Passing the Baton: A Look at Family Business Succession Planning
When there is a desire to pass the family business from one generation to the next, succession planning is usually essential. The absence of a solid plan can lead to family disagreements and financial complications that may jeopardize the enterprise and erode family wealth.
You don’t need to have watched the HBO series Succession to understand how poor planning in this area can create conflicts capable of tearing a family apart. These confrontations often consume significant resources, draining family wealth and causing lasting damage to family relationships.
It’s also important to recognize that crafting a succession plan and ensuring it endures are two very different challenges. Legal structures such as trusts can facilitate the transfer of ownership between generations, but they cannot, on their own, prevent disputes over control or leadership of the business.
For example, a disgruntled family member can always file a lawsuit. Even if such a lawsuit is unsuccessful, the disruption and strain it places on the family can be substantial.
The takeaway: effective succession planning is not just about transferring ownership successfully. It also seeks to reduce—or even eliminate—family conflict associated with that transfer. This is the type of planning family business owners should be thinking about.
Succession planning is often most effective when treated as an ongoing process rather than a one-time event. When it becomes part of a family’s regular dialogue, the likelihood of a smooth transition increases. Making succession planning a recurring topic at family meetings, for example, allows potential issues to be addressed early—before ownership actually changes hands.
Aspects of a Well-Crafted Succession Plan
There are a number of components we see in a well-designed succession plan. Often, the starting point of such a plan is deciding on the future of the family business.
Some of the questions family members usually need to answer include:
- Does it make sense to continue as a family business, or is it smarter to sell the company while it has significant value?
- Are the next generation of potential owners prepared to manage the business, and if not, what steps are needed to ensure continuity?
- How will equity be allocated between family members who work in the business and those who do not?
If the decision is to keep the company in the family, then a well-designed succession plan is needed.
The most effective plans are flexible enough to adapt to changing circumstances while still establishing clear objectives. Roles and responsibilities are clearly defined, including expectations for both inheriting and non-inheriting family members.
Clear communication with all integrated parties or individuals is essential. Succession goals should be discussed openly with all affected family members, ideally in person, so questions can be addressed and concerns heard. In many cases, sharing the broader plan with key nonfamily executives can also be beneficial, helping reduce uncertainty and retain valuable leadership.
Not surprisingly, most well-designed succession plans also aim to foster family harmony. Transparency helps minimize conflict, and involving inheritors in shaping the future of the business—rather than presenting decisions as mandates—often reduces resentment and disputes. When family members understand and accept how the business will transition, serious problems are less likely to arise.
However, it is impossible to guarantee that all major disagreements between family members will be avoided. Different personalities can easily lead to disagreements that cascade into major altercations. For this reason, it is often wise to establish a dispute-resolution process as part of the succession plan. Family business mediation, for example, can provide a structured way for concerns to be heard and addressed before tensions escalate.
Addressing Potential Threats
A well-designed succession plan will also ensure that potential threats to the family business are mitigated. Such threats can include the following (see Exhibit 2):
- Taxes: When estate and transfer taxes are not properly addressed by the succession plan, the money owed will likely come out of the family business. That can potentially make it difficult to maintain, let alone grow, the company.
- Competency: The plan should address whether inheritors are prepared to manage the business effectively and outline steps to develop their capabilities if needed.
- Individual financial problems: . If a family member inheriting the business has serious financial problems—bankruptcy, for example—that family member could take actions that would severely harm the company and consequently adversely affect the welfare of other family members.
- Divorce: If the succession plan fails to take into account the possibility of divorce among inheritors, there is always a chance that the company can suffer.
Formalizing the Plan
An essential step in succession planning is putting the plan in writing. Codifying the details makes it far more difficult for dissatisfied parties to contest the transition and ensures that everyone involved has a clear record of what was agreed upon. These documents should also be reviewed and updated regularly.
Typically, the process involves two types of documents:
- Collective documents, such as shareholder, operating, or board agreements, which define relationships within the family business. These should be clear and accessible, often supported by plain-language summaries.
- Personal documents, including wills and trusts, which outline how individual estates are structured and where ownership transfers are documented.
A Successful Transition
Without a well-designed family business succession plan, there is a strong possibility that a family enterprise might not survive the transfer between the senior generation and the inheritors. If you own and run a family business, it’s worth it to take the time and effort to not just create a plan but also make it one that really addresses the myriad key issues that need to be confronted.
Done well, succession planning not only increases the likelihood of a smooth business transition but also helps reduce the family conflicts that so often undermine otherwise successful enterprises.
VFO Inner Circle Special Report
By John J. Bowen Jr.
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