The Perils of Succession Planning

April 8, 2015 | Roger A. McEowen

Most U.S. businesses are family-owned, but statistics show that only about 30 percent of them survive to the next generation and only about 12 percent to the third generation.  Why?  Conflict among family members – sibling rivalry and battles with cousins are a major reason.  So, a major issue in estate and succession planning for family businesses is how to appropriately deal with the potential for family conflict and associated issues that could be detrimental to the long-term success of the business.  While all conflicts cannot possibly be anticipated and avoided with planning, there may be ways to deal with them if and when they occur.

What causes problems?  Based on over 20 years of experience in dealing with farm and ranch families and other families with non-farm businesses, I have found some common factors:

  • The on-farm/off farm heirs and their divergent interests.  It’s a rare situation where all of the children are active in the business, whether it’s a farm that’s involved or not.  Those that aren’t don’t care if the business is sold.  They want cash.
  • The different financial situations of the siblings.  Those not as well off typically want relatively more income from the family business in the form of dividends or distributions than do the other siblings.
  • The heirs that aren’t involved in the family business tend to get left out - or at least they might feel that way.  For some this is an issue.  For others it’s not a big deal.    
  • Some siblings have more children than others.  This could influence the willingness to sell the business.  Those with no heirs (or none interested in the business) will often be more likely to be agreeable to selling the business.
  • Based on the family, if only one or a few of the kids are named as the trustee or trustees of a family trust, it could lead to resentment by the others.

If the parents select only one child to run the business after the one or both of the parents are gone, it could lead to problems with the other siblings. 

Clearly, all of the above factors depend on the family.  Some families get along quite well.  Others are completely dysfunctional beyond belief.  Sometimes a sibling (or cousin) “lays in the weeds” until their parents are gone to raise issues and complaints that they never raised while at least one of their parents was living.  

For the lawyer trying to do estate and succession planning for the intergenerational transfer of a family business, the process is not easy.  Not only is it necessary to address the complicated tax and entity structuring issues, the appropriate drafting of wills and trusts, and buy-sell agreements, there are ethical issues that have to be dealt with.  The conflict of interest potential is very real.  Many clients are involved and they have numerous interests that differ and sometimes hidden agendas.  So, an initial question that has to be addressed is whether it is even possible to represent those family members that are active in the business as well as those not active in the business.  

On top of all of this, the planner may have to deal with in-laws, the current owner(s) unwillingness to give up control, the liquidity needs of the business, and the potential for divorce among family members.  With all of this, there still remain the unforeseen events that can occur that simply just have to be dealt with as they occur.

So, can anything be done up-front to try to head-off some of these issues?  Let me suggest a few.  First, as for the current owners and operators encourage them to be open and honest about the business and the plan for the future of the business.  Don’t forget that the owner’s spouse can be an important person in ensuring that the next generation remains functional as a team and handles the changing dynamics of the family business beyond the current generation of ownership control.  Second, consider establishing a mission statement.  This can help the family see what the plan is for the next few years.  Third, it’s important to come up with policies that are specific concerning compensation, profit distributions, retirement, redemptions and similar things where conflict can arise.  Fourth, have the family meet on a regular basis.  Fifth, consider the formation of an advisory board.  Finally, make sure that related documents are in place to address issues that could also capsize the succession plan.  These documents include buy-sell agreements and pre-marital agreements, for example.

The estate and succession planning process is just that – it’s a process.  It’s complicated and takes time.  It involves detailed knowledge of the rules surrounding numerous tax issues as well as entity creation, structure and operation.  However, it also involves interpersonal skills to work with the people involved in the family business and insight and perception about the possibility of conflict areas that might arise. 

It’s a tough area of practice.  But it can be rewarding.  As Colonel John “Hannibal” Smith was fond of saying, “I just love it when a plan comes together.”