Family Business Succession Planning: Passing the Business On

Family businesses are the backbone of many economies, from small local shops to large multigenerational enterprises. Yet many family businesses don’t survive the transition to the next generation. Succession can fail for many reasons: no clear successor, family conflict, inadequate preparation, unexpected death or disability, or tax and financial problems. A thoughtful succession plan can help protect both the business and the family relationships that matter most.

The two parts of succession

Succession planning involves two distinct but related questions.

Management succession asks who will run the business. This involves identifying a leader with the skills, experience and commitment to manage day-to-day operations and guide the company’s future.

Ownership succession asks who will own the business and how ownership will transfer. This involves decisions about selling, gifting or bequeathing ownership, along with the tax and financial implications.

These may be different people. One child might be best suited to lead the business, while ownership is shared among several family members. Or the business might be run by a professional manager from outside the family while the family retains ownership. Separating these questions can help families find solutions that work for everyone.

Start early

Succession planning takes time, often many years. Starting well ahead of a planned transition offers several advantages. It allows time to train and develop successors, giving them experience and gradually increasing responsibility. It lets you test leadership, seeing how potential successors perform before handing over control. It allows tax planning to be spread out over time, which can reduce taxes, such as by gradually transferring ownership through gifts. And it reduces the risk of a forced, unplanned transition due to illness, disability or death.

An unexpected event can throw a business into crisis if no plan exists. Even if you don’t plan to retire soon, having a contingency plan protects the business and your family.

Key steps in succession planning

Define your goals for retirement, the business and your family. Consider when you want to step back, how much income you’ll need in retirement, what you want for the business’s future and how you want to treat family members. Your retirement security may depend on the business, so financial planning is essential.

Identify and develop potential successors, whether family members or not. Assess candidates’ skills, interest and commitment honestly. Not every family member wants to or should run the business. Sometimes the best successor is a key employee or an outside professional. Provide successors with training, mentorship and opportunities to gain experience, possibly including work outside the family business.

Get a professional business valuation. Knowing what the business is worth is essential for planning ownership transfers, setting sale prices, calculating gift and estate taxes and treating family members fairly. Valuations should be updated periodically.

Plan the ownership transfer, whether through a sale, gifts or a combination. Options include selling the business to family members, employees or outside buyers; gifting shares to heirs over time; or transferring ownership through your estate plan.

Put a buy-sell agreement in place. A buy-sell agreement establishes what happens to an owner’s share of the business if they die, become disabled, retire, divorce or want to leave. It typically specifies who can buy the shares, how the price will be determined and how the purchase will be funded. Buy-sell agreements can prevent disputes and ensure continuity.

Coordinate with your estate plan, making sure your will, trusts and other documents align with your succession plan.

Common succession planning tools

Buy-sell agreements funded by life insurance are common. Life insurance can provide the money needed for remaining owners or the business to buy a deceased owner’s shares, providing liquidity to the deceased owner’s family.

Gradual gifting of shares lets owners transfer ownership to heirs over time, potentially taking advantage of annual gift tax exclusions and lifetime exemptions while retaining some control during the transition.

Trusts and family limited partnerships can help transfer ownership while maintaining control, providing management structures, protecting assets and potentially reducing estate taxes. These tools involve complex legal and tax rules.

Sale to family members or employees can provide retirement income for the owner. Employee stock ownership plans, known as ESOPs, allow employees to gradually buy the business and can offer certain tax advantages.

Treating children fairly

One of the most sensitive challenges is treating children fairly, especially when some work in the business and others don’t. Fair isn’t always equal.

If one child runs the business, giving ownership equally to all children might create conflict, especially if the active child feels they’re building value that benefits siblings who aren’t involved. On the other hand, giving the business entirely to the active child might seem unfair to others.

Some families balance inheritances by giving the business to the child who runs it and providing other children with other assets, such as real estate, investments or life insurance proceeds of comparable value. Clear communication about the reasoning can help family members understand and accept decisions.

Planning for the founder’s transition

Stepping away from a business you built can be emotionally difficult. Many founders struggle to let go of control. Planning what you’ll do after stepping back, such as consulting, mentoring, serving on the board, pursuing hobbies or philanthropy, can make the transition easier for you and the business.

Assemble a team

Succession planning involves legal, tax, financial and family considerations. An attorney experienced in business succession and estate planning, an accountant, a financial planner and a business valuation expert can help you build a comprehensive plan. Some families also work with family business consultants or facilitators who help navigate family dynamics and communication.