Planning for Family Business Succession: Red Flags & Insider Suggestions

/// By Jeffrey S. Davis & Aviva Sapers

Statistics show that only 12-13% of family businesses are successfully passed down to the 3rd generation of family control. You might ask why this is the case and what can be done to improve the odds? Though there are many factors that contribute to this attrition rate, most do not survive because they haven’t implemented the right development plan and a broader entrepreneurial and leadership perspective prior to transition.

More simply, too often the 2nd generation does not properly prepare the 3rd generation for success. Without a thought-out transition plan with objective performance standards or a structured buy/sell agreement with enough estate liquidity to support it, any number of things can go wrong.  Also, if the 2nd generation leaves the governance of the business to all kids of the 3rd generation—even when some members of the younger generation are not working in the business or interested in it—then a successful transition is already burdened with undo difficulties under a poorly defined 3rd generation control. The 2nd generation (G2) of a family business should never assume that the 3rd generation (G3) will take over running a business without express agreement, and once that agreement is in place, the two generations shouldn’t wait too long to engage in a structured dialogue about how and when the transition can occur.

Having helped to both facilitate and live through successful transitions to the 3rd generation of family control, we have compiled a 14-point list of pointers and potential red flag questions for your family business succession:

  1. Communication is key – make sure the G2 is discussing succession plans with the G3.
  2. If the G2 has no outside activities/hobbies, they may be less likely to give up control.
  3. Don’t rely on the same models as parents for transitions – old methods might have worked for prior times, but markets, resources, and attitudes are not the same.
  4. Review operating agreements and keep them current with changes in the economy and the times.
  5. Retirement plans, disability insurance, and life insurance – does G2 have enough coverage to ensure that G3 isn’t burdened with both running a business and financially supporting their predecessor?
  6. Is there an actionable plan for professional development for G3 – without good professional development, how will G3 obtain the necessary tools to lead?
  7. Avoid leading by feel and old habits rather than structure and accountability – feeling based decisions don’t make for a well-run business, family or otherwise.
  8. Compensation – do you have market-relevant comp for all family members?
  9. In-laws vs. outlaws – giving kids who aren’t in the business a say over the family business brings added challenges, as is giving ownership to those who aren’t involved in the business.
  10. Training outside the business and learning what is needed to perform and meet corporate standards and milestones can add vital perspective of accountability standards.
  11. Setting Performance-based standards for family members along with other staff will help to keep the business productive and fair-minded.
  12. Know how to take risks – which entrepreneurs do, but G2 and G3 can lose amid custodial operations and keeping the status quo.
  13. Outside boards and boards of advisors can bring objective perspectives that foster a growth and innovation mindset – just having an attorney and an accountant aren’t enough.
  14. Don’t let birth order, rather than merit and direct involvement, dictate the structure used for running the business.

Where do you stand with the items listed above? If you haven’t already addressed more than half of the above issues, it may be time to ask for professional assistance, regardless of your plans for a succession timeline.

Don’t set up your children for failure! Encourage the older generation to begin addressing some of these topics sooner rather than later or when it is too late. Bring in outside advisors who are well versed in family business and take proactive steps to protect and strengthen the family legacy.

Tax and legal advice is not offered by Lion Street Financial, LLC.



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