My experience is that a business owner often views the transition of his or her business as an event. I suggest an alternative approach.
Those business owners that have made the successful transition from one generation to the next seem to have one common characteristic: they viewed the transition as a process with a long timeline.
With few exceptions, they did not just announce at the time of their retirement that they wanted to hand over the business to their children, who might have had no practical experience in the business they were about to receive. Rather, the business owner with a successful transition often grooms the children from their early years by immersing them both physically and mentally in the business culture. They force the children to get their hands dirty by making them perform manual labor, work in the copy room, work on the dock, sweep floors, etc. Over time, the owner may provide the children with some form of ownership in the business by making gifts of a few shares of stock each year to gradually reduce his or her ownership and as an incentive to keep the children working hard. This provides perspective and allows the junior generation to experience first-hand the effort and teamwork necessary to make the business run effectively, with the hope they will begin to feel and act like owners, both figuratively and literally.
We find that many business owners also require that their children get a college degree and/or work outside the family business for a specified number of years before being an eligible owner for the same reasons stated above. The idea is to eliminate the chance of an “entitlement” mindset existing in the junior generation; to create a real sense of commitment and pride in the family business; and to understand the necessity of hard work.
Some business owners reading this article may view the foregoing as a feel-good issue. But, aside from the obvious financial consequence if the business fails after transfer to the next generation, there can also be a less obvious financial consequence. Sometimes this consequence is severe.
For example, assume Tom owns all the stock of a warehouse business. Ten years ago, the business was worth $1 million, but it’s now worth $8 million. Tom has always believed that his three children have been ready to assume control of the business for many years, but he just hasn’t been able to let go. He has always viewed the transfer as a milestone event that would occur at the time of his retirement from the business. Tom unexpectedly dies. While Tom’s estate plan does provide for the stock to pass to his children, the economic consequence of Tom not taking action during his lifetime is punishing. Under the estate tax rates in effect for 2006 (and assuming Tom had sufficient other assets passing to his children to use up his $2 million federal estate tax exclusion amount), the $8 million of stock passing to his children will generate a combined federal and Ohio estate tax of over $3 million. While some tax provisions allow for the deferment of the payment of estate tax in certain situations, the general rule is that all this tax will be due nine months from Tom’s date of death. Unless Tom had sufficient non-business assets or life insurance to pay this tax, the business is likely to fail. The real tragedy is that with the help of his lawyer, accountant and financial advisors, many techniques could have allowed Tom to transition the business, over time, to his children while substantially reducing or eliminating any gift and estate tax consequences. These techniques, which only require foresight and planning, also would have allowed Tom to retain control of the business for as long as he desired.
The Boston Globe, on May 4, 2003, reported that 40 percent of all family-owned businesses survive to the second generation, but only 12 percent of those same businesses survive to the third generation, and only 3 percent make it to the fourth generation. I submit to you that those percentages would be more favorable if more owners treated the succession of their business as a process, rather than an event.
DAVID ONEGA is a partner in the family law practice group at Carlile Patchen & Murphy. Reach him at email@example.com or (614) 228-6135.