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Estate Planning for Family Business Owners
By Stephen J. Hyland
When the owner of a family business first starts working on an estate plan with an attorney, the attorney
usually asks, “Do you have a business succession plan?” For an estimated 70% of small businesses, the answer
is “no.” The failure to have a written plan for management and ownership succession is, according to the
Small Business Administration, the primary reason that only 1 in 3 familyowned businesses manage to
survive the transition from first to second generation ownership. The lack of a succession plan also
complicates the estate planning for these owners, since the value of the business, the owner’s future
plans for the business, and the interest of actual and potential heirs in the business, must be
determined prior to crafting the overall estate plan strategy.
Typically, the small business owner has devoted most of their time to developing the business, but little
time planning for the day when they no longer will be there to run the business. Often, the owner labors
under the assumption that one or more close family members—typically a son or daughter—will take over the
business at some point in the owner’s life. Unfortunately, little time is spent by the business owner to
establish how —and when—the inevitable business transfer should take place. Like the old expression,
“a failure to plan is a plan to fail,” the failure to plan for succession in a family business is a
plan for the business to fail.
Small and/or family business succession usually falls into one of three forms. First, there are those
businesses in which several generations of family members are active participants and where other family
members are expected to succeed to ownership and management when the current owners retire or die. Second,
are those businesses where family members are only peripherally involved and where ownership, but not
management, is expected to pass to other family members. Third are those businesses where the owner intends
to sell the business to a third party at some point, usually when they decide to take retirement, and neither
ownership nor management are expected to pass to the next generation. Each of these forms present specific
estate planning challenges.
Often, a business owner envisions their business succession plan taking one of these forms, when in reality,
another form may be more appropriate. For example, a business owner may expect a particular child or younger
sibling to take over the management of the business when, in fact, the “anointed” successor lacks the aptitude
for and/or the interest in doing so. Conversely, a family member may have an expectation that there is an
appropriate successor when, actually, the current owner has an entirely different individual or succession
model in mind. In another example, a business owner’s plan may fail to recognize competition and even outright
hostility between family members who are placed into positions of control. These mismatched or unrealistic
expectations, regardless of their cause, can seriously impact the intended succession plan to fail or to
be challenged by unhappy family members.
The Consequences of Not Planning for Succession
When the owner of a family-owned business dies or becomes disabled without a succession plan, it almost
invariably dooms the business to failure. Even if the business manages to survive the owner, the failure
to plan for succession will have a negative impact on the overall estate plan, leading to significant
disruption and hardship for the owner’s heirs.
For most family business owners, the business is the single most important asset contained in their estate,
and it is the one most likely to suffer significant loss in value immediately upon their death or disablement.
This loss can be attributed to a variety of factors, such as the lack of knowledge about business operations,
loss of confidence in the business’ future by customers, suppliers, lenders, and employees, control struggles
between family members and other potential successors, departure of key employees, and the absence of
sufficient capital to continue business operations. Without an orderly succession plan, these factors can lead
to the layoff of loyal employees, the liquidation of the business assets at fire-sale prices, and an often
substantial diminishment of the owner’s testamentary wishes.
The business disruption that results from the lack of a succession plan usually leads to an immediate
disruption in some or all of the family income. Additional financial demands upon the family, including
unplanned-for expenses, funeral costs, and professional fees, combined with the ongoing financial costs
associated with the business can quickly lead to a cash flow crisis that forces the owner’s family to begin
liquidating portions of the owner’s estate. Since the succession crisis quickly reduces the value and
liquidity of the business, the family will often have to sell other assets of the estate, such as a home or
automobile, in order to meet these short-term needs.
The death of the owner will lead to a substantial estate tax burden on the already financially stressed
heirs, as a result of some or all of the business being counted as part of the owner’s taxable estate.
Opportunities to shelter a substantial part of the owner’s estate from these taxes by, for example, using
gifting, trusts, or alternate ownership forms are irrevocably lost. The need for cash to pay the resulting
estate taxes provides a further drain on the family’s available resources.
Without a proper succession plan, loans necessary to carry out the control of the business may pass in
unintended ways. For example, an unqualified or uninterested son or daughter could inherit the business
in its entirety, or could end up in a position of significant control over other, more qualified persons.
Control of the business may even pass outside the family, as a result of a sale of some or all of the equity in the business.
The lack of a succession plan could also lead to family feuds that arise where two or more family members, with differing opinions
about the business, are given equal control and management of the business.
All of these consequences can be easily avoided by the business owner by simply taking the time to develop a
written succession plan and then putting the plan in place with the help of an experienced estate planning
team.
The Benefits of Proper Succession Planning
Avoiding these consequences should be sufficient incentive to make a business succession plan part of the
business owner’s estate planning process. Fortunately, it is not the only incentive—succession planning
provides a number of benefits that make it an indispensable part of the business owner’s estate plan.
Like a business plan, a succession plan is a valuable tool for obtaining business financing. Banks and other
lending institutions may give the business owner more favorable rates and terms on loans, when they see that a
closely held business has a plan for survival. Lenders are also less likely to call on lines of credit upon the
owner’s death or disability, since they are more confident about the business’ long-term viability. Adequate
funding for transitional expenses can be estimated and any loans necessary to carry out the transition can be put into place.
Furthermore, with a written plan in place, the owner can transition the transfer over a longer period of time,
resulting in a smoother succession that will more likely ensure the business’ long-term survival. During the
transition process the successors can benefit from the experience and advice of the current owner, even as the
owner winds down his or her participation. Planning and beginning the transition process sooner, rather than
later, will increase the owner’s options and reduce the taxes paid to the government.
Another significant advantage is that the owner can choose the successor(s) most likely to lead the business
forward, and can choose alternative successors if their initial choice is unable to assume their duties or
incapable of effectively running the business. If there are no capable family members who are interested in
managing the business, the decision can be made as to whether the business should be sold, and whether some
percentage of ownership should be retained by the family.
Finally, creating a written succession plan clarifies the owner’s long-term goals for the business.
The business can then be appropriately structured and an appropriate estate plan can be formulated that will
minimize and perhaps eliminate the owner’s potential estate tax liability. Alternatives to ownership can be
established so that family members who are not included in the business do not feel “shortchanged” by the
transfer.
In short, business succession planning can be an enormous opportunity for the savvy family business owner to
ensure that the years of hard work and sacrifice are not wasted.
The Succession Planning Process
Although the development of a succession plan is an evolutionary process, the planning process should proceed
through four phases. First, the owner should develop a written statement identifying the goals and the timing
of the transition process. Second, the owner should meet with a business valuation consultant to arrive at a
preliminary valuation of the business. Third, the owner should meet with an estate planning team, composed
of legal counsel, a financial planner, and a tax advisor to determine how best to fit the business succession
plan into the larger estate planning framework. Finally, the appropriate legal structures and financial
arrangements should be implemented in order to carry out the plan.
The first step—preparing a written goal statement—requires the business owner to spend some time writing
down their personal goals for the business and for their future participation in it. Once these goals are in
writing, the owner needs to discuss them with family members, as well as with those key employees who are
critical to the success of or are affected by the plan. Following this, the owner should evaluate possible
successors and, if there are none, identify alternative succession methods, such as a sale of the company.
Lastly, the owner needs to establish the timeline over which the transition should take place, specifically
identifying target dates such as when majority control passes and when the owner intends to withdraw from
the business.
This first step is the most difficult to complete because it depends almost entirely on the owner’s commitment
to embarking on the succession process and to finding the time, in an already busy schedule, to listen and to
reflect on what the owner wants for their business, their family, and the remainder of their life.
Once the owner has completed this step, however, the remaining steps fall readily into place.
Creating and nurturing a family business is like raising a child. And, like a loving parent who spends years
preparing their child for the day when the parents are no longer there, so too, the successful family
business owner must prepare his or her business for that same event. As difficult as it is to let go,
planning for that transition is the only way to ensure that the owner leaves a lasting legacy to his or
her family, employees and community.
At Hill Wallack LLP, we can help you through the process of developing a plan that suits your needs as
well as put together a team of professionals who can help you put your succession plan into place.
Stephen J. Hyland is a partner of the firm
where he is partner-in-charge of the firm’s Trusts & Estates Practice Group. He has a practice
concentration in estate planning and administration, elder law and domestic partnership law.
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