Running your own business is hard, but working with your family can make things even more challenging.
Recently, Ward and Smith's business attorney Deana Labriola participated in a panel, hosted by the Triangle Business Journal, designed to give small business owners insight and the tools for addressing obstacles created by working with family members. In the Family Business Conversation panel, Deana answered questions based off a hypothetical family business.
Here's the background, followed by the Q and A:
Scenario 1: The protagonist of our tale is Paul. He was born into a poor family and was forced to help support his family at a young age. After high school, he took a blue collar job at the local widget factory. He was a dedicated employee with many insightful ideas about how processes at the factory could be improved. However, his managers ignored his suggestions because of his lack of formal education.
Confident in his abilities and driven by the circumstances, Paul saved every spare penny he earned until he had enough to open his own widget production shop. His widget shop was small, but grew steadily. Paul happily poured himself into his business. He began with a small but loyal staff and cared for each of them like family. He reinvested most of his profits back into his business.
Paul’s home life also had stories. He married his high school sweetheart and quickly had three children, two sons, and a daughter. 20 years go by and Paul is in his mid-forties. The business is doing well. Paul has managed to maintain good relationships with his sons and daughter, and all three are in their twenties. Son number one does not work in the business. Son number two and daughter, do. The widget shop now has 50 employees. Paul has self-taught the pieces of the business he needs to know. He knows the business is becoming sophisticated.
Paul begins pondering the future of his business. While both in their 20s, Paul’s daughter has shown more interest and capability than son number two in the business. At the same time, Paul has been impressed more and more with Jim, one of his senior managers. Paul begins to believe that Jim could carry on the business after he steps aside.
Paul is still young, but even in his 40s what should Paul be doing at this point with respect to succession planning?
So he’s in his 40s and I think part of succession planning is just thinking about it. I think there’s a lot of folks that put their head down for so long, get into business and then 40 years pass. And so I think in your 40s if you are thinking about it, you’re already ahead of the curve. Just start talking about it and getting educated about it.
I think in your 40s, or the early stages of succession planning, you really need to make some critical decisions. I think you need to start thinking about the culture of the company, and the legacy you’d like to leave. Really, that’s a process, so take that seriously. Neither of those things are decided or built in one day, but they really evolve. I think you need to articulate your core values of the business. What do you want the business to be? I think this is where you probably already have an idea. You’ve probably been living it out, but now it’s time to really articulate it, and consistently internally, if you haven’t already done so.
Then I think, start looking around. I mean it looks like Paul in our story has already identified some possible successors. Start thinking about what a plan would be to groom those successors. What would that look like?
Then I think you probably need to step back and look at the skills that are going to be needed in the future. Surprisingly or not surprisingly, those might be different than what your leadership needs today. I would say if you can, start identifying some of that skillset that you’re going to need 20 years from now.
Then I think it’s important to just decide as a baseline, your appetite for having a family member as a successor. Is that critical to you? Is it not? I think if you’re asking yourself these questions and you’re making those decisions, that’s really going to guide the next several years of what you do in the business.
Is there any way to incentivize the daughter and Jim to stay with the company to determine whether either could take over?
Yes, I think it’s a good question. Without getting too much into the weeds, but yes. I mean I would say I’m a little bit biased with this decision, but I would never recommend or there would be very few times that I would recommend at any point given this scenario, giving equity to either daughter or Jim at this point in the business unless there are some real specialized circumstances. But there are lots of creative ways where you can get your key folks invested, that I think are basic contractual rights that can just go away if it doesn’t work out. So you can give bonuses based on milestones of the company. You can give phantom stock. If you don’t know what that is, it’s essentially just it tracks ownership of the company, share value of the company, and gives key employees the upside of that growth in value of the business, or just straight up profit sharing. These are all non-equity options. The beauty of them is, they’re easy to get out of. Because the real tricky part of equity is, you can give it, but it’s real hard to take back.
At this point, I would not recommend Jim nor the daughter as an option.
Photo credit: Taylor McDonald
Scenario 2: Five years later Paul’s family hits a rough spot. Son one has challenges and needs money.
Son two is not excelling at any jobs within the company and keeps getting moved to different departments. The daughter continues to thrive and move up within the company. At home, the three siblings do not get along. Paul has decided to begin gifting strategies to give a small but equal part of the business to each of his kids.
So far, Paul has given his company to his children in equal measure. Is that wise to do? Is there another strategy policy to consider for ownership of the company while providing the value to its kids?
So I think it depends on the timing. Michael and I may see differently on this depending on where you’re at in there. I think the answer to that’s really going to depend on Paul and his wife. I think fundamentally, my job in sitting across from a lot of family business owners, is really to talk about what their wishes are and really in some ways to challenge their thinking. But ultimately, it comes down to what they want. Everybody has different reasons for what they want. I would say that we want to honor Paul and his wife. She’s a part of this as well when we’re talking about creating an estate plan, which is really the big piece of this. I’m glad we got to it at the back end, because one of the tactical pieces I think you need to understand is most owners when they come into me are just trying to save taxes. Right? I understand that. They want to be tax efficient. But what I really think is all the other stuff we talked about before this is really, really important.
Culture, legacy, and thinking about who your successor should be before you get to the tactical piece, which that’s all the estate plan is, is far more important.
Paul should be at least discussing with an estate planning attorney and a corporate lawyer, cause typically we advise people together, on how do you gift in a way that is palatable from an economic standpoint to the receiver? There are tactical ways to do that. Discounted values. Splitting up into non-voting/voting shares. Is charitable giving a strategy? We need to talk about that as part of this, as just a family member, as charitable giving. Are there any family members that can’t handle wealth? I mean that’s a critical piece of this. I mean really think about that, right? Do you want to take care of later generations? Is it more important to take care of your grandkids? Do you maybe not like your kids, so you want to take care of your grandkids?
How do you do life insurance the right way? You can use life insurance to fund a lot of the buyout. How do you use trusts and in tax efficient manner to keep things out of your taxable estate? Everybody hears that this in a family business, the buy/sell agreement. If you have Jim and daughter, how do you create a situation where it is all planned out if Paul dies? That there is some buy out mechanism for either the company or daughter and Jim. And so in the event of death or divorce or other transfer of ownership. I think all of these things are what you’re going to be talking to me about, but it’s all going to start with what Paul wants. We’re going to cover that gambit when we finally do get to the estate plan.
Scenario 3: Ten or more years pass and Paul is now approaching 60 years old. Both daughter and Jim continue in their success of the company. So much so that the company has added 50 more employees, for a total of 100, and more than doubled its revenue. Paul is letting daughter and Jim make more day to day decisions, but Paul, Jim, and daughter don’t always see eye to eye.
How do families navigate the generational difference in culture, decision-making, problem-solving within a family business? And does this process differ in non-family members when they’re involved?
[…] I think one way to do it is just with strategic planning. If you’re going to straddle across generations, invest folks in the process. I’m in the middle generation, so I’m not a boomer or a millennial. I think what I see on both sides is that on one end, they’re used to making decisions, but millennials, if I can just make a broad sweeping statement, they really want to be invested in the entire process, right? I think strategic planning for the business is actually the way to create value across the board, because it gets the younger folks invested in the process and why decisions are being made. I would say you should be strategically planning for your business anyway. If you’re bringing those younger folks in early to those decision-making processes, you probably have a better chance of navigating the generational differences.
Paul believes he’s identified successors in Jim and/or his daughter. What does he do now? Should the course for his daughter and Jim be different?
Not necessarily. Again, we talked about this is where Jim would probably start creating that estate plan. I won’t go through that laundry list again. I think it can be different but it doesn’t have to be different. It’s really going to come down to the skillsets that Paul identifies for both parties, and then does he feel like he needs both those parties to bring the business into the next generation. I think whatever he does, he needs to communicate it, though. I mean I think partially, it’s a loaded answer because we could say that for every single question that you asked right here, is just communicate. But that’s really a thing that either drives a lot of family businesses into the ground or props them up. I think he just needs to be tactical.
The other piece is if he’s identified Jim and daughter as successor, he needs to really think through how he’s communicating that not only to them but also internally into the other employees of the company. We cannot leave them out because the worst thing you can do is have identified the successor and nobody in your company understand why they’re the successor. I think being tactical about how and when you communicate that succession plan is really important.
How does Paul assess his options for succession to Jim and/or daughter against that which he would net from the sale of the company?
I think that one of the critical pieces is just timing of payment. It goes along with Michael’s point. If you’re looking at selling in one way or another to Jim and daughter, right? That is probably a longer horizon for payment to get money back out of the business. Because typically, if your business is worth a significant amount of money, Jim and daughter probably don’t have that, and may or may not be able to get financed for that amount.
I think when you’re just stacking up the comparison, you have to look at yourself and say, “Okay, well how critical is it that I get the payday relatively soon versus waiting for it?” Again, that’s really just going to Mike’s point is there’s lots of creative ways to structure things, but it all starts with how badly do you need the money right away?
If Paul were to join us today and ask you, the panelists, for your best advice for him, in two minutes what would you tell him and what would you say to his daughter?
[…] There’s lots of great folks out there that do this and do it well. So I would say have a team of trusted advisors. To Michael’s point, make sure they’re independent too because they’re going to see your business and your objectives far differently than you’re going to see them, so I think it’s just a necessary part of the process.
I would also say that please recognize that when you make decisions, those are fluid as well. You have to be flexible in this. I understand that you have a way that maybe you see your business playing out. It may or may not happen that way so you want to make sure that you stay limber in that and that you have the best advice if you have to take a pivot.
I guess I would say the worst thing you could do in all of this is not being prepared. So even if the process takes years, if you’re in it and starting to do it, that is better than doing nothing. All three of us up here can tell you that from a lot of history and war stories.
Ward and Smith sponsored the Family Business Conversation panel. You can read the entire discussion here.