Ultimately two issues can thwart the best laid plans of a family business owner: taxes and family discord. No one wants to create friction among family members by bringing up the difficult subject of succession. Unfortunately, the longer one waits, the more difficult it becomes when the subject is passing on the reigns of a family business to one or more children. According to experts, about one third of all family businesses survive the transfer from the first generation to the second. Of those, fewer than 50 percent survive the transfer to the third generation. The single largest reason for this is a preferrence for not clouding family relationships by appearing as if business is more important than family issues. However difficult, that is exactly what one generation must teach the next. If the best interests of the business can be shown to support the best interests of the family, then value can be more easily defined to everyone's satisfaction.
The problems of succession and their solutions revolve around management, taxation and ownership. The job of the current owner is to prepare personnel to take over. Determine who the qualified members of the family are who have shown an interest the work and understand the business. Usually, one leader can spot another and there is always one who is better suited to carry the torch. The problem remains to treat others fairly in accordance with a variety of factors. How can the value be allocated and passed on? Who will participate and how? Who controls business decisions and has more votes? If an greement can be found by a family who allows management to be consolidated, half the battle is won.
Preparation of those who will own the business means education in financial obligations and legal advice regarding trusts, investments, stock and other assets. The law is clear, but every situation is slightly different and every business has different potential. Even though business law in most states is similar in terms of requirements, when ownership and control are not clearly defined, the failure of a business can result. Such a loss can come as a surprise to family members who simply needed clarification in order to keep family and business interests in perspective.
Preparation of the business itself will preserve it from liquidation through taxation. At the time of succession it is better to have an accurate accounting of expenses, operations and liabilities than a reserve of high value assets or cash representing taxable capital gains. Since cash is a must, facilitate the fluid transfer of the business by naming future owners as beneficiaries of disability or other appropriate insurance that will keep things running smoothly. Another way to accomplish this is through consolidating value in shares of the company. Stock shares and other assets can be held in trust until the division of ownership, management and non-participating members of the family are defined. There are also buy-outs and buy-backs that can be arranged through a note held within the family to prevent assets from melting away in taxes.
One common practice within family businesses is to value voting shares more highly because there are fewer of them. Non-voting shares, valued at less per share, can be apportioned the non-controlling members, as long as a method of evaluating them is agreed upon. The issue of differentiating between various kinds of shares raises the question of control. There is the possibility that a majority may "freeze out" those who hold minority shares. According to David Naples writing for the American bar Association, "numerous techniques freeze out minority shareholders including failing to pay dividends, eliminating employment opportunities for minority shareholders or selectively reducing their salaries, siphoning corporate profits through excessive compensation to corporate insiders and corporate agreements and leases with the majority shareholders and their affiliates, and preferentially redeeming a majority shareholder's stock without a corresponding offer to buy out the minority shareholders on a pro rata basis". Most states provide for the protection of shareholders. In Minnesota, shareholders have a duty to act in an honest, fair, and reasonable manner. Minn. Stat. 302A.751, subd. 3a. Breach of this duty usually leads to action on the lesser shareholder's behalf, rather than on behalf of the corporation, although findings in favor of non-publicly held corporations have occurred when agreements were not clearly delineated by all the parties.
Because of unclear areas arising in family business, a solution to adequate recordkeeping is paramount. Following are three kinds of records to keep for your successors. First, record how things work in terms of the history and culture of the business, and develop a plan for orientation to this history for new personnel. It's important to begin this kind of recordkeeping while the original owners remember the context. Second, if successful templates for behavior or structure can be discerned, make sure they are codified and collected for the benefit of future leaders, managers and employees. And third, be sure that any division of shares of the business is accompanied by an agreement clearly outlining shareholder's rights and participation at each level. Absent such agreements, the behavior of the corporation in the event a shareholder withdraws or is terminated will be determined by the law. Planned and legal succession not only keeps families in business, it saves generational relationships.