Putting the Horse Before the Cart: Non-Tax Issues in Business Succession Planning

The following is extracted from the ABA-PTL Heckerling 2010 Report #4 and posted with permission of the Heckerling Institute and the ABA Real Estate, Probate Trusts and Estate Section. 

Presenter: Charles D. “Skip” Fox IV
Reporter: John Warnick

Charles D. “Skip” Fox has prepared perhaps the finest paper I have seen on the subject of the non-tax issues in business succession planning.  His outline is heavily footnoted with many important studies and articles which aren't readily available to estate planning attorneys, CPAs, or financial planners.  I believe this presentation will be one that every professional serving family business owners will want to refer to often, perhaps each time we begin a family business succession journey with a client.

The title of Skip’s paper is “Putting The Horse Before the Cart: Non-Tax Issues in Business Succession Planning.”  Early in his presentation Skip makes the point that before we tackle the tax and legal issues involved in business succession planning we need to be aware of the psychological challenges which make this process so difficult.  He suggests that family business succession is rife with potential conflicts between parent and heirs; between siblings; and between family members and the non-family management and employees.  Surmounting the challenges of these potential conflicts requires both sensitivity to family dynamics and an extensive knowledge of a confluence of legal, financial and business issues.

The statistics about the potential for failure in business succession planning are alarming.  Mr. Fox cites a 2004 Trusts and Estates article which reported that only 30% of family businesses pass to the second generation, 12% pass to the third generation, and only 3% reach the fourth generation.  Skip noted that Birmingham, Alabama attorney and former President of the American College of Trust and Estate Counsel, Daniel H. Markstein, III, has observed he has never seen a family business sold to pay estate taxes but he has seen many family businesses sold out of necessity because of poor succession planning.

One of the significant highlights of this session was that Mr. Fox pointed out that in 2007 a survey found that 40.3% of business owners expected to retire within 10 years.  However, less than half of those business owners who were expecting to retire in the next 5 years had chosen their successor and only 29% of those planning to retire in the next 6-11 years had selected a successor.  Another 2003 study of 387 small family-owned businesses found that only 50% had succession plans.  Of those without succession plans, 31.4% stated that they were “uncomfortable making the necessary decisions,” and 14.4% stated that “it’s a difficult topic to deal with.”  Having raised these survey results, begs the obvious question: “Why is it so difficult to select that successor or to start a family business succession process?”

Skip lists the following factors as roadblocks to planning success:  difficulties in selecting a successor; inability to let go; differing outlooks and expectations, both between generations and among the generations of each family; nepotism; sibling rivalry; and the failure to keep disagreements about or within the family business from boiling over into the home front, and vice-versa.

The hopeful news is that Skip doesn't just identify the challenges.  He provides very helpful insights into the psychological and practical aspects of business succession planning which should be very helpful to advisors who are serving the family business owner(s).  For instance, he notes that understanding these non-tax issues can be extremely helpful in formulating an approach to business succession planning that will resonate better with the founder, who Skip feels is the most important person in the process. 

Significantly Mr. Fox noted that there are three broad categories of entrepreneurs: 1) the Basic Entrepreneur for whom the most successful succession is usually dynastic, with a particular emphasis on sons; 2) the Technical Entrepreneur whose analytical and problem-solving approach to his business decision-making means that a simple succession plan, such as cashing out, and passing the wealth on to his or her family, will most likely be most attractive; and 3) the Controlling Entrepreneur, who is generally more interested in minimizing risk going forward than shooting for large returns, and for whom a succession plan that passes the company on to the next generation with an emphasis on maintain the assets with minimal risks.
Importantly Skip cautioned, however, that focusing on the founder alone and disregarding the spouse and children is a serious mistake in formulating a successful business plan.  He acknowledges the wisdom and experience of Gerald LeVan (an ACTEC Fellow) who describes the spouse of the founder as frequently being the family’s CEO (Chief Emotional Officer).  He notes that LeVan’s articles and books illustrate that excluding spouses (both the founder’s spouse and the children’s spouses) from the process of formulating the business succession plan often results in the plan you propose being sabotaged by that CEO.
One very useful part of the presentation was when Mr. Fox shared three common profiles of family businesses which are defined in the pioneering work of Ivan Lansberg, a family business expert.  Lansberg suggested the family business will generally consist of either: 1) a Controlling Owner; 2) a Sibling Partnership which will follow the Acknowledged Leader model or the Shared Leadership Model; or 3) a Cousin Consortium which is the model which you find most frequently when the family business has made it into the 3rd generation of the founder’s family.  Lansberg has suggested a corollary concept that family businesses are either in a recycling transition--where the same profile will continue through the next generation of family ownership--or are evolving into a different form of entity and/or governance, which could be simpler or more complex than the current profile.  Skip notes that appreciating both the profile of the business and the type of transition the family is most likely to find attractive is key to formulating a successful business succession plan. 

Significantly Skip then asks the important question: How Can We Help? He proceeded to discuss seven steps which he feels advisors can follow to provide great value to the family business succession process:
  1. Get a commitment from all family members to work on succession
  2. Help family members set aside competitive ways and teach them more constructive ways to work together
  3. Make sure the business succession planning process begins with a family mission statement and a strategic plan for the business.  The stories and examples that Skip offers of such mission statements are extremely valuable.  Please make sure you take the time to read the history of the J.M Smucker family in Skip’s materials.
  4. Create a personal development plan for family members who work in the business.  
  5. Develop an appropriate governance structure for the family business
  6. Implement the succession plan by putting in place the legal and financial structures
  7. Create a culture in which key employees (whether they are family members or not) are expected to be owners.
As you can see from this summary if the highlights of Skip's presentation, Skip Fox’s materials are full of both important insights into the dynamics of business succession planning as well as practical wisdom.  Both will be very helpful guides in our efforts to assist the owners of family businesses.

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