Experts: Succession planning is crucial for family run business

Only a third of family owned businesses successfully make the transition to a second generation, according to Michael Evans, national managing director of the Newport Board Group, a nationwide business strategy advisory firm.

By the third generation, 95 percent of family businesses are under new ownership, Evans said. This means that owners of family businesses, if they are truly serious about their businesses staying in the family, cannot begin soon enough to establish a succession plan. They must make sure it is as airtight as possible, he said.

Sometimes the negatives in a family business doom a family succession plan at the start, according to Evans. The next generation may not be interested in the family business—or capable of taking it over—or family disagreements can cripple attempts to maintain the business.

“You need to run the business as a business first, with appropriate family participation,” he said. “But there are examples both ways. Bill Ford still leads Ford, while Warren Buffett took over Heinz.”

A well-run family business enjoys advantages that other businesses do not, Evans said. It earns tremendous market advantages through the goodwill of customers, communities and employees, and it can establish a significant presence in industry segments across the U.S. economy.

But many family businesses also have issues, cultures and traditions that complicate the issue of succession, he said. To ensure a smooth succession, family businesses must balance family and business values, with succession plans that take into consideration the overlapping roles and responsibilities of family members.

In a recent presentation, Evans and his colleague Caleb White emphasized the need for family businesses to have well-functioning governance structures.

Family companies, according to Evans and White, must get consensus on the values, mission and long-term vision of the business, and communicate them to family and non-family stakeholders. The governance structure must stress keeping family members—especially those who aren't executives—informed about the business' major accomplishments, challenges and options.

Any rules or decisions that affect family members' employment, dividends and other benefits also must be communicated, they said.

The governance structure must contain guidelines for electing family members to the company board of directors; for helping family members gain educational and professional training; and to help resolve conflicts between family members within a defined scope, Evans and White said.

The governance structure also should build family consensus on fundamental issues, they said, such as:

• Principles for the best short- and long-term outcome for the business, the family and other stakeholders;

• Prospects for the business, including its viability in the market and its capital needs;

• The role of the family in company ownership and management, including the next generation;

• Whether to bring in management from outside the family; and

• How to grow the company while serving family interests.

Once the governance structure is established, family business owners must start the formal succession plan as early as possible, according to Evans and White. Plans to identify the company's next CEO should begin as soon as a new CEO is appointed, they said.

Business owners should seek objective advice from independent directors or non-family executives, and involve key stakeholders in the selection process, Evans and White said. They also should develop a clear transition plan between the current CEO and his successor, including the current CEO's level of involvement after he or she retires, they said.

“Succession problems are the main reason family businesses fail to reach the third generation,” they said.

At South Bend Modern Molding, the transition has been made. Don Zimmerman now is president of the rubber product maker, while his father has switched to being chief financial officer.

“Once I made the decision to come back and work at the company, it was a natural fit,” Zimmerman said. “I looked at my options and I thought of going to work for a large company, and I felt that coming back here you could get what you put into it. The harder you work, the more you can grow the company, and that's what I was excited about. At a larger corporation, you may put in more work than anybody and it could go completely unnoticed or unrecognized. You're in your own little portal.”

As of now, there is no third generation involved in the business. Zimmerman has a sister, but she doesn't work for the family firm.

French Oil Mill Machinery Co. isn't worried about succession planning for the time being. Both Tayte French Lutz—director of marketing and a board member whose great-grandfather founded the company—and President Jason McDaniel (not a member of the founding family) are pretty young and not going anywhere soon.

Asked if there will be a fifth generation of the French family involved in the business, Lutz said, “Who knows?” She and her husband Michael have a 6-year-old daughter and 3-year-old son, so it is kind of early to know what they'll want to do.

It also isn't anything new for the firm to have a non-family member at the helm, as McDaniel is now. After the founder died, a non-family member—Charles B. Upton—handled day-to-day matters for many years while Alfred W. French Sr.'s wife, Grace, served as the president and chairman. There are some other stockholders in the business, too, who aren't family members.

Tayte's father, Dan French, said in the past that family members were told not to think of the company as the “job of last resort.”

“If you're interested in working here, you have to work three to five years somewhere else,” he said. “If you do a good job, we'll come and get you.”

Andrew Johnson, sales manager for O-rings Sales & Service Inc., planned to work for the firm right out of high school, but his father urged him to get a degree in accounting first. After college, he started as an accountant for a year, worked in customer service for several more, before taking on the role of sales manager.

“I had never planned on working with all of my brothers-in-law,” he said. “That just happened naturally. Personally I was drawn to the business in pursuit of the freedom, the risk and the reward.”

And the distributor does have a succession plan in place for its founders, Doug and Judy Johnson, to pass the firm onto the next generation, which also includes his three sisters and their spouses. “All of the men in the next generation will be working full time for O-ring Sales & Service and have plans to grow the business for the future,” Andrew Johnson said.

At Specialty Silicones Inc., the 20-year-old firm could go in either direction: founder and President Dave Brassard could sell it, or his daughter and Vice President Laurie Brassard could lead the company forward.

“If we don't sell, Laurie is just going to continue on,” Dave Brassard said. “And there's no reason for us to have any hiccups at all, because I'm not needed so much. I'm on the end of a phone. We're going to be snow birds, and be back in summer and holidays. I can be around to help and do things if necessary.”

Today, companies have many choices in funding the CEO's exit and selling the business back to family members, according to Evans and White. The forms of sale include installment sales, private annuities and family Employee Stock Ownership Plans.

However, family businesses must be mindful of income tax considerations in making those transfers. “Business interests transferred between family members must be fair market value, and conditions should be arm's length,” they said.

One major pitfall, according to Evans, may occur if the corporation redeems its stock and the retiring CEO remains within the corporation as a director, officer or employee.

“If the retiring owner still has his foot in the door, the IRS will treat the purchase price of his shares as a dividend instead of a capital gain,” Evans said. “That means the entire purchase price will be subject to tax.”

Estate taxes also can create problems in the transfer of a family business, according to Evans.

The current exemption threshold for estate taxes is $5.45 million, according to the Internal Revenue Service. Further exemptions and deductions are available under IRS rules.

“The estate tax has never been a big revenue raiser, and only about 3,000 families in the entire United States are subject to it,” Evans said. “But both Hillary Clinton and Bernie Sanders are lobbying to raise the estate tax.” Congressional Republicans, he added, have shown little will to repeal the tax, as many small business associations have lobbied for.

However, family business owners can alleviate transfer taxes through various methods, he said. These include:

• Annual exclusion gifts of up to $14,000 each ($28,000 for married couples) to as many recipients as the business owner wants;

• Gift tax exemptions that remove the income and future appreciation on the gifted property from the business owner's estate; and

• Family business liability companies that can be valuable in transferring a business to children at a discount from the value of the underlying assets owned by the FBLCs.

According to Evans and White, airtight shareholder wills and trusts are critical to family business succession. Creating a revocable trust to hold stocks avoids delays on ownership transfers and reduces costs, they said.

“Have clear provisions as to whom the stock will pass to upon death,” they said. “You will have done your family a great disservice without making your clear intentions known—and why.”

Chris Sweeney, Mike McNulty, Bruce Meyer and Edward Noga contributed to this report.