family & business succession planning
TRANSCRIPT
FAMILY & BUSINESS SUCCESSION PLANNINGIS YOUR COMPANY EXIT READY?
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I. Succession Planning OverviewII. Key IssuesIII. GovernanceIV. Senior Management: Key StepsV. Board of Directors: Key StepsVI. Funding Your ExitVII. Legal Agreements and DocumentationVIII. Conclusions and Questions
AGENDAAGENDA
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RISKS OF FAMILY BUSINESSES RISKS OF FAMILY BUSINESSES
Family businesses have an opportunity to sustain a legacy and get the benefits of customer and community goodwill. But:•2/3 to 3/4 collapse or are sold by the founders•95% do not survive third generation ownership•Simple planning and action can double the chances for success
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RISKS OF FAMILY BUSINESSES RISKS OF FAMILY BUSINESSES
Reasons: • Inadequate management• Insufficient cash to fund growth• Non-alignment of incentives
among family members• Lack of clearly defined practices
and procedures• Taxes• Lack of a succession or exit plan
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CHALLENGES & OPPORTUNITIESCHALLENGES & OPPORTUNITIES
What Makes Family Companies Different?
Families Are Changing
• Changes from the traditional family (e.g. divorce/remarriage; unmarried partners) may complicate issue of who should participate in the business and how they should benefit (salary, capital appreciation, retirement income etc.).
• Need well thought out Board governance and management processes that are fair and consistent for all family (and non-family) stakeholders.
• Well run family business can earn tremendous market advantages in goodwill with customers and communities, employee loyalty.
• Family companies have significant presence in segments and niches in industries across the economy
• Family companies include first generation companies hoping to transition the company to younger generation.
• Family businesses have issues and transitions, which may require consideration of family values alongside strictly “bottom line” thinking.
STAGES OF COMMON ISSUES STAGES OF COMMON ISSUES
STAGE 1The Founder(s)
STAGE 2 The Sibling Partnership
STAGE 3 The Cousin Confederation
Leadership transition-Aspiration to transmit the business-Succession -Estate planning
- Maintaining teamwork and harmony - Sustaining family ownership- Succession
- Allocation of corporate capital: dividends, debt, and profit- Shareholder liquidity- Family conflict resolution, participation, and role- Family vision, mission and linkage with the business
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KEY ISSUE: BALANCE FAMILY & BUSINESS VALUESKEY ISSUE: BALANCE FAMILY & BUSINESS VALUES
OVERLAPPING OVERLAPPING ROLES AND ROLES AND
RESPONSIBILITIES RESPONSIBILITIES OF FAMILY OF FAMILY MEMBERSMEMBERS
Family Member
Director
Manager
Owner
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Generational transition. Only a third of all family businesses make the transition to the second generation successfully.
Alignment of family interests. Alignment of interests between current owners and others becomes more pronounced as members retire and turn over the reins to the new generation.
Balancing of financial returns. Creating buyout agreements is challenging. When the retiring generation looks to the value of their interest, they often look to a static balance sheet number.
II. KEY ISSUESII. KEY ISSUES
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Interfamily disputes. The interests of family members may not be aligned. For example, a death or divorce may leave a surviving spouse who is not involved in the business holding stock (including voting rights).
Estate and inheritance issues. These include taxes and probate delays upon the death of a family owner.
II. KEY ISSUESII. KEY ISSUES
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III. GOVERNANCEIII. GOVERNANCE
• Get consensus on and communicate the values, mission, and long-term vision for the family business--to family and non-family stakeholders.
• Keep family members (especially non-executives) informed about major business accomplishments, challenges, and options.
• Communicate the rules and decisions that affect family members’ employment, dividends, and other benefits they get from the business.
WELL-FUNCTIONING GOVERNANCE WELL-FUNCTIONING GOVERNANCE STRUCTURES AIM TO:STRUCTURES AIM TO:
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III. GOVERNANCEIII. GOVERNANCE
• Establish formal communication mechanisms that allow family members to share their aspirations, ideas and issues.
• Facilitate building of consensus around key decisions.
• Avoid or minimize family disputes as to value, succession and fairness. They will happen!
WELL-FUNCTIONING GOVERNANCE WELL-FUNCTIONING GOVERNANCE STRUCTURES AIM TO:STRUCTURES AIM TO:
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KEY GOVERNANCE POLICIESKEY GOVERNANCE POLICIES
Employment: Stipulates fairness and optimizes motivation for all employees, family and non-family.
Shareholding: Establishes rules for share ownership and transfer to ensure shares are kept in the family when desired (e.g., Share Redemption Fund, Single Manager LLC, Common/Preferred stock).
Dividends: Establishes principles to help resolve differing family cash demands.
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KEY GOVERNANCE POLICIESKEY GOVERNANCE POLICIES
DIRECTORS and Officers: Guidelines for electing family members to the company Board of Directors and to fill executive positions.
FAMILY EDUCATION POLICY: Guidelines for helping family members gain educational and professional training (may include Education fund).
CONFLICT RESOLUTION POLICY (AND COMMITTEE): Measures to help resolve conflicts between family members within a defined scope.
11 Analyze talent Analyze talent implication of the implication of the business strategybusiness strategy
• Where are we taking the business?
• What type of leaders do we need?
22Define Define talent talent standardsstandards
• What does “best-in-industry” talent look like?
• What are the critical experiences, skill set and behaviors required for leadership roles?
33 Analyze individual & Analyze individual & pool strengths & pool strengths & weaknessesweaknesses
• Who are our stars? Blockers?• Where do we have issues in
our overall leadership talent portfolio?
44Conduct Conduct regular talent regular talent reviewsreviews
• What actions are necessary to address talent gaps?
• Who “owns” what actions?
55 Execute talent Execute talent plans &plans & measure measure impactimpact
• What actions are necessary to implement plan?
• Are we getting the results wanted? If not, why?
5 STEP EVALUATION
PROCESS
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FAMILY FIRST VS BUSINESS FIRSTFAMILY FIRST VS BUSINESS FIRST
KEY ISSUE FAMILY FIRST BUSINESS FIRST
FAMILY EMPLOYMENT
Open-Door Policy for all family members; qualifications less stringent for family members
Qualification-Based Employment, as for any other new hire
COMPENSATION Equal pay for all, regardless of their experience or performance
Merit-Based pay, based on experience, performance
LEADERSHIP Leadership based on Seniority in Family—assuming basic qualifications are met
Leadership granted to the right person (family or non-family), based on merit and qualifications
RESOURCE ALLOCATION
Business Resources used for personal needs (e.g., loans, grants)
Business resources only used for business purposes – separate family reserve fund utilized for family needs
DECISION-MAKING
Unilateral & Concentrated with Senior Family Member (e.g., Chairman/CEO)
Multi-lateral, based on Defined Governance Structure (e.g., Executive Committee)
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BUILD CONSENSUS ON FOUNDATIONAL ISSUESBUILD CONSENSUS ON FOUNDATIONAL ISSUES
• Principles for best short- and long-term outcome for the business, the family and other stakeholders.
• Prospects for the business, its viability in the market; its capital needs.
• The role of the family in company ownership and management, including personal and business goals of the next generation.
• Whether to bring in non-family professional management.
• How to grow the company while serving family interests
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STEPS TO FORMAL SUCCESSION PLANSTEPS TO FORMAL SUCCESSION PLAN
1. Start Early
• To ensure continuity of business, plan to identify next CEO should begin as soon as CEO is appointed.
2. Career Development Processes
• Consider strategic direction of company and what executive skills will be needed• Create development systems to help family and non-family executives fill skills gaps.
3. Seek Advice
• Get objective advice from independent directors or non-family executives.
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STEPS TO FORMAL SUCCESSION PLANSTEPS TO FORMAL SUCCESSION PLAN
4. Build Consensus
• Involve key stakeholders in the selection process.
5. Clarify the transition process
• Develop a transition plan between the current CEO and the successor, including level of involvement of current CEO after retirement.
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BENEFIT FROM OBJECTIVE ADVICEBENEFIT FROM OBJECTIVE ADVICE
• Identify and address tensions between family-based values and the performance culture that a business needs to survive in today’s competitive environment.
• Balance long-term and short-term financial and family interests.
Issues on which family businesses often seek advice from outside experts:
• Get beyond the personalities and family dynamics that can impede successful decision-making.
• Ensure that shareholder agreements, by-laws and other structures do not prevent the company from raising money, selling shares and otherwise conducting itself in the market as a non-family company would.
• Get expert tax, legal and estate planning advice.
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IV. SENIOR MANAGEMENT – KEY STEPSIV. SENIOR MANAGEMENT – KEY STEPS
• Formalize a strong senior management team, composed of family and non-family members.
• To manage day-to-day operations of the business and the direction that is set out by the board of directors.
• Consider establishing Executive Committee.
• Remuneration based on performance (subject to “family” versus “business” values).
• Performance evaluations conducted fairly and objectively.
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SENIOR MANAGEMENT SUCCESSION PLAN
• This is most important issue for family-owned business.
• Succession problems are the main reason family businesses fail to reach the third generation.
• Formal succession plan should allow selection of clearly competent person (whether it is a family member or not).
• Family members, the board, key senior managers, and other stakeholders must be involved.
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IDENTIFY AND PREPARE SUCCESSORSIDENTIFY AND PREPARE SUCCESSORS
• Determine policy regarding whether successor will be from family.
• Evaluate readiness and capabilities of candidates among family, non-family (depending on policy) owners and managers of the company.
• Define ongoing role in the business of the retiring owner, if any.
• Identify active and non-active roles of family members going forward.
• Identify support for the successor that is expected from family members.
• Help prepare the next generation for leadership roles.
• Provide counsel and support to successors.
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• The Board of Directors is central to governance of family-owned business.
• Initial role: comply with legal requirements and agreements.
• Role becomes more complex as the business grows. (As interim step, many family companies add an Advisory Board to complement skills of current directors). Ultimately, the Board must mature to be a platform for long-term sustainability. For example:
Include outside, independent members. Delineate roles of the Board and role/responsibilities of
family and senior management. Ensure Board has ultimate authority to direct and
control the organization, separate from family influence.
V. BOARD OF DIRECTORS – KEY STEPSV. BOARD OF DIRECTORS – KEY STEPS
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INDEPENDENT DIRECTORSINDEPENDENT DIRECTORS
• Normally, a board consists initially of family members and a few trusted non-family members.
• Independent directors: Bring outside perspective on strategy and
control. Add new skills and market knowledge to the
firm. Help to approve important hires. Bring objectivity to resolving disagreements
in the among family-member managers. Can use their connections to the advantage of
the business.
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VI. FUNDING YOUR EXIT – EXTERNAL SALEVI. FUNDING YOUR EXIT – EXTERNAL SALE
• Senior Debt – generally term debt with a low rate of interest available from banks and often secured by company assets or company cash flow. (5-10%)
• Mezzanine – available as subordinated debt (behind in priority to senior debt but above equity) from lenders or PE firms, often with a warrant or other equity kicker. ( 10-16%)
Today, companies have a range of different types of capital available to create liquidity to buy out retiring owners:
• Equity – Often issued in the form of stock together with options. If new investor is PE firm or strategic buyer, will usually want control of the company.
• Subordinated Debt Restructurings – gaining importance as way to get capital and maintain control of the company as long as cash flow covers interest and any payment of principal.
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TRANSFER OBJECTIVES
Objective 1 business owner’s objective to retain control of the business for some period of time – just in case!
Objective 2 lower the gift/estate tax value due to valuation discounts for lack of control and marketability.
Objective 3 assure a smooth transition of the business and consider non-participating family members.
Objective 4 avoid and shift as much tax as possible.
Objective 5 create retirement income.
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FORM OF SALE – FAMILY MEMBERS
Installment Sales - An installment sale is an excellent way to provide a steady stream of cash flow (and retirement income) to the business owner while transitioning ownership of the business to the active children.
The installment sale must bear interest at not less than the applicable federal rate published monthly by the IRS. (Caution - bargain sale rules).
Private Annuities - With a private annuity, the business owner (the annuitant) sells the business interest to the active children
(the purchasers) for an unsecured promise to make periodic payments to the annuitant for the remainder of the annuitant’s life.
Family ESOP – essentially an installment sale but to a family Employee Stock Ownership Plan.
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VII. LEGAL AGREEMENTS & DOCUMENTATIONVII. LEGAL AGREEMENTS & DOCUMENTATION
• Review current buy sell agreement as to whether it achieves the goals of all owners and future management.
• Assess full range of potential transaction options such as sale to a third party, debt-financed sale to next generation owner, capital structure alternatives such as preferred/common stock restructuring.
• Identify a team of professional advisors (attorney, CPA, bankers, financial advisors).
• Document the succession plan (including emergency plans) in writing.
• Communicate the succession plan to family and stakeholders.
• Establish a timeline for implementation of the succession plan.
• Always consider tax implications – Estate, Gift and Income and liquidity needs to pay taxes.
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INCOME TAX CONSIDERATIONSINCOME TAX CONSIDERATIONS
• Transfer of business interests between family members –(IRC 2701-2704). Business interests transferred between family members must be FMV and conditions should be arm’s length.
• Corporation redeems its stock and the withdrawing shareholder remains with the corporation as a director, officer or employee, the purchase price is treated as a dividend rather than a capital gain. (302,303 and 318).
• This means the entire purchase price will be subject to tax, rather than the amount in excess of basis.
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TRANSFER TAX CONSIDERATIONS
Annual Exclusion Gifts - Gifts of business interests up to $14,000 ($28,000 for married couples) in 2015 can be made annually to as many donees as the business owner desires.
Gift Tax Exemption - $14,000 gift tax annual exclusion ($28,000 for a married couple), indexed for inflation, the business owner can gift $5.43 million unified credit (dollar for dollar) the estate tax exemption at death - such gifts remove the income and future appreciation on the gifted property from the business owner’s estate.
Family limited liability company (FLLC) - LLC that only includes family members. It can be a valuable tool to transfer a business or business real estate to children at a discount from the value of the underlying assets owned by the FLLC – Single member manager or collective management?
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BUY/SELL AGREEMENTS – YOU NEED ONE NOW!BUY/SELL AGREEMENTS – YOU NEED ONE NOW!
A Buy-Sell Agreement is an agreement among business owners to: • Provide a mechanism to limit who can become a new co-
owner. • Define approach to creating a market for the sale or
transfer of ownership interests. • Specify the mechanism for determining a purchase price
and how purchase price will be paid. (Warning: beware of book value-based formulas.)
• Provides funding for purchase of a deceased owner’s interest.
Owners typically required to purchase life insurance on each other.
In some situations, remaining owners may pay over a period of time on an installment basis.
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SHAREHOLDER WILLS AND TRUSTS – CRITICAL!SHAREHOLDER WILLS AND TRUSTS – CRITICAL!
• Create Revocable Trust to hold stock – avoids delays on ownership transfers and reduces costs.
• Consider gifting of stock to transfer ownership under the Uniform Gift and Estate exemption.
• Have clear provisions as to whom the stock will pass to upon death – family management versus heirs.
• Consider the spousal effect of the ownership passing to offspring in case of death, divorce.
• Establish equalization provisions to reflect rising stock values passing to selected beneficiaries.
• Avoids probate and time delays upon death, both first and second.
• You will have done your family a great disservice without making your clear intentions known – and why.
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VIII. CONCLUSIONS & FURTHER DISCUSSIONVIII. CONCLUSIONS & FURTHER DISCUSSION
• A sound governance structure—between Board, owners and senior management--can mitigate many challenges of family businesses and provide the right foundation for succession planning.
• Governance structure must clearly define the roles, responsibilities, rights and interaction between the company’s main governing bodies.
• A clear governance structure will make it easier to maintain family cohesion and attract capable non-family employees, to help provide long-term sustainability.
• A fair buy/sell arrangement and well designed wills and trusts for owners will avoid disputes on death and retirement.
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SUMMARY TAKEAWAYSSUMMARY TAKEAWAYS
• Every business has succession issues – create a succession plan now.
• Establish buy/sell agreements that reflect the true value of the business.
• Consider multiple classes of ownership of your business (common/preferred).
• Draft wills and revocable trusts.• Begin gifting program to utilize tax
credits.• Review company structure to make
sure to avoid double layers of tax.
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QUESTIONSQUESTIONS
Michael Evans(415) 990-1844 [email protected]
Caleb White(860) [email protected]
Contact Information:
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ABOUT NEWPORT BOARD GROUPABOUT NEWPORT BOARD GROUP
Newport Board Group is a national professional services firm of partners who are highly experienced CEOs and operating leaders. They are experts in helping middle market companies navigate the challenges of No Man's Land. They have led businesses, driven major initiatives, worn many operating hats and experienced many significant M&A and capital transactions. All have deep experience building growth companies and helping them through transitions. NewportBoardGroup.com