ComplianceLegalFinanceFebruary 07, 2021

Planning for business succession

Transferring your business to family members or other insiders, in an orderly and successful manager, may be the toughest management challenge you face in the life of the business. Not only must you choose your successor wisely, you must thoroughly prepare him or her while confronting and resolving conflicting goals and agendas. Plus, you need to structure the transfer to minimize the tax impact on the business and your family.

You've invested a great deal of time, money and energy into your business. As a result, you probably want to see the business continue and flourish once you leave the helm. This is especially likely if most of your family wealth is tied to the business, in one form or another. 

However, simply wishing and wanting a successful transition to family members or other insiders isn't enough because orchestrating a smooth succession can be the ultimate management challenge. On top of these "people" issues, you must also consider business, tax, and estate issues when planning for the succession of both management and ownership.

Any transition of an ongoing business must preserve the continuity of leadership. Therefore, it is critical that you view succession of ownership and management as a planned process, rather than as one-time event. Even though you (and your successor) might like to skip the difficulties associated with implementing a transition plan, you can't simply hand the keys to your successor and walk away--at least not if you want your business to continue. Succession is a process requiring planning, teamwork, and constant re-evaluation.

As we've stated, simply wishing and wanted to pass your business to the next generation isn't enough. In fact, barely 30 percent of family businesses survive into the second generation and fewer than 15 percent of them endure into the third. This is a sad fact, not only for the families, but for the nation's economic health, because much of our economy is made up of small, family-owned businesses. If the business of succession is not done by process (through planning), it will be done by crisis (a failure to plan), with perhaps disastrous results.

A typical succession plan has two elements. Each element must be managed separately:

  • Transfer of power. You transfer control over the business's operation to the individual (or individual's) that you feel are the most suited to succeed you.
  • The transfer of assets. You transfer the wealth concentrated in the business to designated family members. Those benefiting from a transfer of wealth may be a different or larger group than the person or persons who will be assuming power.

Planning helps avoid pitfalls in transferring power

The family business is affected by all the issues that face by any type of business, such as technology, laws, climate, competitors, economic trends, and employees are among these influences. In addition, the family business is influenced by anything that influences the family itself, such as the relative health of its members, their various interests and skill levels, their individual marital status, and the level of business participation of each individual.

Managing a transfer of power while balancing the internal and external environmental influences of the business is a juggling act. If the founder is reluctant to give up control and/or the successor is not well prepared to accept it, the transfer can be a challenge that would daunt the most skilled psychiatric social worker or business consultant.

Fortunately, most family business people are professionals who manage their companies to compete effectively in our global marketplace. They don't have time to dwell on petty jealousies and family squabbles. However, that doesn't mean that you should not consider carefully the factors surrounding a transfer of power

The major issues confronting a family business owner seeking to transfer power to successors are:

  • selecting a successor;
  • managing inter-generational conflict, different agendas and different goals;
  • providing adequate training for the successor; and
  • timing the transition.

Tips for Selecting a Successor

The business successor is often selected by default. Most family businesses will have one member of the next generation who is more active, qualified, and interested in the business than his or her siblings. Frequently, the founder has already spent a great deal of time grooming the successor-apparent or the successor has soaked up much of the necessary knowledge on his or her own. In this case, the challenge of succession planning to to find ways to ensure equitable treatment for the non-participating family members, be they the spouse or siblings.

The other side of the coin is the under-prepared, disinterested or lazy successor-elect. Sometimes the founder is willing and eager to give the business to his daughter, but she'd rather be a marine biologist. Or, one child wants to be the boss, just so he can get a classy company car and play golf every day. Or, perhaps a child is interested and willing, but hopelessly unqualified for the task.

Between these extremes are the majority of family business successions. Able founders need to pass along a hard-earned creation to able successors who have worked hard to become prepared to take on the task. There will be the usual number of differences of opinion and approach commonly found between generations and between co-workers of the same generation. These can and will be worked out mutually over time to the benefit of the individuals, the family and the business. Planning and communication are the tools these successful teams must use consistently.

If succession has not already been determined by interest, proximity, or birth order, a group effort in choosing and grooming an individual is one way to proceed. Key employees who are not family members can often be recruited for a transition team. If your valued, long-time employees participate in the selection and initiation of a successor, the entire team will benefit over the long run. Involving key employees is a good way to retain them, and retaining them is essential for continuity and credibility in dealing with outside sources such as banks and suppliers.

If there is competition between your children for the position, a decision to divide the power between them is not likely to be successful. Ownership may be divided, but management should be clearly delineated. Often ownership can be split into passive and active shares, giving the active successor the necessary control over the business while providing an equal economic benefit to the inactive shareholders. In some cases the business can be divided along functional lines, so that different family members can assume control over well-defined functions or business units.

Navigating Intergenerational Conflict

Conflict between the founder of a family business and his or her successor is a matter of degree. It's normal for some intergenerational conflict to exist. However, in the worst cases, a "sandwich generation" effect may be visited upon the middle layer in a family business.


A powerful founder's successor is often responsible to the generations that precede him/her and for the generations that succeed him/her. In these days of longer life spans, b the time #1 daughter takes over the business, #1 grandson is already coveting that position. And the founder may be more favorably inclined toward the grandchild since he feels like less of a threat to the founding father.

The child who accepts this should be a well trained manager of himself, as well as others. Then he or she will be able to manage around the unbusiness like emotional upheavals that frequently are generated in power struggles. Leadership and communication skills will win the day if applied consistently. A true understanding of the feelings and motivations of the founder will enable the successor to deal rationally and effectively with them. After all, the founder spent his or her entire life building the firm and sees it as an extension of his or her self.

Different Generations Have Different Goals

It's normal and expected that you and your successor--no matter how carefully selected--will have different plans and goals for the business going forward. For example, you might be interested in withdrawing assets from the business to fund your retirement plans, while your successor wants to leverage those assets for expansion or modernization of the business.

If these differing expectations are not addressed, the resulting conflict can destroy a promising succession plan. The two generations need to sit down and define the mission of the business as well as that of the family. The needs of the family and the needs of the business to achieve their respective goals may conflict from time to time, but these differences can be dealt with or managed around when they are identified during planning sessions.

This isn't the type of conflict that occurs only once. Indeed, both your and your successor should plan to discuss the balance between business and family needs as circumstances, both internal and external, change over time.

It's up to you--as the business founder and owner--to define your retirement goals and to determine how the business fits into those goals. You then must communicate these goals to your successor(s). By taking the lead and communicating clearly, any conflicts can be resolved in advance and the potential for misunderstandings can be reduced.

In contrast, the ongoing business goals need to be defined by your successor(s) and accepted by you. It is important to work together to ensure that your successor has the opportunity, the capital, the authority and the responsibility necessary to achieve success in and for the business. It's also essential that plans be in place to provide the successor with adequate compensation to support family needs during the "dues paying" period of the transition?

In selecting your successor, it is important to consider the impact that the increased time commitments and responsibility of running the business will have on the successor and his or her family's life. Your successor needs to clearly understand what your will expect of him or her with regard to time requirements, compensation, and scope of authority during the transition period. If any of these conflict with the successor's personal or career goals, or with the successor's family's wants and needs, the transition may be doomed to fail.

It's Not Just About the Founder and Successor

While the founder and successor must communicate and negotiation their respective goals for retirement and the future of the business, the needs and goals of the entire family must be addressed as part of the succession plan. 

Indeed, the first issue to be discussed should be "can this business support all the family members who will be relying on it after the transition?" Then, ways of passing ownership without creating inequities, jeopardizing security or triggering excessive tax liabilities must be addressed.


Be careful not to let tax planning control your decisions. A tax lawyer can make compelling arguments for strategies that can minimize estate and gift taxes. A CPA can be very convincing when suggesting strategies for controlling income taxes. 

No matter how talented and earnest your professional advisors are, their limited specialties should not dictate your choices for your business or your family. First determine the result you want, and then let the professionals find the most tax-efficient way to achieve that result.


Training Your Successor Is Essential

Having a well-trained successor is crucial if you want your business succession plan to succeed. Ideally, your successor will know your business inside and out and have whatever formal education is required to be successful.

Much of the training will be done by the example you set and actual experience in the family business. Formal education, not just in the specialty of the business but also in management and accounting, is immensely valuable. It often is helpful if your successor has had experience working outside of the family business

Experience in all aspects of the family business operation, from sweeping the floor to driving the truck or counting the inventory, is necessary. If the successor is active over a period of time in the business, he or she will not only become familiar with what it takes to run the firm, but will also have a chance to interact with employees, suppliers, and customers to gain their confidence and respect. 

A formal job description for each task assigned during the training mode will clarify everyone's expectations and enable useful periodic performance evaluation and feedback to the trainee.


Many universities operate centers for family business education and research. Among the most prominent are Baylor, Cornell, DePaul, Loyola of Chicago, Northeastern, University of Massachusetts, University of Southern California.

Also, many community colleges offer a wide variety of courses and programs on all aspect of business management and development--these are often extremely reasonable in cost and an excellent source of contacts within the local business community. 

Contact the universities and colleges in your area to see what workshops they may have to offer.

Your local Small Business Development Center offers free, confidential business advising. There are also many regional conferences on family business topics offered during the year. For a calendar of upcoming events, check out the Family Firm Institute's website.


Gradual Transitions Can Be Most Effective

Transition of the control of a family business can take place over a period of months or even years, depending on the needs and wishes of the family members and the business itself. One of the first A transition plan or timetable should be roughed out initially to assure continuity of management. 

This timetable should be reevaluated periodically to see if goals are being achieved As the successor gains confidence and credibility in day-to-day operations and dealing with suppliers and other third-parties, the founder can back away into an advisory role.

If the founder encounters difficulty in "letting go" of the business entirely, the successor must be prepared to be reassuring and supportive and ensure some type of ongoing role for the founder so that he or she feels included. If the successor resists, it may only cause the founder to become more rigid and the successor to become more frustrated. Transitions are stressful and must be dealt with on an objective basis by the successor at all times.

The transfer of power can be seamless and subtle if good communications and careful planning are practiced by all parties to the transition.

Careful Planning Is Required for Asset Transfers

As you make your exit from the business that you founded and developed, you not only need to transfer control and management of that business, you need to transfer the business assets.

Transferring assets is easy. However, transferring assets in the most tax-effective manner always requires significant advance planning and may require specialized and highly evolved techniques.

Some of the more commonly used strategies for minimizing taxation on asset transfers are

  • liquidity strategies (deferrals, redemptions, buy/sell agreements);
  • private annuities;
  • trusts (such as a Grantor Retained Annuity Trust);
  • recapitalizations; and
  • management of assets via a family office.

Before any of these methods can be used, it is essential to obtain a thorough and accurate valuation of the business must the foundation of all these methods. In fact, it is wise to plan for periodic reevaluation to ensure that the asset management strategy continues to be your best option.

Liquidity Strategies Provide You With Cash

Liquidity strategies permit you to take cash out of the business in exchange for the transfer of assets to another individual. While liquidity options are most common when the sale of the business is to a third-party, they can also be used when the assets are being transferred to family members or business insiders (such as your partners.)

Buy/sell agreements can be between the business and its owner (a redemption plan) or among the various owners (a cross-purchase plan.) Frequently, the agreement will be backed by life insurance policies on all the principals, so a ready supply of cash will be there when needed. In a partnership, a buy/sell agreement is like a pre-nuptial agreement between the partners. For corporations, it's an attempt to set future value on some rational basis that may well hold up during IRS scrutiny. The tax benefits of a buy/sell agreement depend largely on careful drafting so a very good lawyer will be necessary if this strategy is used.

Private Annuities and Grantor Trusts Can Provide Lifetime Income

When a private annuity is used as a business succession tool, the owner sells (transfers) his business to a family member in exchange for a lifetime income. The value of the business will not be included in his gross estate for tax purposes, provided the value of the annuity equals the value of the exchanged business interest. 

If the founder dies early, the appreciation in value of his business after the transfer escapes tax. If he lives longer than his life expectancy, the annuity payments will exceed the value of the business.

Self-canceling Installment Note (SCIN). A drawback of a private annuity is that the seller retains no secured interest in the business. A variation of a private annuity is known as a self-cancelling installment note (SCIN).  In this case, the business owner sells the business in exchange for an installment note that calls for a specific number of payments, over a specified period of time and with a set interest rate.  However, the note is self-cancelling if the seller dies before it is paid in full.  

Because the note is extinguished when the seller dies, there is no estate tax due on the remaining (unpaid) balance.  And, if the parties added a premium to either the amount due or the amount of interest to offset the possibility of cancellation, then there will not be any gift tax due either.


Estate preservation and asset transfer strategies are extremely complex! You must work with an estate planning professional.


Grantor trusts. Grantor trusts can take a variety of forms. Each provides the individual who creates the trust (the grantor) with income once the assets have been transferred into a trust. These trusts are a complex method of transferring assets to the next generation with minimal gift or estate taxation. 

One common type is the Grantor Retained Annuity Trust (GRAT.) GRATs are a way to make gifts, and transfer the fair market value of assets, on a discounted basis since only part of the gift gets valued in the irrevocable trust. There are several other forms of trusts, such as charitable lead trusts and grantor retained income trusts (GRITs), that are permutations of this concept.


The complexity of grantor trusts requires expert legal advice.


Recapitalization Is Possible For Corporations

If you operate your business as a corporation, then the range of strategies that you have to transfer assets independently of corporate management increases. Recapitalization, or the issuance of two classes of corporate stock, is one method corporations can use to transfer ownership at minimal tax cost. Stock is generally divided into voting and non-voting categories which permits control to remain with one individual or group, usually the family members who are active in the business. The non-voting stock is used to provide equity to the inactive family members. There are stringent laws limiting recapitalizations and, again, expert legal advice is necessary.


Succession planning should include exploring all of ramifications of continuing or changes your form of business. Discussing options will in advance of implementing them gives you the most opportunities to craft a plan that meets your needs and reduces any tax liability.


Family Offices Manage Family Assets, Build Wealth

If you have a significant amount of assets that you can invest, you may want to consider placing those assets under the stewardship of a family office to administer and manage. Until recently, a family office was feasible only for the richest families (think Rockefeller, Kennedy, Hilton.) Recently, organizations known as "multi-family offices" have appeared on the scene. As the name implies, a "multi-family office" oversees that assets of a number of families.

If you have over $50 million in assets that can be invested, a family or multi-family office can fill the gap left when the operating business has been sold and is no longer there to provide the record keeping, tax planning and general support the family members had become accustomed to over the years. An employee, perhaps a bookkeeper or business manager, is generally hired to run the office. Having an outside third party to administer things and a businesslike location in which to do it can achieve a level of professionalism impossible in a strictly family setting and the cost need not be high.

If you don't have enough assets to justify a family office, you can to take advantage of professional asset and investment management offered by many of the larger banks. Ideally, you want to place your assets with a firm, bank or company that is independent--they do not earn any commissions on products that they sell and they are able to undertake a wide variety of investments.

Nikki Nelson
Customer Service Manager
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