Tools for successful business succession

Continuity from owner to successor owners is critical to successful implementation of any plan

The orderly transfer of a business as part of a planned retirement or at death is typically accomplished through what is commonly referred to as a “business succession plan,” which refers to a process rather than to a specific document. A succession plan is most effective if implemented during the lifetime of the family business owner to ensure seamless transition to a purchaser or succeeding generations.

Regardless of whether a business will be left to succeeding generations or sold, a critical dynamic that cannot be under-emphasized is the need for substantial lead time to position a business for sale or transfer to succeeding generations.

Continuity from owner to successor owners is critical to successful implementation of any plan. It is never too early to start work on a succession plan.

Prior to embarking on the process of developing a plan, it is necessary to carefully and frankly assess the business owner’s family dynamics. While the tendency is to favor transfers of family businesses to succeeding generations, that process often results in failure.

According the Institute for Family-Owned Business, a family business operated by the second generation has only a 53 percent chance of surviving 10 years. A family business operated by the third generation has a 68 percent failure rate within the first 10 years. Other sources suggest much higher failure rates.

The statistics may, however, overstate the risks of failure to some degree. Statistics apparently do not exist regarding the failure of succession plans that have been based on thorough advance planning, and many failures may be attributable to an absence of planning.

Frank communication

An effective business succession plan typically starts with a restructure of business ownership or recapitalization. The objective is to create a system of dynamics that will help ensure that business decisions are sound and considerate of all family members.

The typical family business has a basic ownership structure through which the active participants own the business as shareholders, partners or members of a limited liability company. Ownership is restructured with the objective of providing those actively involved in managing the business with the autonomy needed to manage the business and receive a comfortable income.

Those not involved in the business typically receive an equity stake or debt instrument with limited or no rights to participate in management of the business. Restructure of a business can be complex and must balance the ability and desire of those actively involved in the business to manage its operations against the desire of those not participating in the business to protect their income or capital investment.

One evolving tool that offers great promise is to provide for dual management boards. One is a board composed of persons unrelated to the family but having business, legal or accounting experience. A second board consists of family members. All significant business decisions, including key employment decisions, require the approval of both boards. The objective is to create a system of dynamics that will help ensure that business decisions are sound and considerate of family dynamics. While effective, the dual board approach can be costly, as the independent board will typically be compensated. The approach is thus limited to those businesses that reliably produce cash.

Virtually without exception, authors and experts on family businesses stress that continuous, frank communication is critical to success of any business succession plan involving multiple family members. Family members involved in running the family business must have the confidence to recognize their limitations and hire outside help when necessary to further the success of the business.

While planning for transfer of a business to succeeding generations involves significant challenges, those that do succeed offer great advantages to future generations.

Kenneth R. Cargill is a shareholder and director of Cooper Cargill Chant, a law firm with offices in North Conway and Berlin. He can be reached at 603-356-5439 or kcargill@coopercargillchant.com.