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Is Your Succession Plan Ready?

September 1, 2011 5 Min Read Family Business Structure, Family-Owned Businesses
Mario O. Vicari, CPA
Mario O. Vicari, CPA Retired Director

Less than one-third of privately-held businesses survive to the second generation of ownership and fewer than 15 percent of those go on to the third generation. Most family-owned businesses do not recognize a serious problem—the absence of a clear, concise, long-term plan to address the succession of the business.

Compounding the issue is that succession can be fraught with complexities including lack of capital, estate taxes, sibling issues, and lack of foresight by most founders to address their own mortality as it relates to the company they founded.

To reach a clear path to a good succession strategy, it’s important to consider three major areas:

  1. Family and organizational issues
  2. Financial and liquidity issues
  3. Tax and personal financial issues of the founders

Family and organizational issues

Having a contingency plan to survive the absence of the founder or other leader who has been driving its success is a critical part of the company’s business plan. Here are a few action points to address this issue:

  • If the business has a clear successor, identify that person and be explicit in communicating that to the family as well as employees. Include the successor in high-level meetings and decisions so they will be up-to-speed when they take over the company.
    • Get the successors connected to networking and peer groups so they can interact with others in the same circles. Invest time and money to train the successor in key skill areas like leadership and communication.
    • Identify the key management team members who will support the successors and make sure they are involved in important operational and strategic decisions.
    • Communicate the roles and expectations of all family members in the business so there is no confusion when the founder is no longer involved. Hold family business meetings addressing these often sensitive issues that can destroy family relationships if not addressed in advance.
    • If no clear successor exists, establish instructions for the founder’s spouse or designated executor on what to do with the company when the founder is no longer present. Create an advisory board that meets regularly so other experienced and trusted advisors can advise the spouse or designated executor in the event the founder is no longer able to run the company.

Financial and liquidity issues

Private company successions can be difficult because of limited access to capital for day-to-day operations as well as transactions involving stock ownership and succession. Keep the buy-sell agreement updated because it addresses how equity is transitioned for private companies. A properly formulated buy-sell agreement should address five triggering events that can have a negative liquidity affect on any private company: death, disability, retirement, separation of any shareholder, and the sale or liquidation of stock. Most often, insurance products can be attached to a buy-sell agreement to provide liquidity in the event of death or disability. Beyond that, the buy-sell agreement protects the company by providing guidance on the amount and terms of a payout that will be fair to the recipient while protecting the long-term interests of the firm.

Tax and personal financial issues

The biggest financial payoff for most business owners is typically the realization of the value that has been built up in their company over the years. One of the toughest issues in succession is how to provide personal liquidity to owners while still providing enough capital to the business to operate in a healthy manner. That can create a high level of conflict between the objectives of the company and the objectives of the founding shareholders. One way to address this issue is to establish an employment contract that will continue to compensate founders as they move into other roles, such as chairman of the board. Another option is to establish deferred compensation plans that begin to pay founders at retirement age and continue long after they have left active employment.

Proper estate planning on the part of the founders is another critical consideration. Without it, the company could be forced to sell assets to pay estate tax in the event of a death. Financial and estate planning should not begin when the founder is ready to retire, but rather, should be set in motion long before there is a need. Additionally, ownership can be transferred to other family members at more favorable valuations if it is given over time, while the company is still growing.

Succession planning is a complex and difficult process but a necessary element of any company’s business planning process. The key to minimizing conflict is to establish plans for the company as well as its founders that are in sync. As management guru Peter Drucker once said, “The final test of greatness in a CEO is how well they choose a successor and whether they can step aside and let the successor run the company.”

Mario O. Vicari can be reached at Email or 215.441.4600.

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Mario O. Vicari, CPA

Mario O. Vicari, CPA

Retired Director

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