It’s a Family Affair

Some business owners who are also parents might love to see their children become involved in the business and eventually take it over. Unfortunately, the idealized vision is difficult to achieve, usually because issues from their family dynamics can take a life of its own and override common sense.

There are many reasons why family businesses do not always successfully pass down through the generations. Sometimes no family member wants to, or is able to, manage the business. Not everyone is an entrepreneur capable of running a business successfully. However, when a family business follows some simple rules, the family business experience can be enriching in many different ways.

Succeeding with succession
The successful transition of the business for the future generations requires planning. The founding owners need to plan for their retirement, death or disability. Without a good plan, the fate of the business is up to the whim of outside influences, such as the courts.

Also, the lack of any plan may create a situation that will drastically lower the equity or value of the firm, thereby not preserving the family wealth. Business succession planning is more important for a family business because the problems can tear a family apart. It can be even more crucial when there is only one son or daughter of the principal’s children involved in the sale and/or operation of the firm.

Many agency owners, including some of our clients, act as if they will not die, or become disabled, and some never want to even think about retirement. They may even already be past the 65-year-old mark, and yet they have not loosened the reigns on control.

We would all rest more easily knowing that what we would like to have happen, if we were to be disabled or to die, will most likely happen. This reduces our stress as well as the anxiety of our heirs’ and key employees that have paid their dues.

Often at the core of a founder’s reluctance to “let go” is a clash of ideologies. Nobody wants to be thrown out. Kids have to recognize the emotional stability and well-being of the parent. In some cases, the parent/principal:

• May have very little interests or hobbies outside of insurance;
• May be afraid that their successors will not require their presence after they sell their stock,
• Does not want the other children to feel the child in the business is being favored;
• May not have many assets outside of the insurance firm, so there is uncertainty as to what would be left to the other children;
• May not have faith (real or perceived) in the perpetuation candidates; for instance they are not sure their child or key people can run the firm profitably enough and grow it in order to afford to buy-out the principal;
• Feel they want to “milk” the firm for all they can (their ongoing salary and increasing asset value if they hang on with controlling interest); this may be despite their retiring in their chair.

Decide who will be next
The natural desire of a parent to want all their children to get along can be a disaster for the business. Waiting for the family to work out issues with the children usually creates bigger problems as resentment builds. It may even break apart the family. Even if the parent is not worried about their own children being at odds with each other, there may be a son-in-law or daughter-in-law that may pick a fight.

Treating all the children equally may not necessarily mean treating them all fairly. Ownership should only be reserved for children active in the business. A non-active owner tends to create many problems for the active owners. For some people, the lack of day-to-day control is often asserted by other means, such as not agreeing to a major decision just to show their power.

There are many other issues that need to be investigated and resolved. What rewards should be given to children already in the business? If there is more than one child, who will own the company? Should control be given to only one child, and if so, which one? Once the decision is made to pass the business to the next generation, the next goal is how to do it and to put the plan in writing.

The key is to have a plan from the beginning. The parent/owner needs to feel confident that those who will be left to run the firm are competent. This may mean that their perpetuation candidates (which may or may not include a child) might need someone else to be brought in, to assist them in the process (like an administrator or maybe an Agency Manager). In some cases the best course of action is to merge in another agency which has the needed talent to help run the combined entity.

What solutions are there?
Nothing can take the wind out of a young person’s sails more than to realize that their efforts in building their own book of business and the agency is costing them money. One step that should always be taken is to use vested account ownership to allow the child to not have to pay for his or her own efforts.

Make sure the children (or other perpetuation candidates) have a producer agreement with a vested ownership interest or deferred compensation for their book of business that they produced themselves. This book should be separately coded and it should be excluded from the overall value of the agency. Using this technique the agency value is properly lowered, less taxes are paid and the financial burden on the buyer/child is reduced.

The producer-vesting contract should not be drafted just before the business succession plan takes effect. It should be in place long before, so it is not looked at as gifting by the IRS. The child/perpetuation candidate might feel relieved knowing that his or her efforts will not cost them money.

Plan ahead, be fair
It is important to be fair and to think proactively. A family business should have a Family Business Charter that outlines the goals and expectations of the family for the business and each other. This charter will allow the parent/owner as well as the children to express their vision for the future. This should be set up with the assistance of an outside party to help to bring some objectivity to the process.

Any succession planning will take time and must include the advice of tax and estate planning professionals. Keep in mind that any techniques used must be done within the context of acceptable legal limits and must not be used in a manner to avoid taxes.

A final thought
Most owners would like their business to continue and thrive well after they exit the firm. With the proper planning, owners can create a structure that will increase the chances that their business will be passed successfully to the next generation.

Bill Schoeffler and Catherine Oak are partners in the international consulting firm Oak & Associates based in Northern California. The firm specializes in financial and management consulting for national and international agencies, including valuations, mergers, acquisitions, clusters, sales and marketing planning, as well as perpetuation planning. For more information, call (707) 935-6565, e-mail catoak@sonic.net.