The information on this page is for educational purposes only. It should not be considered financial, tax, or legal advice. Specific approaches to succession planning should be carefully considered, as regulations do change.
Family businesses are a labor of love that can create a legacy for generations to come. Unfortunately, many family businesses don’t last that long: Only 30% of family businesses survive the second generation of leadership, 12% make it to the third, and 3% operate into the fourth generation and beyond.
Careful succession planning is the key to keeping your business alive. Find out how to do what’s best for you, your business, and your heirs. Often, this means safeguarding your company not just with strong business plans and agreements, but also by including strategies for ownership, management, and succession in a prenuptial or postnuptial agreement.
Why Many Family Businesses Don’t Survive
There are reasons family businesses may not survive:
- Lack of planning. Many business owners don’t understand the importance of succession planning and preparing family members to take the reins. Others know it’s necessary, but are unsure of where to start. Some simply don’t have time. This may set up a business to fail.
- Family conflicts. It’s easy for tensions to run high among family members who work together. When issues at home spill over into the business, the organization can sometimes not survive the fallout.
- Market changes. Each generation will face distinct market realities, but when younger leaders cling to family traditions, they may not be equipped to handle current realities. Without a willingness to evolve with cultural, technological, and legal shifts, a family business may lose relevance.
- No leadership development. Some owners believe business acumen is in their DNA, so they see no need for training. As a result, unprepared relatives take the reins without being adequately prepared.
- No balance between business and family interests. The love of family can cause leaders to make bad business decisions. When nepotism blurs the lines between business and family, it can put a company’s longevity at risk.
The First Step of Succession Planning: Honest Conversations
Handle succession planning with the same diligence you used when building your business. The first step is having honest conversations about the future. These tips can help.
- Don’t wait to start: Don’t wait until you’re about to retire to start talking to family members about succession. Start the conversations early so details can be sorted out. The more time you have to plan, the better it will be for the business.
- Plan ahead: Business owners should decide who needs to attend succession planning meetings, what topics will be discussed, and how often they should occur. Remember, this will not be a one-off conference call, so plan to have regular conversations.
- Have open discussions: Have an open dialogue about each person’s vision for the future. Find out how everyone views the business's missions and goals, and the role they can play in fulfilling them. Address what fairness looks like and how to achieve it.
- Separate family and business concerns: This is a business meeting, not the time to air out old familial grievances. Keep the focus on the company's plans. This doesn’t mean you can’t discuss relationships at all. Talk about how you can maintain business success while keeping family relationships strong.
- Acknowledge everyone’s feelings: Tensions may run high, especially if someone doesn’t feel heard. Listen to everyone’s point of view, even if you don’t agree.
- Outline next steps: Detail when owners will leave, define each person’s financial responsibilities, and create a timeline to make the transition between generations smoother. The role that non-family members will play in the business should also be considered.
- Get professional help: Invite a neutral third party to your succession planning meetings for unbiased guidance. Attorneys, financial advisors, and even therapists can be valuable resources.
Governance Structures That Can Prevent Conflict
Strong governance helps family businesses run more efficiently while removing the emotion of working with relatives. This fosters good decision-making and minimizes familial conflicts. The following are common governance structures in family businesses:
- Family council. This includes family members who are part of the business and those who are not. It’s designed to promote open communication about both business and family matters.
- Advisory board/board of directors. Boards are made up of family and non-family members, which injects objectivity into decision-making. They provide the oversight and structure needed to keep the company's best interests front and center.
- Employment policies. Specific policies allow leaders to judge family members in the business by objective standards, such as education requirements and outside work experience.
- Distribution policies. These help define when and how profits will be distributed or retained for growth purposes. If there’s no agreement on these policies, it can create conflict among operating and outside family members. For example, those actively involved in the business may want to reinvest profits, while others may want the dividends.
The Buy-Sell Agreement: Your Safety Net
A buy-sell agreement helps reduce friction in succession planning by explicitly outlining who will buy shares of a business and at what price. In addition to allowing owners to pass down a business seamlessly, it minimizes the impact of estate taxes.
Key provisions of a buy-sell agreement include:
- Business valuation methodology. Decide how shares should be priced. Whether you plan to use a formula based on revenue multiples or annual third-party appraisals, the valuation methodology should be determined in advance.
- Right of first refusal. This provision gives family members the right to decide whether to accept shares in a business before anyone outside the family has the chance. Keeping a business in the family in this way can decrease company conflict.
- Trigger events. Trigger events are circumstances that lead to a company buyout, such as death, disability, a high-stakes divorce, bankruptcy, voluntary exit, or termination for cause. Trigger events can be different for every company, so get professional advice on how to choose them.
- Funding mechanisms. Decide how buyouts will be paid for. Some funding mechanisms include installment agreements, life insurance for death-triggered buyouts, company redemptions, or cross-purchase by other shareholders.
- Dispute resolution. To avoid potential conflicts, a buy-sell agreement may require mediation or arbitration. This provision can reduce the chances of litigation and help maintain harmony within the family.
You’ve worked hard to build your family business, and you want to safeguard your legacy during a divorce. If you need guidance on how to protect your business and your family with a prenuptial or postnuptial agreement, get guidance from our attorneys at Bikel Rosenthal & Schanfield LLP. Call 212.682.6222 or connect online.