When Naming a Relative as Successor, Business Comes First

Handing the reins to a family member requires in-depth planning, skill development, and a smart tax strategy

Our previous blog highlighted how almost 12 million businesses will transition ownership in the next 15 years; a process involving $10 trillion worth of assets. And family-owned businesses make up a significant portion of organizations that will be changing hands.

SCORE research on family-owned businesses shows they’re crucial to the U.S. economy. They generate 64 percent of the gross domestic product, employ 60 percent of the workforce, and are responsible for 78 percent of new jobs.

Selecting a relative to inherit the business can be a comforting choice. There’s a lot of trusts and good faith in place—but those same benefits can impede a clear focus on four core succession steps.

Have a succession plan

The most important insight in the SCORE research was this: only 30 percent of family businesses survive the transition from first to second generation ownership, and only 12 percent make it through the second to third generation change. If a business infrastructure is in place and there’s a pre-existing relationship between both parties, why does this failure rate exist? The answer is that almost half of owners don’t have a succession plan.

The Value Builder System pioneered by John Warrilow is an excellent approach to setting one up. It’s designed to make a business attractive to an outside buyer while proving it can perform smoothly during and after a transition.

The principles of the VBS apply equally well to family succession since they make owners take a hard look at every aspect of their organization, from customer relations to how much freedom a new boss can enjoy. Every change in ownership should be treated with the same meticulous attention, regardless of if the next boss is a family member or an outside entrepreneur. Planning family succession as you would impressing an outside buyer will set the business up for continued success.

Explain the plan to key parties

The definition of a key party will vary between owners, but it’s best to treat nearly every member of the staff as such. Obviously, the successor and any executives or shareholders are key. There may be a price to pay, however, for not making all employees fully aware of what transition means for them.

There’s a “right time” to inform everyone. Senior staff should know from the outset, while anyone further down the chain should be informed once all aspects of the transition are finalized. Early knowledge of a transition makes people feel vulnerable; unsure of the company’s future and the security of their jobs. And not clearly explaining the transition too late can have a similarly disruptive impact.

This uncertainty can hurt a business during a changeover through impaired performance or even losing staff. Your successor is family, but they may also have their own way of running things. Give everyone clear information on what a transition means for their individual role. This transparency will benefit the new boss since every employee will know where they stand and can act accordingly.

Develop the skills of the successor

Small increases in your successor’s current responsibilities are a good way to ease them into taking on more. Crafting a schedule of achievement dates and milestones is a proven method to gradually boost their skill set on the way to assuming full control. Don’t be afraid to constructively point out any areas where their skills could be stronger.

Let them accompany you to meetings with staff and customers to forge new bonds and participate in all aspects. The more a successor learns to see things from the point of view of fellow team members and your target market, the more prepared they will be.

Owners should not only expect but embrace the fact that their successor is an individual and not a “second self.” Improve their skills but don’t impose every aspect of how you do things; training should augment their talents, not stifle their growth.

Understand how smart tax strategy impacts family succession

Family members may choose to sell aspects of a business to each other at a lower price than to strangers. In some cases, they may gift the stake entirely. U.S. business owners can gift as much as $5.43 million in assets over a lifetime before capital gains taxes are necessary. This figure increases based on how many family members own the company; for example, a couple counts twice for a total of $10.86 million before capital gains taxes kick in.

Consider a business worth $5 million that was first purchased at $500,000. The cost base is $5million and the successor will owe tax starting at that amount if the business is sold to them. If it’s gifted, the tax would start at the original cost base of $500,000 when they choose to sell. Keep in mind: if the businesses thrives and achieves much greater worth, your child will owe quite a bit of taxes upon a sale.

For more information on operating a family business, visit FamilyBusiness.org. For succession planning and tax advice, get in touch with us at the link below.

Provident CPA & Business Advisors helps successful professionals, entrepreneurs, and investors get more out of their business and work less. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning and discover how we help businesses exceed expectations.

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