Estate Taxes, Family Relationships Complicate Succession at Family Firms
In the next five years, according to one estimate, 39% of family-owned firms will see the retirement or semi-retirement of their current leadership as the post-World War II generation passes the entrepreneurial torch.
Clearly, said Dave Harman, co-founder of Cal State Fullerton’s Family Business Council, “succession is the big issue.”
And passing that torch,or, less metaphorically, the business they’ve spent some 40 or 50 years building,involves a large set of difficult and unique decisions. They include whether to keep the business in the family, deciding who to turn the reins over to, and when and how to manage a transition.
But only 28% of family-owned businesses have a succession plan, says Gary Boudreau, West regional succession planning partner at Deloitte & Touche’s Costa Mesa office.
“Most family-owned businesses do not survive to the next generation,” Boudreau said. “A web of complicated issues,from paying estate taxes and finding competent managers, to gaining consent of stock-holding family members,means survival is not assured just because the business is growing and profitable.”
The issues, Boudreau said, are best confronted sooner rather than later.
“It’s certainly not easy, but it’s going to be much more difficult later on … with the added level of emotion following a death in the family,” he said.
Estate planner Joel B. Goldhirsch of Irvine-based Goldhirsch & Goldhirsch, which specializes in large estates, said the first decision to be made is over what to do with the business. There are different strategies to go with different goals, he said, but all are geared to minimizing or avoiding federal and state estate taxes, which amount to 55% in California, and keeping the business intact.
“If you leave it to be liquidated (after your death), there may not be a buyer and the heirs won’t get the best value for the business,” he said. “You can sell it to a co-owner, or to the employees,in which case you might want to set up an employee stock-ownership program. If you want to sell it to an outside third party, you’ll want to move the company out of the estate (to a trust), so they’re buying it from the kids. Or you can transfer it to the family.”
There are financial issues with the latter course, but they are the easy part, Goldhirsch, Boudreau and Harman agree.
The hard part is getting all family members to agree on who will run the business and what the ownership structure will be when the current leadership generation is gone.
“Communication is a huge issue in these matters,” Boudreau said. “Many families have a difficult time talking about what will happen when the parents die.”
Plus, each family has its own unique individuals, relationships and issues.
“The overlay of family issues blurs all the normal selection criteria for the successor, and the dynamics of the family go back for generations,” said Judy Harman, co-founder of the Family Business Council.
Meanwhile, in deciding who inherits what, Boudreau said, “equal is not necessarily fair.”
Boudreau cites a hypothetical example of founding parents who have several children, including a son who has a criminal record and has been in jail, and two daughters who are stay-at-home mothers.
“Does it make sense for them to have millions of dollars tied up in non-liquid, non-dividend-paying stock? No,” he said. “It makes more sense for them to take cash or more liquid stocks.”
One family that did begin succession planning early, only to find that it had done so in the nick of time, is the Dunnings, owners of Irvine-based OCT Group, a $7 million annual revenue, 55-employee firm that tracks customer satisfaction and develops relationship marketing for car dealerships.
Ronald and Floranne “Flossie” Dunning founded the firm in 1986. They had two children, son Grant and daughter Valen, both of whom helped out at the company. Valen married and divided her time between the company and her family. Grant went to college and took a job at Cayman Development upon graduation.
In 1992, Grant joined his parents’ company full-time.
“The business was really starting to grow and they needed help with day-to-day operations,” he said. He started in sales, soon becoming sales manager.
About that time, Grant said, he and his father “had a heart-to-heart. His plan was to have (the company) belong to my sister and I.”
The family decided that Grant eventually would succeed his father at the helm.
“My father and mother were very proactive in grooming me,” Grant said. “It was a real mentoring process.”
In 1994, Ronald Dunning was diagnosed with cancer. He died in 1998 and Grant, who by then had become general manager at the firm, moved up to president and CEO in a smooth transition.
It’s not always smooth, however. Boudreau cited an example of a company run by a father who had two daughters and a son, all of whom held positions at the firm but were not good businesspeople.
“They wouldn’t be in those positions at another company,” he said. “The father recognizes that the children shouldn’t run the business, but he’s in a tough position,the son feels it’s his birthright.”
Boudreau said his firm is working with the father “to develop a role for the children, but not as managers.” Meanwhile, they also surveyed the various stakeholders,the family, top managers,on who should be the father’s successor. That list had several names on it, and the family is still working out its plans, Boudreau said.
And that’s to the second generation.
“When you get down to the third generation, you’re dealing with cousins,” Harman said. “Choosing a successor becomes very difficult.”
Harman said her program encourages the formation of a board with outside members to help chart a path for the company.
The key though, Boudreau said, is that the issues be addressed before they become critical.
“You need to deal with it while you still have strong management in place,” he said. n
