Succession Planning

Eddie Schwartz, the second-generation owner of an automotive recycling business, decided that 45 years was enough. He was ready to retire and turn the business over to his son, Larry, 35, and daughter, Sara, 32, both of whom had entered the business immediately after graduating from college. Eddie had never funded a retirement plan and assumed that he would sell the business to his children as a means of funding his retirement.

It is the failure to plan for retirement and a transition to the next generation of owners that is the primary reason for the family-owned businesses to continue successfully into multiple generations.

However, as soon as Eddie began exploring the steps he needed to take in order to retire, he was confronted with a number of challenging questions for which he had no answers, including:

• Can the business remain competitive, or should he and his children consider a sale?
• Do his children want to own and manage the business? If they want to own and operate the business, can they work together collegially? Are there other senior managers his children may need to retain or recruit in order to successfully manage the business?
• What is the market value of the business? What is the price his children could afford to pay for his shares without placing an undue financial burden on the business?
• What annual income will be required in order to maintain his current standard of living? In addition to the possible sale of his shares, what other sources of income are available to him?
• Will he lose any insurance coverage if he sells the business? What other insurance coverage might he need that he did not contemplate earlier in life?
• To what advisers can he turn to guide him as he contemplates these questions? Who can advise his children through the transition and after he leaves the business?

With the packaging business going through a period of rapid consolidation, the competitive environment is becoming ever more intense. Decisions about whether to keep or sell the business are at the forefront. Some family-owned businesses like Eddie’s may have opportunities to sell at a premium, or they may find themselves with a competitive niche that allows them to remain independent and continue to thrive. But most find themselves confronting less-than-favorable options.

Historically, only 32 percent of family-owned businesses continue successfully in the second generation, and only 12 percent are able to sustain success into the third generation. Industry consolidation is one factor contributing to this trend. However, it is the failure to plan for retirement and a transition to the next generation of owners that is the primary reason for the failure of family-owned businesses to continue successfully into multiple generations.

Laying the Groundwork

Situations like Eddie’s are all too common. Most business owners in their early 50s have little time to plan for business succession and retirement. But that is exactly what is needed.

As a consultant to family enterprises, I can attest to the benefits of planning for ownership and leadership transitions well before health or market conditions prompt unplanned changes. Indeed, succession planning can be liberating for those who are retiring, and empowering for those who are assuming responsibility for the future success of the company. The most successful ownership and leadership transitions entail more than the transfer of assets and authority. They involve family members and their advisers working together across generations to ensure the continuation of a proud family legacy.

To be certain, succession planning must address questions that can be difficult to answer, such as:

• Should the business continue operating under family ownership or be sold to others? Are qualified next-generation members interested in leading the company?
• What changes will be needed to sustain the family enterprise? Is the family enterprise sufficiently diversified to meet changes in market conditions?
• Which next-generation family members are the most qualified to lead the business forward, and how will they work with other family members and key nonfamily executives to ensure success?
• Have retiring leaders undertaken the necessary financial and estate planning to ensure their retirement and family needs can be met while leaving the next generation of leaders with sufficient assets to compete successfully?
• What professional advisers will be needed to execute the desired ownership transfer? Are next-generation family members acquainted with these advisers?
• What governance structures might the next generation of owners consider for making decisions and communicating with the family?
• What meaningful endeavors might the retiring generation pursue once they relinquish ownership and/or operating leadership?

The most successful ownership and leadership transitions entail more than the transfer of assets and authority. They involve family members and their advisers working together across generations to ensure the continuation of a proud family legacy.

A Multistep Process

These questions and others can be answered through a multistep succession planning process that engages and educates all family members. First, a successful transition process requires the commitment of all family members, particularly the current owners and leaders of the business, to work on succession planning. The most critical step in the process will feature the engagement of next-generation members in detailing plans for assuming ownership and operating leadership responsibilities. In developing plans to present to their parents or other retiring family members, these leaders can demonstrate their maturity and business acumen, while allowing the current owners to provide helpful feedback and to make final decisions. Once both generations of family leaders agree on a plan, they can engage their legal and tax advisers in finalizing details before sharing their intentions with the entire family and initiating changes. Each family faces different challenges, but a sound succession planning process can permit all business-owning families to prepare for ownership and leadership transitions, and ensure that success continues in the next generation. Families will need this if they are to beat the odds and continue ownership in future generations.

Sam Davis is principal at The Davis Group. He can be reached at 804-314-1836 or sdavis@sdavisgroupconsulting.com.