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Your Business: The Success in Succession Takes Planning

Lerch, Early & Brewer's Legal Update

Perhaps unwittingly, many business founders have successfully followed the dictum “Be fruitful and multiply.” Their companies generate profits over the founders’ long careers. And these profits may have helped to raise and sustain children who married other children, and who have had grandchildren.

But then what? All or many of those children or even grandchildren may want to emulate or enjoy the founder’s same level of success, power and prestige—in the same business!

Succession planning is a process designed to answer whether and how other family members, or non-family member employees or partners, can continue and grow a business that previously relied on a single attentive owner or owner group’s initiative, experience, intellect and control.

A common set of problems face a family business when it moves beyond one family member managing and controlling the entire business. How do you deal effectively with family dynamics that can hurt the business? Can you satisfy the financial needs and expectations of both children who are active in the business and those who are not? How do you keep key employees motivated who are not members of the family, or transition control to non-family members without hurting the family’s own well being?

These are some of the typical issues the process of succession planning can address. It is a collaborative process rather than a standard product because there is no magic formula that will prove effective for all businesses or all families. However, although there are no easy solutions, there are many principles and tools that can assist a business owner to plan for his or her succession.

What’s Best For the Business?

Foremost to consider is what is best for the business before you consider what you think is best for particular family members. Just as the airline flight attendant instructs you to secure your own oxygen mask before your child’s, we would tell you that your business is an income generator that sustains you and your entire family. You must tend to it first, if it is to continue to work to help your children.

For example, if you know that no younger family members can operate the business, your succession planning should more likely involve grooming reliable outside management, and long term protections for family shareholders not actively involved in the business, including strong corporate governance structures to supervise and motivate non-family managers. Another alternative may be an outright sale of the business so you and later your children, can earn income from the proceeds of the sale.

An additional principle is transparency. Family members should know what to expect. There is surely a problem with any plan about which you cannot or will not tell your loved ones until after you die. Such a plan will never benefit from the scrutiny and questions of affected family members, and it will fail to let them plan for their own place (or absence of a place) in the future operations of the business. A plan that is a surprise may be a bad surprise for your business or your loved ones.

Ownership vs. Control

Many of the tools for succession planning recognize that ownership and control are distinct concepts. There are a variety of means of dividing business ownership relatively equally among offspring, while limiting control of the business to those family or nonfamily individuals who are most qualified, energetic, and actively involved in day-to-day management. An optimal situation is one where the owner has sufficient diverse assets to leave the family business exclusively to one or more qualified family members, and other equally valuable assets to less-involved children.

On the other hand, if the only asset is the business, one alternative may be to issue different blends of voting and non-voting stock, and possibly preferred stock, to different family members. This can allow voting control to be vested in one or more selected family members, while assuring all family members of a stake in the company's financial dividends that can be paid to shareholders, whether or not they vote. Similar or additional protections can be provided through a stockholders’ agreement, or an operating agreement if the company is an LLC. These agreements can provide for financial controls such as required auditing, provisions on salaries paid to controlling shareholders, selection and participation of outside board members, and methods to prevent voting deadlocks that might otherwise freeze all productive corporate activity.

These concepts and tools are by no means exhaustive. Every family business has its own unique attributes and challenges, including tax considerations and opportunities, that require a team approach including your attorney to help meet and resolve. Good planning is no guaranty, but it certainly improves the odds of putting success in your succession. 

Ted Goldstock is a principal in the firm’s Business & Tax and Litigation practice groups. Prior to entering private practice, he served as COO of a family-owned business and is well-versed in the dynamics unique to family-owned businesses. For an additional article about “Using Stock Classes to Determine Control and Profit Sharing,” contact Ted at 301-347-1274 or trgoldstock@lerchearly.com. Ray Sherbill chairs the firm’s Business & Tax group and works with family-owned businesses, including helping to develop succession plans. You may contact Ray at 301-347-1275 or rjsherbill@lerchearly.com.

This article originally appeared in Lerch, Early & Brewer's Legal Update, 2010, Vol. II. It is for your information only and is not intended to constitute legal advice. Please contact your attorney for more information.

Copyright 2010 by Lerch, Early & Brewer, Chtd.

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This content is for your information only and is not intended to constitute legal advice. Please consult your attorney before acting on any information contained here.

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