If you’re a Walton, inheriting part of the
family business will probably work out
well for you — four of the 10 richest Americans on Forbes magazine’s annual
list are Waltons — but the odds are against
most of us. A study of 3,000 wealthy families found that 70 percent of the wealth did
not pass to the third generation. Eric
Papenhagen, vice president of asset management and trust for MB Financial Bank
in Rosemont, said the majority of family
businesses experience some problems as
they transfer ownership and operations
from one family member to another.
The upcoming retirement boom will trigger the transfer of thousands of family
businesses in the next few years. Smart
Business spoke with Papenhagen to get
continuity and transition tips for family
businesses.
Do most transfers of family businesses go
well?
Statistically, most family-owned businesses struggle and do not survive the transition to the next generation. Two common
reasons for failure are liquidity issues and
family issues.
Liquidity is an issue because most family
firms have most of their wealth tied up in
the business. When a business is inherited
or sold from one family member to another, significant taxes and buyout obligations
may be due, not to mention the capital
required to continue operating the business.
Family issues that need to be resolved
center around conflicts among family and
non-family employees in the business.
Many owners and partners are very
focused on running their business today,
and they neglect or wait too long to think
about succession issues that could be
addressed with family discussions and
planning.
What are the keys to making a smooth transition and keeping a business in the family?
First is to ensure adequate funding. When
a family business transitions to the next
generation, additional liquidity may be needed to fund a retirement package and
pay taxes. These businesses need to review
their transition options, create a plan,
anticipate their capital needs and fund the
plan appropriately.
Family issues can be more difficult.
Sometimes the second generation does not
have the same passion, knowledge or
experience as the founder. It is really
important to have discussions with the
family and develop long-range plans to
bring out these potential issues. Many owners do not look five, 10 or 15 years down
the road and do not have the same enthusiasm for long-range planning as they do
for running the business.
In addition to key employees and family
members, most successful businesses also
have key advisers, such as accountants,
attorneys and bankers. During most transitions, it would be wise to maintain the
same advisers. These key advisers are
familiar with the business and its success,
which will likely increase the chances of a
successful transition.
What are some of the errors and oversights
you commonly see during business transitions?
Planning is the leading shortcoming.
Planning tends to get put off, and when
plans are done, they are not thorough or
updated. One reason is because businesses
may use their regular accountants or attorneys for the planning, instead of someone
with specific expertise in estate and succession planning. We often see plans that
are outdated or not very applicable to the
specific business.
How can insurance help business transition?
Insurance is a commonly used vehicle to
fund transition costs. Three main insurance strategies include: ‘key man’ insurance, buy-sell agreements and irrevocable
life insurance trusts.
Businesses can take out a key man insurance policy on the owner or perhaps a
salesperson that generates a majority of
the revenue. The business owns the policy
and pays the premium. If the insured unexpectedly dies, the business is the beneficiary and will receive the policy payout. The
proceeds can be used to operate the business until a qualified replacement is found.
Buy-sell agreements are used when a
business is owned by partners. The agreement details what happens upon the death
of one of the owners, and it is funded with
a first-to-die policy ensuring funds are
available for a buyout. A properly funded
buy-sell agreement can provide assurance
to the surviving owner that the business
can continue and it can also provide the
deceased owner’s heirs with funds to meet
their ongoing needs.
Lastly, family business owners that wish
to pass their business to the next generation upon their death should consider an
irrevocable life insurance trust. If they have
a taxable estate, the proceeds from an
irrevocable life insurance trust can be used
to cover significant estate taxes and
expenses. This vehicle can prevent an
unwanted sale of a family business by providing liquidity at a time when the business
is not liquid and cannot obtain sufficient
financing.
ERIC PAPENHAGEN is a relationship manager and vice president of asset management and trust at MB Financial Bank. Reach
him at [email protected] or (847) 653-2138.