Family business Featured

8:00pm EDT August 26, 2007

The one maxim that holds true for all business owners is that eventually they will be forced to exit their business. For many, the next best thing to perpetual ownership is having a child assume control.

When preparing to transfer a family business, it is critical to expose children to all aspects of a business early on, so they will be aware of the myriad challenges involved.

“Bring the kids into the business as they’re growing up, so it becomes part of them,” says David Rose, executive vice president of Gumbiner Savett Inc. “Let them work evenings, weekends and summers in their teens, so they can get to know the business and learn what the challenges are.”

Smart Business spoke with Rose about the challenges that multigenerational businesses face, the importance of delegation and how to avoid excessive inheritance tax costs.

What is the most common mistake parents make when passing along a business to a younger generation, and how can this mistake be avoided?

One of the most common mistakes parents make is dividing their assets equally among their children. This can be a problem since not all of the children may be involved in the business. The active participants will have different business objectives than the inactive owners. Inactive owners want to receive dividends and cash from the company while active owners want to retain cash and use it to grow the company.

One business owner, whom I served for a number of years, not only founded his own company, but he also invested in real estate. What he did was give the company to his son, who was co-managing it, and gave the real estate to his daughter who was not actively involved with the business. Not only did he take care of each of his kids, but he also put each of them in positions where they were not in conflict. Avoiding this kind of conflict is key to a business remaining a successful, viable entity of its own.

How can a founder’s inability to delegate adversely impact the business?

Founding owners are risk-takers with an entrepreneurial spirit who are willing to put in 80 hours a week to make their business successful. Often, not only do they know every supplier, every employee and every customer, but they also handle marketing and administrative functions. When the business takes off, the founder may become the force that limits the growth of the business because he or she is used to doing everything him- or herself.

Ultimately, the founder has to make the choice to allow other people to assume responsibility and do the best they can, knowing that mistakes will be made. Learning to delegate and trust so the company can continue to grow is one of the most difficult tasks that founders will eventually face.

What inheritance tax considerations should be taken into account with multigenerational businesses?

One way to avoid inheritance tax costs is to gift ownership to the next generation during the organization’s growth years and before mature valuation is achieved. For example, if you have a company currently worth $1 million and you give away a percentage of the company now, there will be far less tax to be paid than if they inherit the business later on when it is worth $10 million. It is important to start the succession phase of the planning early on in your company’s growth pattern.

What advice would you give to a multigenerational business about establishing a philanthropic commitment?

I believe it is very important for people who succeed in their business goals to try and give something back to the community that fostered their success. We don’t have a caste system here, where if you’re born poor, you’re going to die poor. The world we live in, here in America, gives us the opportunity to be successful. At some point, it’s important to say thank you, and there are many ways this can be accomplished. For example, donor-advised funds allow you to place money with a charity and make suggestions on how the money should be used.

Many wealthy families like to start their own foundation with the goal of ultimately having their children run it. Not only does a family foundation serve the community, but it also serves as a money-management tool for the younger generation as they learn how to research and select charities, as well as manage the foundation’s assets.

How important is it to get outside help with succession planning?

It’s very important. A family’s accountant generally knows more about its asset structure than any other outside person. When the accountant teams up with an estate-planning attorney and a life insurance broker, they can work together to help the family define a plan, pick a proper trustee or executor, and work with him or her when the time arrives to make sure everything is done efficiently.

DAVID ROSE is executive vice president of Gumbiner Savett Inc. He has worked with many multigenerational family businesses and has advised them in their transitional phases. Reach him at (310) 828-9798 or drose@gscpa.com.