All In The Family
Designing the right plan for the next generation
Running a company is hard enough for most small business owners. Still more challenging for many is parting with the firm–especially when kids are involved.
The hurdles lie not only in the financial aspects of designing and implementing a succession plan. For parent-owners, more fundamental issues can be excruciatingly difficult to face: when to loosen control; how to divide business assets among competing siblings of unequal talent; whether to gift all or part of the business; and how best to fulfill kids’ desires while providing for their own retirement security.
“The ultimate question to ask the client is, ‘What, in a perfect world, do you want to see happen to your business,’” says David Nelson, a financial planner and president of NelsonCorp Wealth Management, Clinton, Iowa. “Often, one party will say what the other wants to hear.
“The greatest value we as advisors bring to the table is getting these wishes out,” he adds. “Anybody can do the numbers.”
Too often, however, no one is doing the numbers. According to the 2005 Phoenix Wealth Survey, 63% of 1,514 respondents–small business owners with a net worth exceeding $1 million–have no business succession plan.
Another 50% do not have a business transfer or continuation plan. And 60% are without life insurance for business-related purposes, such as key person coverage.
Because exit planning touches upon so many hot-button issues–business, personal and end-of-life–small business owners tend to ignore the topic for too long, sources say. Part of the sensitivity stems from a natural squeamishness about addressing succession questions. Parents, Nelson observes, often don’t want to burden their children. And many kids avoid raising the subject for fear of appearing greedy.
Parents avoid the topic for other reasons. David Parthemuller, a financial planner with the Normandy Group, Lakewood, Colo., cites owners’ fear of losing control and the difficulty many have “working on the business” when they’re so engrossed “working in the business.”
Some owners, adds Parthemuller, have trouble justifying hiring a succession planner, believing they can handle the process themselves or aided by an attorney or accountant. But delayed or inadequate exit planning, advisors stress, has a price.
“Everyone will have a plan,” says Nelson. “The only question is whether it’s yours or one that a probate court will create for you after you’re gone.”
To kickstart the process, a growing number of advisors are tapping outside parties (such as clinical psychologists) to help parents and children deal with family dynamics that can hinder a smooth transition. Advisors suggest excluding certain third parties. Among them: in-laws (or, as Nelson describes them, “outlaws”).
The heart-to-heart talk between advisor and family members–experts suggest alone with the parents first, later with the kids–can point up problems that, left unaddressed, might prove fatal to the business or to family harmony.
Example: a son or daughter whose business acumen leaves something to be desired. Pete Wheeler, a financial planner and partner at Wheeler/Frost Associates, San Diego, Calif., cites one client who had to leave retirement to resuscitate a family business that his son proved incapable of managing.
Frequently, too, children take the company helm only to fulfill a parent’s wish to keep the business within the family, though their career interests lay elsewhere. Another of Wheeler’s clients, a man in his early 50s, closed a firm that his parents gifted to him to pursue a lifelong dream: working in hotel management.
Even if a child has the requisite skills and enthusiasm for running affairs, a parent risks losing key employees after transferring control. Conversely, selling to a key employee or third party could alienate children whom the parent deems to be less business savvy.
If a son or daughter is fit to assume control, then parent-owners need to determine whether a sale or gift of the business (or some combination of the two) is in everyone’s interest. In most cases, parents will opt for a sale, say experts. Chief reason: the need to provide for a comfortable retirement.
For most owners–especially those with annual revenues of from $1 million to $5 million–the company is their largest asset. They therefore need cash derived from a whole or partial sale of the business to ensure adequate funding of their retirement.
Also dictating a sale, observers say, is the belief among many business owners and exit planners that children who acquire a parent’s business through a purchase feel a greater sense of responsibility for the company. And they take greater pride in their own efforts.