By Kathryn Tully
Planning your exit from your own businesses can be emotionally fraught and financially complex, but developing a business transition plan is crucial.
Founders of family businesses often put off thinking about what will happen to those businesses after they retire. They are often focused on the day-to-day management of their firms; they may assume that their children will have the desire and ability to take over; or they may just wish to postpone making emotionally fraught decisions about the future.
Yet developing a transition plan that outlines what will happen to your business when your retire and what will happen in the event of your death or disability is crucial, particularly if you want to leave the business to your heirs. According to the Harvard Business Review, 70 percent of family-owned businesses fail or are sold before the second generation takes over. Only 10 percent remain privately held companies run by a third generation.
A comprehensive transition plan has to fulfill three major objectives: who will run your business when you are no longer willing or able to be at the helm, how will the business provide an income for you in retirement, and how will the business (and any other assets) provide for your heirs.
Deciding who will take over the management of the business is often the most challenging part. Even if you have a child or other family member who you think is up to the task, they may not want to take over –or other family members may believe the job should fall to them.
"When you start talking about who is going to run a business and more than one person wants to, it’s highly emotional," says James Puckett, Jr., Senior Vice President and Private Banker at BBVA Compass. "That is one reason why many business owners procrastinate about this decision."
This is where hiring an external advisor can be helpful. "Sometimes children don’t have the aptitude to take over the running of the business, even if they already work in it," says Bob Smith, Financial Advisor at BBVA Compass Investment Solutions. "In one case, we suggested bringing in a business advisor and that person recommended hiring someone outside the family to run the business." He adds that if business owners do elect to pass on the business to a family member, they need to think at least two generations into the future to ensure the plan is sustainable.
Good communication is also key. Your objectives for the future of the business should be explained clearly to all family members from the outset so that they are all aligned with your goals.
Your transition plan must also outline when your chosen successor will take over upon your retirement, what will happen in the event of your death or disability, and how the transition will be made as seamless as possible for the business’s customers, employees, suppliers and creditors.
If there is no obvious successor to take over the company, arranging for your interest in the business to be sold upon your retirement, or in the event of your death or disability, is another option. "When you’re evaluating your options, that should be a key consideration," says Smith, adding that this is a common exit strategy for family business owners.
The transition plan must also cover the lifetime income that you will require from the business once you retire, as well as how your business and other assets will be divided equitably among your heirs working inside and outside the business when you pass away.
"Sometimes, a business can make up over 80 percent of a family’s net worth," says Puckett. "In those cases, it’s difficult to equally divide assets among remaining heirs without looking at some other financial products."
This is why it is also important to incorporate future tax liabilities in the plan. To avoid a situation where your heirs will have to pay estate taxes on your business assets after your death, you must turn over control of your assets to the next generation while you are still alive.
In short, you need to consider whether your business is robust enough to support yourself, you heirs, your tax liabilities and still continue as a viable entity. "You are asking your business to perform a lot of things – to give the owner a lifetime retirement income and support all of the children in the family. If there’s more than one business owner, a lot of times those problems multiply," says Smith.
So when should founders start planning the succession of their business? Puckett says that it is never too early for a someone with a successful business to start thinking about this, whatever their age. "This is very easy for clients to put off, so our job is to start discussing this with them as soon as possible."
He suggests establishing your goals and objectives, talking to your financial advisor, who will encourage you to think about any issues you haven’t considered, creating a written transition document and updating it periodically. "If a client drew up a plan five years ago, things may have changed and they probably need to look at it again."
The key thing is to give yourself plenty of time to make the right decisions for you, your business and your family. "Nobody acts on this overnight – they stew on this for a long time ¬– and there comes a time when it’s too late to plan ahead,” says Puckett.
Kathryn Tully is a business and financial journalist who is based in New York.
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