Succession Planning Crucial for Family Businesses
YOUNGSTOWN, Ohio -- Once the founders of a family business see their dreams of success become reality, they confront two questions: How will they recoup their investment so they can retire? Who will carry on the business?
Accountants help them with tax strategies and lawyers with the legal aspects. Members of both professions are essential to an orderly transition, or as orderly as the founders and successors can make it.
It’s not uncommon for founders to procrastinate about succession or to confine their planning to a will, says Harold Davis, a certified public accountant and owner of H.D. Davis CPAs, Liberty Township. Second generations, perhaps recalling the state of affairs when the founders exited their companies, are more aware of the need for estate planning (and creating trusts where appropriate) and succession planning.
“And I’ve seen instance where the owner did everything right and the next generation screwed it up,” Davis says, and either sold the business at a loss or closed its doors.
Five lawyers at Roth Blair Roberts Strasfeld & Lodge LPA, Youngstown, shared stories where business owners failed to consult a lawyer before they acted and made matters testy.
A decade ago, Stuart A. Strasfeld related, two businessmen, “both relatively young,” bought sizeable life insurance policies, each naming the other as beneficiary, before signing an agreement on how their company was to proceed should one die.
One did die before Strasfeld was approached to draw up the papers for their cross-purchase agreement, he says, “so if one died the other was obligated to purchase that stock with the proceeds of the insurance policy.” Moreover, the proceeds of the policy exceeded the value of the deceased shareholder’s interest.
“The surviving shareholder was very generous,” Strasfeld says, “and they worked it out.” Their mistake was “talking to no one but their insurance agent, who shouldn’t have allowed it.”
Thomas J. Lodge tells of how in an effort to reduce his son’s tax burden, the father sold him the family business “at an extremely low price. Let’s say he used a very aggressive [tax] approach.”
That might have worked, Lodge says, had the son’s wife not later sued him for divorce, valued their community property at fair market value and claimed she was entitled to half the appreciation (the difference between the price he paid his father and fair market value).
The moral, Lodge says, “Had the father made a gift of the business, she would have had no claim.”
As Jeffrey D. Heintz, a partner in Manchester, Bennett, Powers & Ullman LPA, Youngstown, has found, “It takes time to establish a plan and carry it out.”
The first issue of succession planning at a family business, as Heintz and Davis know, is: Are the children interested in carrying on?
Related to that is the older generation’s confidence in the next generation’s competence and preparedness.
The lawyers at RothBlair, Heintz and Davis find that in only half the cases are the owners’ children interested in assuming control of the enterprise.
Even then, family conflicts can make things difficult. Joseph Bishara at RothBlair has found that “One of the most common and unfortunate things is brother versus brother or father versus son or son versus brother-in-law” who has entered the business and proven his worth.
Feelings in some families are so strained, Strasfeld says, members won’t talk to each other and he acts as intermediary in relaying messages as the members try to work out an equitable succession plan.
A business owner has the choice of many tax strategies to pass on his company, most of them complex, Davis says, and the owner should consult both his accountant and his attorney.
All options should be carefully explored and the owner, CPA and attorney “should work together several years before initiating it,” he advised.
Even when a plan is in place, RothBlair’s Lodge advises reviewing it every five years. “Markets change and the tax laws change,” he explains. “Not only that, you go through a different stage of life every five years.”
Adds Strasfeld, “Old agreements may have formulas for pricing the stock that have gone out of date and tie your hands, taking away flexibility.”
While the owner of a business is likely to want to see the next generation succeed, “If you have five children, it may not be a business that can support five children,” Heintz says. It might support one or two but the rest want a share of the profits.
“That can lead to family conflict,” he says, as the children who choose not to stay agree on what’s fair with those who remain and run it.
“You’ve got to ask, how do you fund equivalent assets,” Heintz points out, such as life insurance or other investments the parent(s) made.
“And you have some parents who don’t want to treat their children equally,” he adds.
The manufacturing and construction industries in the Mahoning Valley remain very traditional, Davis, Heintz and the lawyers at RothBlair agree. Increasingly, women are coming into their own in these fields, the lawyers say, although they see their numbers remain far behind those in law, accounting and medicine.
“I have [a manufacturer] who’s trying to bring his daughter into the business, Lodge says.
Historically, however, it’s more common to see a father favor a daughter’s husband as a successor if the father doesn’t see a son as up to the task.
Davis tells of a client who knew his son wasn’t up to succeeding him but sold him the business anyway. The son took out a bank loan to pay the father and closed the doors three years later.
More common, Heintz says, is the son taking out a promissory note to his father or parents. Rarely will a bank lend the entire amount in such a situation.
Says RothBlair’s Bishara, “Sometimes the people you think won’t succeed surprise you.”
Regardless, advises James E. “Ted” Roberts, also with RothBlair, in such a situation, both owner and child should have their own attorneys.
One reason family businesses rarely retain family control for three generations, as Davis observes: “Not everyone is made to own a business. This is why 90% of all new businesses fail.”
Second and third generations often benefit from growing up in the business and learning it directly from their parents.
Some find they like it and are good at it. Others find they like it but lack their father’s personality or drive, Davis says. They do well but not as well as their fathers although some hit their own stride after a while.
Others decide to they’d rather follow another career and sell the business.
“Patience is the key to a successful takeover,” Davis has found. A business enters turbulent waters when the new owner wants to change it immediately, not appreciating why his family ran the business as they did.
“The American Dream ends up the American Nightmare,” Davis says, “and the people who failed don’t learn the lessons and want to try again.”
EDITOR'S NOTE: This story was first published in the October edition of The Business Journal. CLICK HERE to subscribe.
Copyright 2012 The Business Journal, Youngstown, Ohio.