The topic of privately held/family business succession may appear to be rather mundane, but improper succession planning can literally cause the loss of a company and place family members in situations in which they never speak to one another again. It’s that serious.
Statistically, only 1/3 of all family businesses will survive from the first to second generation, and less than 15% will survive from the second to third generation. I’m not referring only to companies that are struggling to stay afloat. This sobering statistic includes many, many, businesses that at one time were hugely successful. Think it can’t happen to you? None of the individuals involved with those businesses expected it to happen to them either. The fact is, improper business succession planning is a leading cause of ultimate business failure.
My client base of proven business owners and entrepreneurs stretches across the U.S., and although they are involved in different industries, they share many similar attributes, including understanding the importance of business succession planning. More critical than understanding the importance is that they actually took action and implemented a business succession plan that protects the company owners, their families, the employees, and business.
Inadvertently disinheriting your children from business ownership
Yes, it happens—more often than business owners realize. Worse yet, this trap snares many business owners who have actually taken the time to implement succession planning. There are many ways in which a business owner can inadvertently disinherit his or her own child. Think it can’t happen to you? Think again.
A common situation is a business that has two or more owners that happen to have their children actively working in the business with the intent of continuing the business well into the future. The problem arises when a succession plan doesn’t get updated.
Many years ago, siblings, Larry, Harry and Mary started a single lumberyard, as equal owners. The single lumberyard grew to five locations, and the business was thriving. The siblings had the good foresight of establishing a funded buy-sell agreement that would make certain if one of the owners departed the business for any reason that there would be mechanisms in place for the exiting owner’s business interest to be bought, and the remaining owners would own the company 50/50. There were many components of the plan. However, the overriding objective was for the company to buy back the stock of any owner who departed the company for any reason.
Sounds fairly straightforward, right? It was straightforward when the plan was implemented. However, as time went by Larry, Harry and Mary each had a son come into the business with the intention that their own sons would acquire their own parent’s shares. Again, a very common intention for many business owners. So, what’s the problem? Harry unexpectedly passed away and the dream of having his son own his shares passed away as well. Remember, each of the owners’ business interest was structured to be bought by the company at their passing. In this particular situation, Harry’s shares at his passing were purchased by the company. Harry’s son’s business ownership future—over and done.
Unintended owners-forced sale of the company
Bill and Will, two lifelong friends, started a lumber supply company together. Bill’s strengths were on the entrepreneurial side and Will brought blue collar talents to the team. They determined that company ownership would be held 55% by Bill and 45% by Will.
Although Bill and Will remained the closest of friends and business associates, neither was particularly close with the other’s wife, as neither wife was actively involved in the business. Furthermore in the 25 years that Bill and Will owned the company, there weren’t more than a few times per year that the spouses stopped by the business. One day that all changed. Bill was in a fatal accident and because there wasn’t properly structured succession planning, Bill’s wife was now the owner of his 55% interest.
Bill’s wife and Will, now co-owners, talked and Will assured her that he would be able to keep the company profitable as it always had been. Even though Bill’s wife wanted to believe in Will, she was not comfortable putting her financial future in the hands of someone she couldn’t know for certain could keep the business successful without Bill’s input. Bill’s wife decided to immediately sell…during a down economy and for a sales price much less than what the company would have garnered during a more normal economic time.
Clearly, well-thought out succession plans (whether the objective is to keep the company in the family, or to prepare it for sale) can have an enormous impact on a company’s future. We’ll address this topic in parts II and III in the next two issues of LBM Journal, as well as at the LBM Strategies Conference, Sept. 19-21 in Philadelphia.