This information is for educational purposes only and is not intended to be financial, tax, or legal advice. Approaches to succession planning are based on an individual company’s circumstances and current regulations.
All family businesses are different. There’s no one-size-fits-all approach to succession planning. Different business and familial dynamics call for different legal and financial solutions. Some owners will pass down their company to heirs, sell it to an outsider, or retain ownership as the family runs it.
Here are some common succession planning scenarios for family businesses.
Scenario 1: One Successor, Multiple Children
Some owners have multiple children, but only one who’s capable of, or even interested in, running the family business. When this happens, the options include:
- Unequal ownership agreement with compensation. The business owner will transfer controlling interest, or operational shares, to the child who is actively involved in the company. To equalize inheritances, the children who aren’t involved may receive luxury real estate, investment portfolios, life insurance proceeds, or cash.
- Buy-sell agreements. These agreements outline the acquisition of shares over time. This may include an installment sale or earn-out based on performance. This is a fair solution that allows children involved in the business to earn ownership, while non-active siblings benefit from liquidity.
- Intentionally defective grantor trusts (IDGTs). Owners can sell their interests to an IDGT that benefits the child involved in the business. It removes appreciation from an estate, leading to tax benefits. Also, IDGTs provide income for other children or charities through installment note payments.
Scenario 2: Multiple Successors With Different Roles
For owners with multiple children involved in the business in different roles, succession options include:
- Voting versus non-voting shares. Dividing a company’s stock into voting and non-voting shares ensures that all heirs receive income from the company, but it separates governance from financial benefits. This arrangement can apply to children who are not actively involved in the business, such as minors.
- Co-CEOs. Having two family member Co-CEOs maintains continuity and preserves what older generations have built. Open communication is necessary to ensure that one CEO doesn’t undermine the other's authority. It’s also a good idea to explicitly define the duties of each Co-CEO, so there are fewer opportunities to butt heads and overstep boundaries.
- Division-based structure. A division-based structure organizes a company into segments according to specific criteria. This division can be based on services, products, or geographic location. It gives family members the autonomy to run their divisions as they see fit, while still advancing the company’s mission.
- Management agreements with performance metrics. This structure promotes meritocracy because compensation and ownership are tied directly to objective performance benchmarks. Family members don’t receive compensation based on tenure or nepotism, and they’re held accountable for results.
Scenario 3: No Family Successor
If no family member is willing or able to take over the business, an outside successor will be necessary. Arrangements include:
- Professional management with family ownership. This allows the family to maintain ownership of the business, while outside executives run day-to-day operations. There may be a family board with clear governance structures and independent directors who provide oversight to the leadership.
- Sale with earnout for key family employees. When this occurs, owners sell the business to a third party or private equity company. To stay involved, continued employment and earn-out provisions can be negotiated.
- Employee stock ownership plan (ESOP). An ESOP transfers ownership of the business to employees, helping preserve the family's legacy. It also provides tax benefits and allows family members to remain in governance positions.
Internal and External Succession Considerations
For some business owners, passing down their company to family is natural. However, in other cases, a business may be better served by external succession. Some factors to consider include:
- Skills. If a business owner has been grooming family members for several years, then internal succession makes sense. However, if they don’t have the skills, it may be best to have someone from the outside run the business. This could be a short-term arrangement if heirs need time to be trained, or permanent if they’re unable or unwilling to take over.
To make this decision, owners should explicitly define the characteristics leaders need and determine whether family members meet those criteria. Honest assessments will reveal skills gaps among family members. Remember, an outside CEO will likely have corporate experience and leadership skills, such as strategic planning and budgeting.
- Family involvement. Even if family members aren’t going to run the business, they may still have active involvement. Family members should discuss the ways they may want to contribute, even if they aren’t at the helm. For some owners, familial influence on the company may be paramount.
- Experience. An outside CEO can often boost a company's profile. Not only do they come with a wealth of experience, but they may also have the skills needed to take a business to the next level. For example, a new CEO could help a family business expand globally if they have experience in international growth and product development.
- Culture. Since family business culture can run deep, owners often want to hand it down to the next generation. Bringing in an outside leader won’t guarantee the culture will remain the same. A non-family CEO will want autonomy to shape the company in their image.
- Family dynamics. The dynamics of a family can influence the direction of succession planning. Family feuds may not bode well for the business's future. This makes bringing in an outside successor preferable to keep the company alive.
- Privacy. Bringing in an outside successor can compromise a family’s privacy. In addition to opening finances to scrutiny, personal secrets can surface when a non-family member is brought into the business.
- Financial ramifications. Different succession options have distinct impacts on people’s finances. Whether the business is passed down to a family member, sold to an existing employee, or run by an outside party, the financial implications will differ. Owners should work with an attorney to explore the implications of these options for taxes, capital structure, and liquidity.
After dedicating years to your family business, it’s natural that you’ll want to protect the legacy you’ve built. If you need advice on how to safeguard your company and heirs with a prenuptial or postnuptial agreement, the knowledgeable attorneys at Bikel Rosenthal & Schanfield LLP can help. Call 212.682.6222 or connect online.