THE NEXT GENERATION
"One day this will all be yours."
It's a part of the lexicon of the American Dream. Working for
yourself. Owning your own business. Building something to pass on to the next generation.
The only problem is, a lack of planning can turn "One day this
will all be yours" from promise into curse.
The challenges a company founder faces in turning his creation into
an ongoing legacy are manifold. Estate taxes can consume up to 55 percent of the
business's worth once the founder passes on. Rivalries between siblings can destroy their
birthright. And how does a parent train a child to keep the business growing and thriving?
According to the American Family Business Survey, the owners of up
to 20 million family-owned businesses plan to retire in the next five to 10 years,
involving a transfer of $350 billion to $450 billion.
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Cover Story
by jacquelyn horkan, editor
The
Next Generation
"One day this will all be yours."
It's a part of the lexicon of the American Dream. Working for yourself. Owning your own
business. Building something to pass on to the next generation.
The only problem is, a lack of planning can turn "One day this will all be
yours" from promise into curse.
The challenges a company founder faces in turning his creation into an ongoing legacy
are manifold. Estate taxes can consume up to 55 percent of the business's worth once the
founder passes on. Rivalries between siblings can destroy their birthright. And how does a
parent train a child to keep the business growing and thriving?
According to the American Family Business Survey, the owners of up to 20 million
family-owned businesses plan to retire in the next five to 10 years, involving a transfer
of $350 billion to $450 billion. If the law of averages holds, fewer than 35 percent of
those companies will survive into the second generation; fewer than 15 percent will make
it to the third generation.
Beating those odds means making a start on succession preparations today. It means
taking time out from launching new products, attracting new customers, and solving
day-to-day crises to plan for the future. And it means grooming your successor, whether
he's five or 50.
SUCCESSION SUCCESS
This issue of succession planning has been a hot news item in the financial world
lately, and not just because of the upcoming transfer of wealth prepicted by the American
Family Business Survey.
Earlier this year, Disney shareholders staged a rebellion - ultimately unsuccessful -
against the company's board of directors because of it would not force management to
develop a succession plan. AT&T's chairman's inability to choose a successor generated
a year's worth of unfavorable publicity. Frank Sinatra's death cast a spotlight on family
squabbles over who controlled the licensing of the crooner's recordings and merchandise.
For most family-owned businesses, the problems involved in making the transition to the
next generation are less newsworthy but more potentially devastating; without proper
planning the family could easily lose the business to bankruptcy or estate taxes.
At the very least, succession planning for a family-owned business must include an
estate plan. The world of estate planning is accompanied by its own arcane lingo of SCINs
and GRATs and GRUTs, and the high priests (lawyers and CPAs) to perform the necessary
rituals.
The point of such a plan is to get more of your estate into the hands of your heirs and
less into the hands of the IRS. That becomes doubly important because a company is not a
liquid asset and paying estate taxes on it can wipe out a family's available cash.
Joel Bronstein, a St. Petersburg lawyer with Bronstein, Carlson, Gleim, and Smith
advises his clients on how to "shift the benefit of their business interest to their
children and cut out the IRS. Legally of course."
Some of the most common forms of shifting the business to the next generation include
- gifting - the owner transfers the business to his children in annual increments
($10,000 per individual a year)
- life insurance policy - a policy is bought, commensurate with the value of the
business, to pay for the purchase of the business upon the owner's death
- buyouts - a plan for the children to buy business from parents thereby ensuring a
steady stream of retirement income for the parents
- family limited partnerships - all family members become equal partners in the business
and the parents retain control until retirement.
- Trusts of various kinds
Bronstein urges his clients to begin planning for transfer early on. "Value
creates tax. The earlier you do something in the life cycle of the business, the lower
that value probably is, and the more you can do with less tax consequences."
By planning ahead, an owner can start giving the business away before it appreciates,
thereby reducing the amount subject to the hefty estate tax, without losing control of the
company.
There is another aspect of business succession planning beyond the mere transfer of
ownership. That is the transfer of management. This is the area that involves sticky
emotional issues such as the controversies that arise between heirs who work in the
business and those who don't. Those who work for the company draw salaries and perks - and
sometimes the resentment of their non-working siblings. And the two groups often clash
over management issues and distribution of dividends.
Formal estate planning can eliminate, or at least minimize, the possibility of
antagonism. For example, non-working heirs, instead of inheriting shares in the business,
could inherit other assets. Or plans could be made for the working heirs to buy them out
after the patriarch's death.
The discipline of estate planning - and the objective insight of financial advisors -
can also help a business owner confront the biggest question: Who's going to take over
once I'm gone?
IT'S A FAMILY AFFAIR
Long a fixture in cities and towns, W.S. Badcock is the quintessential family business.
The home furnishings company was begun in 1904 and is now in hands of the fourth
generation of Badcocks.
In November of 1996, the third-generation patriarch, Wogan S. Badcock, Jr., passed away
at the age of 64, leaving three 30-something sons to take over.
"Dad should've lived another 10 years," says eldest son Wogan S.
"Wogie" Badcock III. "We don't retire at 65, at least my forefathers
didn't. They worked until 85. So we probably got cheated a little."
Nevertheless, the elder Badcock, suffering from a progressive disease, knew he wouldn't
survive to the advanced age of his predecessors and carefully groomed his sons to take his
place. What he neglected to do was select the one son who would succeed him as president
and CEO. It would have been a grievous failing in some families, but the Badcocks enjoy a
carefully inculcated family ethic that keeps family rivalries from boiling over into the
business of the business.
"We all understand that if we have infighting, we lose the valuation in our
business," says Wogie Badcock.
Instead of losing that valuation, the Badcocks have hired a executive search firm and
are looking outside the family for the next CEO. Badcock says that one day someone in the
family may take over again but for now they are seeking someone to help them
"solidify our ideas, our growth patterns - to teach us."
The Badcocks are proof that the right kind of family culture can ease a business
through a less-than-ideal succession. So too is the Nicklaus family.
The Nicklaus family business was begun in 1961 by Harry Nicklaus. The senior Nicklaus
died in 1981 after having accumulated several hotel properties but no will. His two sons
split the properties. Today the four children of the older son operate two of the hotels,
the Best Western Sirata Beach Resort and the Quality Inn Beach Front Resort.
Because the estate was tied up in the hotel properties, both branches of the Nicklaus
family found themselves cash-poor and owing about $500,000 in estate taxes. Taking
advantage of one of the friendlier provisions of the estate tax law, the family elected to
pay the taxes plus interest over a 15-year period. In July of 1996, they fulfilled their
obligation to Uncle Sam with a final check and a big party.
"[The tax] was a large burden at the beginning," says Deborah Nicklaus.
"We were a smaller hotel. But we were able to grow and it makes a big difference
after 15 years what the price of a dollar is."
Today, it is an $8 million (1997 revenues) company getting ready to embark on a
nine-month, $11 million expansion project.
The four meet over lunch every day and schedule a mini family retreat at the beginning
of every year to go over goals for the year. Nonetheless, Deborah admits that sometimes
they don't reach decisions as quickly as they should, preferring to wait until they can
build consensus.
Like the Badcocks, the Nicklaus siblings all worked at the family business as children
on summer and Christmas vacations, learning about operations and sharing in the family
work ethic at an early age. That shared experience helped build a lasting sense of family
solidarity. Today, three of the four siblings live within a mile or two of each other and
the hotels.
"Friends come and go," says Deborah Nicklaus. "People come and go but
your family is always there."
PASSING IT ON
Developing the family's next generation of leaders takes time: time to allow the
children to grow into management roles, time to develop relationships of trust with
employees, suppliers, and customers, time to learn the business. And time to decide
whether a career in the family business is what the child really wants to pursue.
One of the questions most commonly not asked of heirs is, "Who wants to run the
business." Sometimes a child's earliest impression of the family business is gained
at the dinner table listening to his parents gripe about the demands it makes on them.
But those dinner conversations can also become the first step in preparing Junior to
take over.
"You're teaching them values and a work ethic," says John Dufresne, a Tampa
business consultant. "You're teaching them what Daddy or Mommy does."
Dufresne's consulting group provides the full array of succession planning services,
from short-term management of the company in emergencies to ironing out wrinkles in the
family dynamic. One of the intangibles in planning for succession is the planting of
entrepreneurial fervor.
"One of the difficulties in transitioning from one generation to the next,"
says Dufresne, "is that the founder has a real passion for the business. You've got
to find a way of passing the passion on to the next generation."
From the board room to the CPA's office, and yes, even the kitchen table, it's never
too early to start planning for the next generation to take over - it can only be too
late.
SIDEBAR
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Steps to be taken in
PREPARING THE NEXT GENERATION
can include the following:
Written job descriptions for family employees, outlining specific jobs and
responsibilities as well as prerequisite qualifications.
An arrangement for children to work outside the family business for a three-year
period, preferably in the same industry. This gives the heirs exposure to different
business practices and management styles, as well as outside validation of talents and
abilities.
Objective evaluation by outside advisors (CPA, lawyer, consultant) of heirs' management
capabilities and leadership qualities.
As more responsibility is turned over to heirs, the founder should take longer and
longer vacations, giving himself and the heirs increased confidence in their ability to
manage the business.
Formalize the plan of succession and write it down so there is no question as to what
you want to do.
Discuss your plans with family members, both inside and outside of the business, and
with key employees. Open discussion gives them the opportunity to express their viewpoints
and allows you the chance to share your reasons for your decisions and to ensure agreement
with them.
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July/August 1998 -- Florida Business Insight, 501 N. Adams St., Tallahassee,
Fla. 32302
(850)224-7173, insight@aif.com
