plan
  Based on the risk, timing, and cost assessment for each option, develop a work plan and schedule to tackle and resolve the major risks over the next twelve months. Include regular reviews and check-ins to help keep you focused and on track toward your goals throughout the year.

• Step 5: Implement Your Plan
  Remember that transitions do not happen automatically. With the major risks minimized, continue to work on implementing the planned change in roles and operations, so both the older and younger generations, - and key employees - know the details about how the business runs and what to expect in the future business transition.

Resources

U.S. Chamber of Commerce: Small Business Data Center - https://www.uschamber.com/small-business/small-business-data-center 

McKinsey Institute for Economic Mobility: The Great Ownership Transfer: A new era of business stewardship - https://www.mckinsey.com/institute-for-economic-mobility/our-insights/the-great-ownership-transfer-a-new-era-of-business-stewardship 

PricewaterhouseCoopers: PwC’s 11^th Global Family Business Survey - https://www.pwc.com/gx/en/services/family-business/family-business-survey.html

Clute Wealth Management: Why and How Estate Planning Can Save Your Small Business - https://www.clutewealthmanagement.com/design/money-and-you/why-and-how-estate-planning-can-save-your-small-business

Clute Wealth Management: Don’t Let Ignoring Financial Decisions Overwhelm Your Business Success - https://www.clutewealthmanagement.com/design/money-and-you/dont-let-ignoring-financial-decisions-overwhelm-your-business-success 

Adam Robert, CFP® is a co-owner of Clute Wealth Management in South Burlington, VT and Plattsburgh, NY, an independent firm that provides strategic financial and investment planning for individuals and small businesses in the Champlain Valley region of New York and Vermont. For informational purposes only. LPL Financial does not offer legal or tax advice.

Securities and advisory services offered through LPL Financial, a registered investment advisor, member FINRA /SIPC. Clute Wealth Management and LPL Financial are separate entities.