VMM was invited by the New York State Society of Certified Public Accountants (NYSSCPA) to discuss the legal aspects of exit & succession planning for businessowners and executives in their journal, Tax Stringer.
This article is the third part of a three-part series on succession planning. Part I, by VMM partner Morris Sabbagh, focued on estate planning and estate & gift tax planning. Part II, by VMM managing partner Joseph Milizio, focused on business planning. Part III, by firm colleague Steven Goodman, president & CEO of SHG planning, focuses on financial planning.
The article can be read here and below.
The Success in Succession, Part III: Financial Planning
By Steven H. Goodman, CPA, MBA
Published Date Dec 1, 2024
This article is the third in a three-part series on succession planning. In Part I of the series, we discussed the legal considerations in creating an exit or succession plan, including estate planning and estate and gift tax planning. In Part II, we discussed the business considerations, including how to avoid the mistakes business owners and executives often make in preparing for exit or succession.
In this part, we’ll focus on the financial considerations, especially in transfers of a closely held business to family.
Transferring a private or family-owned business, whether yours or a client’s, to the next generation of owners usually involves complex estate planning issues. And generally, the greater the value of the business, the greater the issues.
According to the U.S. Small Business Administration, only 30% of family-owned businesses survive from the first to the second generation, and only 12% from the second to the third generation.
There are countless reasons why this happens, including, of course, various legal, tax, and business issues, but in my experience, more often than not, it’s the relational, emotional, and communication issues.
Succession planning discussions tend to focus on the business owner, yet surprisingly, they often tend to overlook the successor. The most important question isn’t how to minimize the estate tax; it’s who will run the business and how.
Do the two generations share the same perspective on the business, or is it vastly different? Do all the successors relish the opportunity to carry on the legacy and continue growing the business, or are they accepting the responsibility out of a sense of duty? Or do they simply plan to sell the business or their stake as soon as the parents are deceased and pursue their true career objectives? And what if they start off with the best of intentions but regret it and wish to sell the business? These are meaningful considerations and should be discussed honestly and early on.
Additionally, the relationship between siblings, other involved relatives, or children of business co-owners should also be considered. Money, stress, and responsibility tend to change things. Is each successor’s authority clearly delineated, or will they be stepping on each other’s toes? Is there a system in place to resolve disagreements and conflicts, or will boardroom meetings turn into family squabbles? Is the compensation set up so that all successors feel it’s fair, or will it breed resentment and possibly malfeasance? You don’t have to be the Roy family from the TV show Succession to face these issues, and many of them can be avoided or mitigated through proper and comprehensive planning.
An easy point to make here is that giving equal rights in ownership to individuals who have different skillsets can backfire. As a business owner, take the time to consider the strengths and weaknesses of each family member you wish to transfer the business to. A business succession plan that transfers ownership equally isn’t always a good idea.
In some cases, splitting up the business into separate entities, spinning off or creating a whole new business, and having these businesses interact with each other can ensure efficiency, stability, and longevity.
I’ll give an example of an actual client: John owned a successful business that manufactured and sold carpeting. His son, Brian, was a gifted craftsman who, since childhood, loved to help install carpet. His other son, James, disliked physical labor but had an interest in the business end. He attended college while Brian worked in the business.
To transfer ownership equally to both sons would have generated predictable issues, which could have ended the business. Instead, John’s succession plan divided the business: he gifted half of the manufacturing and retail business to James and sold him the other half in an installment sale. John then used a portion of the sale income to invest in a new carpeting business for Brian to own. By a structuring agreement, Brian’s installation business provides services for clients of James’s manufacturing business on terms they all agreed on. Each business operates independently and stands on its own, but they nonetheless form a family enterprise that continues John’s legacy.
Decisions like these should be made well in advance of any planned succession, among other reasons to give the successors some real experience in operating and managing the business. They should be allowed to make significant decisions while the safety net you provide is still around to catch them if they fall—but let them soar or tumble on their own. The test goes both ways: can they prove they have the skills to take over the family business, and do they actually want to?
These are just a few considerations that change with each ownership structure and family: the number of families or other shareholders controlling the business, whether they’re equal, the number of successors, and whether they’re equal, and so on. This canvas isn’t big enough to paint the whole picture in detail, but hopefully it provides some broad strokes.
Passing a business down to children can be fraught with challenges. An experienced estate planner, who’s also an independent third party, can help a business owner anticipate potential problem areas and craft a solution to obviate or minimize them. Ensuring the success of a business is important. Ensuring the happiness of the family is more important.
Steven Goodman, CPA, MBA is the president and chief executive officer of SHG Planning. As a CPA and former VP of the Trust and Investment Division of JP Morgan Chase, he’s served hundreds of estate planning clients for over 30 years. He also holds an MBA from Fordham University and was a supervisor for KPMG Peat Marwick. He can be reached at sgoodman@shgplanning.com and 516.297.7390.
