A Crisis of Succession

Part 1: The Family

Nothing exemplifies the American Dream more than the desire for upward mobility. The overwhelming majority of Americans trace their story back to someone of very humble means that took a risk and made tremendous sacrifices because they wanted better for their descendants. It is quite common to talk to someone about their family background and hear the story of an amazing entrepreneur who left a lasting mark on their community and whose influence is still felt generations later.

The Williams Brothers Grocery Store chain that my family started in 1950 is still fondly remembered by many along the California Central Coast. For three generations, both sides of my family have been business owners. Grocery & Liquor Stores, Bar-Restaurants, Accounting Offices, Import/Export Companies and Real Estate ventures have all been owned and operated by my family members. I find that this experience applies most of all to my current role in wealth management when I talk to clients about planning for succession.

According to the Bureau of Labor Statistics, 20% of businesses fail in their first two years, 45% during the first five years and 65% during the first ten. This does not take into account how many projects never get off the ground and how many businesses change ownership during their lifespan. The number of businesses that have multi-generational staying power is very small and if you are fortunate enough to have one of these, keeping it in the family should always be an option. Speaking of families, roughly 50% of first marriages end in divorce and the stats are worse for second and third marriages. This statistic only covers the marriages that end in divorce and leaves out the many unhappy couples that stay together or opt for separate lives without officially divorcing. Successful businesses are rare as are happy families. Since we are having this conversation, congratulations are in order. Having built a successful business and raised an intact family, you have truly succeeded where few others can!

Now what? Getting to this point is hard enough and it is at precisely this moment of transition where many businesses and families are shattered. The tax & estate planning concerns are huge. Inheritance taxes alone can destroy decades of value when mismanaged. This does not begin to approach the emotional strain of the elder letting go and the younger stepping into their place. Far too often the elder only gets one foot out the door and hands over the reigns while retaining the right to intervene whenever they like. This is cancerous to both the business and the family. Anyone who has ever been in a leadership role knows that decisions need to be made and if your decisions can be overridden by the whims of others, then you are not the decision maker. I have seen countless relationships destroyed in this manner and often it takes the business down with it. This is a hard conversation, even for the most functional families, running the most prosperous businesses.

Businesses have a life cycle and this is seldom multi-generational. For many children, this is the curse that comes with the diamond. In their formative years, they look at their parents running a successful business and are told “One day this will be yours!” The child grows up with a life plan which can discourage them from exploring all of their options and fostering talents that might well have led to fulfilling alternative paths. Fast forward to adulthood and the elder is not always eager to pass the torch and worse still, the business is well past its prime. The business could be facing any number of challenges, competitors, technological, economic & political changes that were neither present and often undreamt of during the years of growth. I have had the regrettable experience of watching families sell a business they have owned for decades and barely break even. The child has invested years with the expectancy of inheritance. The elder would have been better off financially and personally by selling the business or handing it off years earlier.

Does the child want to take over? This is a difficult conversation for many families. More than once I have been the outsider who reveals years of false expectations by asking “Is that what you want?” Consultants often find themselves in the role of mediator or counselor when they turn over the rock that the entire family has tiptoed around for decades. Moreover, is the child the right person for the job and are there multiple siblings in the picture? Let’s make this even more complicated and add a troublesome spouse or soon-to-be ex-spouse to the picture. Worse still, perhaps the son or daughter-in-law thinks they married into the family business for which their skills are wholly unsuited. Disclaimer; poison and involuntary exile are not solutions I can legally recommend. Business is all about business, except when we enter the territory of succession, because now it is all about Shakespeare.

Part 2: The Finances

You have built a successful business and now comes the decision that will define your life and legacy. More importantly, how you handle this will be a critical turning point in the lives of your heirs. Do you sell the business or pass it onto your children or another relative?

Having been an outside consultant in this situation many times, my starting point is so basic that it often goes overlooked. “What is this company worth?” People who have built and operated a business for many years often find it very hard to accurately assess what someone else will agree to pay for it. What are its revenues? Assets? Liabilities? What is the outlook for the sector in question? Is it based in a community & region that is on the upswing? It is not uncommon for a client to have a more dispassionate understanding of their children’s strengths and weaknesses while being thoroughly unrealistic as to the sale value of the company they have built. So before we do anything else, let's have a solid understanding of what it is we really have to work with and what options that presents.

If you sell the business to your heirs or an outside party, you incur Capital Gains Tax. If you decide to transfer the business via inheritance after your passing, you are setting your children up to pay a good deal more in Estate Tax. Speaking of the Estate Tax, as of 2024 your heirs are facing a 40% tax bill for an estate or business valued at $13.61 million or more. As any business owner knows all too well, having a business valued at $13.61 million, does not mean you have $5.44 million handy for that tax bill.

Trusts can mitigate and defer some of these tax costs while allowing you to functionally transfer control to your heirs. There is no such thing as a partial transfer of ownership, you are either handing over the reigns or you are staying in control. Unless your name is Vito Corleone, putting your son in charge while you take an advisory role will probably not work.

You can get creative with Trusts that are based outside the United States. These have other tax advantages in addition to adding different layers of legal protection against lawsuits, divorce and other legal hazards. This brings us back to the business itself. If we are talking about a brick and mortar company with 50 full time employees in California or an online business owned by a Wyoming LLC with sales in multiple countries owned by a family in Massachusetts? Obviously the former is going to have far more legal risk exposure and require a more creative estate strategy than the latter.

What if your kids do not want to follow in your footsteps and you do not want to work up until your final days? Selling the business is the next logical option. Other players in your given sector and outside investors are probably the potential buyers that first come to mind. There is an in-between option called an ESOP. An Employee Stock Ownership Plan can allow you to retain control while increasing liquidity and realize tax benefits as ownership transfers to your employees who are taking an ownership stake. Obviously this can be well suited to certain businesses in some sectors and wholly unsuited to others. If your kids do not want to inherit, your employees are not in it for the long haul and you don't want to sell, what option does that leave? Perhaps a Charity? Donating your interest in a company to a registered 501(c)(3) can have some tax and estate planning advantages. Take that a step further, legal ownership in your business can pass to a Foundation you establish and in which your children and grandchildren can retain an interest while the day-to-day management is done by hired professionals. The point is, there are a lot of options between "Sell" and "Bequeath."

Has Insurance crossed your mind? If you qualify as an accredited investor or the value of your business and or combined net worth is high enough, then PPLI may be the solution. A Private Placement Life Insurance policy can hold liquid assets, precious metals & stones, artwork, real estate and shares in a business. This allows the beneficiaries of the policy to receive your interest in the business as a death benefit....not an inheritance.....ie PPLI within a Trust.

You built your business through hard work, knowing your clientele and knowing how to find the right advice to solve problems you have not faced. Utilize these virtues when crafting your exit plan. Many of the best careers have left a sour legacy by not knowing when or how to leave the stage. Don't be one of them! Make your legacy as brilliant as your career and your exit a masterpiece all can be proud of.