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Succeeding at Family Business Succession Planning

May 03, 2022

Succeeding at Family Business Succession Planning

Synopsis
4 Minute Read

Communication, governance, grooming and fair vs. equal are important principals to keep in mind when developing a succession plan.

Family Business Practitioner

Nothing succeeds like success, the saying goes. But for family businesses, it’s the right succession planning that can be the key to sustaining your business in the future and keeping it thriving. The issue is, few family business owners are doing a great job preparing to turn their businesses over to the next generation. So where do you start? Communication, governance, grooming and fair vs. equal are important principals to keep in mind when developing a succession plan.

Communication and governance

Research shows that 60 percent of failures in family businesses are due to a lack of communication in the family. Another 25 percent of failure is due to a lack of education and preparation of the next generation.

Only three percent of failures are due to issues related to financial planning, taxes and investments. Thus, it is important to set up family governance structures, such as family meetings or family councils, with open lines of communication to help resolve issues relating to the family and the business.

Grooming plans

Grooming plans should expose the next generation of successors to all aspects of the family business with a focus on continued learning both within the business and outside the business. Preparing successors for leadership and ownership is an integral part of any succession process. Ensuring a grooming plan is in place for all the potential successors will help the current owners obtain an appropriate level of comfort with respect to the successor’s competencies, work ethic, and commitment to the family business.

Fair vs. equal

In a family business, equal is rarely fair and this is one of the main sources of conflict. This issue applies to many facets of a family business from compensation to ownership. It is often the case that all next generation family members are paid the same despite a large discrepancy in responsibility, years of experience, education and commitment.

This often results in frustration from those who work the hardest, and in extreme situations can result in the family business losing the most valuable next generation family members.

To avoid this pitfall, successful family businesses develop a compensation philosophy or approach based on paying fair market value. Often, because parents love their children equally, they want to divide the business equally amongst their children whether they are active in the business or not. This can often lead to further conflict between the next generation of family members and is one of the biggest contributors to the ailing statistics in family business succession.

Anecdote: When equal is not fair

A family business owner had three daughters, of which only one worked in the business. He had transferred ownership equally to all three of his daughters. Sarah, the youngest of the three girls, worked in the business and had been managing the daily operations for the last five years. The business continued to be successful under Sarah’s leadership and annual dividends were paid to all three shareholders. However, as time passed, dividends became an issue. 

The two non-active sisters made it clear to Sarah that they were counting on their annual dividends, and they expected that the dividends would increase given the performance of the business. Sarah had no choice but to concede and continuously alter her plans for investing in the future growth of the business as her sisters held two thirds of the voting control.

The parents had no idea that choosing to split the shares equally among their three children could lead to so much family conflict. Unfortunately, the other two sisters decided they wanted to sell the business in order to maximize their personal wealth and Sarah had no choice but to accept. Had proper succession planning happened on the onset, the conflicts that ultimately arose could have been avoided.

Fair market value

Family businesses that develop their “family business rules” do so in order to establish clear expectations and terms and conditions with respect to a number of succession issues including ownership. 

Some family business rules will stipulate that in order to own shares in the family business, one must have a certain degree of education and must be working full-time in the business.

The rules may also stipulate a number of years of full-time work is required to make it into management and ownership, and may incorporate a test of ‘compatibility’ to ensure that the family members actually get along and have proven they can work together.

Keeping the ownership in the hands of active family members has proven to be a highly successful succession strategy. But to ensure that no child is privileged over another based on their life decisions (working in the family business or not), the successors that meet the ownership criteria would purchase the company at fair market value paying the owners over time from the profits generated from the business.

Purchasing the family business at fair market value makes this process fair even if ownership is not divided equally amongst all family members.

If one or more of your family members are interested in owning and running your family business, you’ll likely want to work with a family business advisor to help make the succession smooth. An advisor can objectively discuss with you the pros and cons of your plans and set you up on a successful succession course that incorporates communication, governance, grooming and fair vs. equal as key elements.

Contact us

To learn more about how MNP can help your organization, contact Danielle Walsh, CPA,CA, Family Business Practitioner.

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