Passing the Baton

By Melissa Spievack, Associate, Dinsmore & Shohl, LLP

The past several years have engendered an unprecedented environment for family businesses. With a global pandemic impacting historical business models and disrupting the global supply chain, workforce insecurity, political turmoil, massive economic growth, and estate, gift, and income taxes all in flux, rarely has there been a more confusing — and perhaps more fruitful — time to be a business owner in the United States. Family businesses have faced even more unique challenges against this backdrop, as they face tremendous pressure from private equity and other sources of capital to sell fledgling and well-established enterprises alike. When faced with these market pressures, how does a successful family business enterprise respond? What is “success” in a climate like this — and how does succession come into play?

PricewaterhouseCoopers’s recently published 10^th Family Business Survey reviews the responses of more than 230 family businesses in North America to questions regarding business growth goals, diversification, governance, and continuity. It indicates that 58% of such family businesses seek steady growth, with another 16% seeking aggressive growth in 2021, while 69% predict steady growth and 23% predict rapid growth in 2022.[i] Only 26% of such businesses are predicting consolidation or downsizing in 2021, and even fewer (8%) predict consolidation or downsizing in 2022.[ii] Notwithstanding the growth goals of most U.S. family businesses, only one-third of those family businesses surveyed indicate that they have a “robust, documented and communicated” succession plan in place.[iii]

But what factors should family business principals consider in writing and implementing such a succession plan? With historically high estate and gift tax exemptions in 2021 of $11.7 million per person, many family business owners are considering setting a successful plan in motion today.

While tax planning can and should be part of the conversation that family business owners undertake in implementing such a plan, it is not the only factor that must be considered. Indeed, family business owners can lose sight of critical governance issues in a race to “give it all away,” inadvertently diminishing the value of the business and putting ownership in the hands of second- and third-generation owners who may not be ready for it. So how does the savvy family business owner combat these issues?

Many closely held or family businesses start with a great idea and rudimentary governance documents. Perhaps when the family business was a fledgling enterprise, the simple single-member LLC operating agreement or basic bylaws were viable. But with time and growth, many business owners find that they have outgrown those documents, and they do not often provide for the eventualities of the owner’s death or disability. First and foremost, family business owners must dust off these documents and have their legal and tax advisors review their viability. Reviewing such documents should entail a robust consideration of what will happen when the business owner is no longer able to participate in decision-making. Will a family member take over day-to-day operations? To whom does the business owner want their interests to pass in the event of their death? Is there sufficient liquidity in the business to continue operations in the event of their untimely demise—and if not, how can liquidity be obtained? The successful family business enterprise will have addressed these questions before such events arise and will continue to address them as multiple generations of business owners come to the business.

Family business owners, in assessing the next generation of owners, will sometimes mistake equality of ownership for equality of management. If a business owner intends to leave a business interests to multiple children, it may be that not all of such children can—or want—to be involved in its day-to-day operations. The discerning business owner will take note of these differences and develop governance documents that accommodate them, whether that is through employing the children who are involved in the business and paying them a salary, or through leaving other assets to children who are not involved in the business. While there is no one-size-fits-all approach, business owners should be cognizant of what will work for their businesses and their families.

Once the business governance documents are in order and the business owner has determined who will be an integral part of the business in the future, then a wealth transfer strategy may be deployed. Transfer strategies may involve a gift of business interests, a sale of business interests, or some combination thereof. Such transactions should be discussed and reviewed with the family’s legal and tax advisors to ensure that the tax implications of such transfers are consistent with the business owner’s desires. The successful family business owner will also consider an often-overlooked part of this analysis: whether they are emotionally ready for such a transfer. Even if the economics of the transaction may be favorable, if the business owner simply does not desire to cede control or involvement, it may be possible to structure the transaction in a manner that is both tax-advantaged and accommodates these concerns.

With the economic climate in the U.S. poised to produce significant family business growth in the coming years, successful family business must be mindful of effectuating a succession plan consistent with the family’s vision and goals for the enterprise. Considered planning can ensure the future growth and success of the enterprise even in the face of political, economic, tax, and legal challenges.

For more information, contact Melissa Spievack at melissa.spievack@dinsmore.com or (513) 832-5465.

Dinsmore is a Goering Center sponsor, and the Goering Center is sharing this content as part of its monthly newsletter, which features member and sponsor articles.

[i] 10th Family Business Survey – North American Report: An approach for lasting family business success, p. 2. Available at https://www.pwc.com/us/en/private-company-services/publications/assets/pwc-family-business-survey-2021.pdf.
[ii] Id.
[iii] Id. at p.10.