How to Solve Your Succession Planning Problem So Your Family Wins -- Every Time

If you own or run a family business – a business you want to continue after your leadership ends – then this article is must reading.

The problem is clear: You need a succession plan. Yet, with all your years of experience, you have never done a succession plan. If you are typical, you have some ideas but don’t know how to put a plan in place. The purpose of his article is to show you how.

Let’s start with the three most basic succession plan problems: (1) who will own the company? (2) who will run the company? and (3) who will have control of the company (not day-to-day operating control, but legal voting control)? Chances are you now enjoy all three. Often explaining to my client how (in the perfect succession plan) three different individuals might own, run and control the company (but more than one person can own), gets the succession ball rolling.

Let’s start an example. We’ll call the company “Success Co.” and the owner “Joe” (who owns 100% of Success Co. and runs it). Joe, like any other family business owner, has three basic choices, when it comes to determining who will finally own Success Co.:

1. One or more family members (66%)
2. One or more key employees (24%)
3. Some third party (or company) to whom Success Co. will be sold (10%)

Note: The percentage after each choice is what I see in my practice in real-life succession plans. This article ignores the other possibilities – merger, combination of family and key employees, Joe keeping part of the ownership, and other ways – that do not come up often in practice.

My experience over the years is that each of the hundreds of succession plans I have helped create has had some unique twist. So, yes… it’s a fact: Succession planning (with one exception) does not have a one size fits all solution. Who (when and how) will ultimately own your company drives the exact terms of your succession plan. So, what’s the exception? Taxes! To be specific, income taxes and estate taxes. You’ll read the tax solution toward the end of the article.

A suggestion: As you read, zero in on the fact situation described below that best fits your circumstances. This is a huge subject… all that is contained in this article cannot apply to any one family, person or business.

Now, back to our example. This article focuses on Joe’s first choice: family. The following four family situations come up in practice on a regular basis:

1. Joe has no children or none of his children (even those now working in the business) could run Success Co. Of course, one or more of these kids could own all or part of Success Co. if a professional manager ran the company (rarely done).

2. One child, Sam, (Joe’s only child) works for Success. Co. and Joe is confident that Sam could run the company.

3. Two or more children and all are in the business. Most of the time Joe wants each of them to own an equal number of shares (i.e. 50/50 if two children in the business, 1/3 if three children, etc.). This creates a special problem: There must be a clear leader (with voting control) to make the final business decisions.

Here’s how we solve this problem: We create voting stock (say 100 shares) and nonvoting stock (say 10,000 shares). This is a tax-free transaction and is simple to get done. The technical name is a recapitalization. As long as Joe is alive, he keeps the voting stock and has absolute control of Success Co. Of course, the nonvoting stock, which we will deal with later in greater detail, goes to the business kids. When Joe goes to the big business in the sky, 51 shares of the voting stock (and control) goes to Sam (or the other child who is the clear leader). Sam’s nonvoting shares would be reduced by the exact number of extra voting shares he receives… now all of the business children would be equal.