In a previous article, we discussed succession planning and transition options available to business owners.
When entrepreneurs launch their businesses, many dream of passing them down to family members after decades of operation. The most frequent form of familial transition is an intergenerational transfer from parents to one or more of their children.
Transferring a business to the next generation is frequently viewed as an ideal situation for business owners, however, doing so creates its own set of difficulties and complications, especially when family dynamics and relationships are involved. This article will focus on business succession to family members, particularly the advantages and disadvantages of this transition option.
Advantages of a Business Transition to a Family Member
- Continuity: Family members have usually spent several years working within the business. Therefore they will likely possess specific experience and relationships, both internal and external to the company, and can continue to operate it in a similar manner. This stability can reassure stakeholders, including customers, suppliers, and employees.
- Inheritance: Succession offers the ability to provide children or other family members the chance to inherit an already well-established business as a source of income rather than starting a new business on their own or working as an employee.
- Legacy: For business owners who are concerned about their legacy, transitioning their company to family members can ensure their wishes will be better addressed, and provide added emotional support for the ultimate change in control.
- Flexible Succession Period: Family business succession offers the business owner several years to groom their successor. This additional time can offer the ability to gain vital exposure and experience across various areas of the business to mitigate the risks of transition.
- Tax Minimization: Taxation strategies can be implemented in advance of and following the transition to maximize tax-efficiency and deferral opportunities. This can involve estate freezes, the introduction of trusts and holding companies, or a number of additional options.
- Maintaining Involvement: Owners have more latitude with respect to their ultimate involvement in the business post-transition, rather than with arm’s length transfers that often include strict contractual components in this regard.
Disadvantages of a Business Transition to a Family Member
- Family Discount: Younger children or family members may not have the financial resources to purchase the business for fair market value. Thus, the purchase price may be less than that of third-party purchasers and may require the owner to provide more flexible financing options that could impact retirement plans.
- Parental Expectations: It is common for successful entrepreneurs to assume that their children will be eager to take over the family business. However, younger generations may lack the interest or desire for the industry, or they may not possess the requisite skills to assume active control. The absence of either may make the transition untenable. Therefore, it is crucial to have an open dialogue with potential successors to understand their interest, motivation, and capacity to operate the business.
- Family Feuding: Families may include several members competing for certain roles which can add a layer of complication to succession dynamics. A business owner may have to balance emotional family relationships with the operations of the business, which can result in sub-optimal results for either or both.
- Equalization Amongst Beneficiaries: Further to the family feuding noted above, there can be further challenges arising from uneven motivation or responsibilities amongst family members. This can make the succession plan particularly difficult, as the overall benefit received for each family member may not be consistent with their expectations or the estate plan as a whole. Should the benefits of the business be divided equally amongst children, regardless of their level of participation? Should inheritance of other assets be adjusted to equalize the beneficiaries? These are some of the most common and concerning questions that impact a familial transfer.
- Low Success Rate of Family Succession: Studies have indicated that the success of family business transitions is approximately 30% when passing to a second generation, and 10% when passing to a third generation. Planning and clear communication are vital elements to consider in order to maximize the probability of success. Ultimately, this process may determine that a family transfer is not the optimal decision and other exit options can be considered.
- Impact on Existing Staff: Transition of the business may upset existing employees or management who may have been more active in the business than other family members. This can result in resentment or alienation, and can impact internal culture and operations, including the potential loss of key personnel.
Succession planning is always challenging but it can become even more complex when family dynamics are involved. Open and honest communication about the owner’s wishes, motivations, skill and interests of family members are key concerns, along with sufficient time allotted to complete the transition process.
At Grewal Guyatt LLP, our team of experienced professionals can assist you throughout your family business succession plan by providing valuation, tax planning and other support services. We would be delighted to discuss how we can assist and guide you through the relevant steps. Do not hesitate to reach out for a complimentary consultation.
