Imperative for Our Times: Business Succession Planning

In 2009 several economic factors have converged causing succession planning to be an imperative for businesses in the current, somewhat unprecedented, financial times. Some of the convergent factors to be considered include:

  1. the maturity of the current ownership of companies which, according to some statisticians, may result in a large transfer of wealth from one generation to the next in the coming few years;
  2. asset valuations that are arguably the lowest in recent memory and, while there is hope that these will increase, the valuation multiples of 8, 9 and 10 are not likely to return in the foreseeable future; and
  3. tax rates are still relatively low but are not likely to remain low in the future because the government the large revenue defects will need to be addressed.

Consequently, the need for succession planning is even more critical at this juncture.

Business owners generally view themselves as being active in their businesses forever. Realistically, a business owner will not be involved in the business forever and, at some point, must pass the responsibility to others. Even so, that same business owner believes in the back of their mind that, even in the worst case scenario, the business could be sold by family members for multiples of the earnings. However, in the current economy, such is not the case. This further identifies the need for succession planning now so that the business owner and family have a viable alternative to a fire sale or a liquidation of their business.

Without having in place the viable alternatives succession planning can create, if the business owner is no longer able to participate in the operation of the business, a forced transition will surely increase the difficulties which can arise and place added strain upon the family and the business. For example, often a business owner’s estate plan treats his or her business as merely another asset which is left to the surviving spouse or is to be divided among their children. This type of “planning” can put the business in a very difficult position, especially since the heirs’ concerns are generally focused on financial security and making sure that they are each treated equally. This often causes conflict that forces a liquidation of the business on an unprepared family and business.

Management of the business is necessarily considered as part of succession planning. Failure to separately address the need for on-going management of the business can have disastrous results. If only one family member actively participated in the business while the business owner was alive, then generally, that family member may be in the best position to run the business successfully going forward. However, if an estate plan divides ownership, that family member who has been active in the business will certainly face conflict with other family members who were not.

As an example of where a family would have benefited from business succession planning, examine the case of Tom Smith. Tom built a successful business which provided a comfortable living for him and his family. Although he had three children, only his son Bob went to work with Tom in the business. When Tom died unexpectedly, the business was left to his wife Alice, who insisted that all three children share equal responsibility in management and operations of the business. At that time, Bob had spent nine years in the business. Upset that he was not put in charge, Bob left the company. The remaining family members were not capable of running the business in Bob’s absence so the company was soon put up for sale at less than optimal price.

In this situation, it would have been advantageous for Tom and the other family members to address management succession and ownership issues before a disastrous event occurred. No business owner wants the family business to come between the family members. However, because no succession planning occurred, conflict did occur causing a forced liquidation of the business which was not in anyone’s best interests. Current economic conditions cause businesses and families to be particularly vulnerable to predatory buyers.

Addressing ownership and management succession issues in advance also allows the business owner to focus attention on the protection of his or her family in addition to continuation of the business. The business owner, while evaluating his or her alternatives, can contribute to the planning process and make an informed decision. More importantly, succession planning in these economic times affords what may be a once in a lifetime opportunity to take advantage of favorable values for planning while avoiding being victimized by predatory buyers who seek bargain basement pricing.

Tom could have implemented an ownership and management plan that would have helped alleviate any problems that arose after his death. If he had provided for the continued operation of the business until the economy improves, his planning could have enhanced the financial security of his family.

Business owners, such as Tom, should consider transferring some of the ownership of their business to those family members who are active in the operation of the business and who are seen as the next generation of the leaders for the business. But this should only be done in the context of a complete succession plan which should strengthen the business and the family. The plan could also provide for the transfer the remaining ownership of the business to other family members at some future time. This will help insure that the future leadership for the business and provide an incentive for other family members to remain with the business. There is no time like the present to develop a business succession plan. By taking advantage of current valuations and tax rates, the family may be saving taxes and ensuring the future viability of the business.

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