Non-Tax Related Rules for Business Succession
Blood may be thicker than water but blindly following blood lines can create a quagmire.
I am not a lawyer. I am not an accountant. I am not an expert of succession. I am a 40-year plus business consultant who has seen many a messy family business succession. Sometimes the pain is so great the business is lost; other times family members grow hostile and no longer to talk to each other. Sadly, all of these situations were created with good intentions.
Know this: the odds are against you. Family business consultants and research estimates that 30 percent of businesses make it to a second generation, and only 12 percent to a third. And a measly 3 percent make it to the fourth generation.
A few years ago, we researched and created a great business management class for family succession and spoke at conventions and industry events with low attendance. Most business owners are reluctant to deal with succession as it forces them to confront difficult situations and to try to answer some difficult questions. When the owner does deal with succession, he or she tends to be motivated to avoid taxes and handle things legally, not deal with human behavior and skill transference. Legalities are important but human behavior and avoiding what should be common sense relationship rules tend to create ongoing problems that doom the business transition to failure. Blood may be thicker than water but blindly following blood lines can create a quagmire. Here are some guidelines and insights that might prove helpful.
Fair is not equal. Most of us tend to have a sense that life is and should be fair. Trying to create a situation where all children are treated equally financially may be unfair and inhibit the businesses’ success. I may love my brothers and sisters but if I run the business and work 60 hours a week and my siblings can’t find the front door, human nature will take over. The managing successor will grow resentful. And if he or she doesn’t complain, spouses will be quick to point out the unfairness of the situation. My firm belief is whoever runs the business needs to have control. If the business is large and profitable enough, you may be able to get away with paying other family members some money but it is still very complicated. The best way to deal with this is to leave non-business assets to children not involved in the business. This can include real estate the business owns and the successor can pay rent.
As a business owner, prior to succession your first step is to determine how much money you will need to live on. Until you determine that amount, it’s difficult to come up with a payment structure or succession process. Not only should you determine your financial requirements, you also need to determine your life requirements. Most business owners are consumed by running the business. They think they want to retire but after a year of playing around, they tend to get bored, come back and worry the heck out of their kids. Having a senior past owner wandering around taking up everyone’s time can be a real profit drain. Remember, employees are probably too polite to say no and a former owner can suck their time dry.
When it’s time to no longer be involved, business owners must reduce their liability in the business. A large lawsuit or bad financial year can suck the owner back into funding the business. At 65 or 70, it’s too late to financially recover from a large financial setback. Someone else has to bare the risk. If at all possible, get the money you need to retire prior to giving up control. I’ve seen many a successor leap back into the business and throw their life savings down the drain. When you leave, all the financial risk and headaches need to be someone else’s problem. If the successors can’t cut it, maybe you shouldn’t leave or you should sell the business and give your kids the money.
Make a transition of skills by training others to do what you do, think like you and make decisions. No one will be you, so the business may look different, but you’ve spent your life building a successful business. Too many successors make too quick of a decision to leave. It generally takes 4 to 5 years to have someone learn what you do and replace your involvement. Make a list of the skills you possess and start training others to do what you do. If you tend to run the business out of your head, you may have to create systems to replace your card counting and instinctive abilities. People cannot follow what’s in your head. When training people, give them a chance to make mistakes. We learn quickly from mistakes. Don’t take that learning process from them, just limit the amount of damage he or she can do.
Succession is never easy. It forces us to confront our mortality and our successors’ abilities. It’s a process you only do once so it’s not something you’re experienced in doing. Your business is your identity and legacy. Passing it on provides tremendous satisfaction but doing it haphazardly can impact your family for years to come.