CRW • Corporate Report • Wisconsin's Business Magazine

When considering whether to pass on the reins of your family business to the next generation, consider this sobering statistic: While somewhere between 80 to 85 percent of all businesses in the U.S. are family-owned, only 33 percent pass on to the second generation, with 12 percent to the third generation and a mere four percent to the fourth, according to Deb Houden, director of the Family Business Center at the University of Wisconsin-Madison.

“A lot of people focus on the premise of shirtsleeves to shirtsleeves in three generations,” says Houden, who has worked with many family-owned businesses in succession planning over the course of her career. “You’ve got your entrepreneur, then the second generation who keeps it at that level and your third generation that blows it off. This is a cross-cultural phenomenon of rags-to-riches to rags that plays out again and again.”

More often than not, the reason is a failure to plan for succession, Houden says, while adding that there tends to be a lack of knowledge on how to structure a business succession to come out well.

“Many times, parents want to split the company equally, and unfortunately that is often not the best move for the business,” Houden says. “If you treat everyone equally, that just opens up a can of worms.”

A difficult balancing act

“It’s always a delicate issue when you get into family businesses,” adds Mike Steinl, a partner with Smith & Gesteland in Middleton, a CPA and business consulting firm. “One sibling is picked and another isn’t — it’s always a balancing act. There are some difficult conversations that you have to have and decisions that have to be made.”

And estate planning cannot happen in an executive bubble, with the current owner making isolated decisions about the future.
“For me, you can have the most gorgeous estate plan, but without the good decision making it can lead to all kinds of problems from court cases, estrangement, to people not talking to one another,” says Kathy Wiseman of Washington, D.C.-based Working Systems Inc.

Wiseman is a family business consultant with 30 years of experience in getting family-owned business to have those difficult conversations. Wiseman will give a video presentation about her experience working with two family-owned businesses at the Fluno Center in Madison on March 16.

“I try to help them make decisions… let’s say you have two kids and the daughter is much better qualified to take over the manufacturing business than the son,” Wiseman says. “Do you risk the assets or the relationship? How do you do that in an open way that moves the situation forward?”

Using Bowen Family Systems Theory, Wiseman helps family-owned businesses see that what they are reacting to is automatic and rooted in the past.

“This kind of decision making is not easy, and is not for the faint of heart,” Wiseman cautions. “The people who take it on are willing to say to a kid, ‘In my opinion, this is not the best avenue for you. You are still my kid, but I need to take care of this business decision. And I’ll let you know why.’ It’s a level of candor that is hard to bring in to families, but over time I have seen it work.”

Best practices

While there are many variables in succession planning, there are some best practices to follow in order for a business to be passed on successfully.

First, when the business is passed down, make sure everyone understands the distinction of being an owner of the company, being a family member and someone who actually works in the business.

“Sometimes people get those roles convoluted,” Houden says. “You need to separate those roles, and understand what your function is in each role. Just because you are a family member does not mean that you are qualified to work in the business. Just because you are a part owner, it doesn’t mean that you are qualified to work in the business. Just because you are an owner, it doesn’t mean you want to work in the business. Make sure everyone understands what role they are in.”

Second, don’t make the assumption that the second generation wants to work in the business. Talk with the children early on and try not to lead them, Houden says. Ask what their dreams are, and their plans, and allow them to make their own choices.
Another best practice is to have kids go and work somewhere else for at least for three years, Houden says. This way, the child has an opportunity to see how other business are run, and they have the ability to stand on their own so if they succeed or fail, it is because of their own efforts. If they do come back in to the family business, they have the confidence they can do it, and the parents know the child is capable.

Another good idea is to have a clearly outlined exit strategy for the senior generation to avoid a power struggle. Houden recalls one family business where the children were taking over and one of the parents didn’t want to retire.

“He kept saying the younger generation wasn’t prepared enough, when truly they had been running the company,” Houden recalls. “This person was so afraid that he would have nothing to do when he retired, and he was just hanging on and getting in the way of the company flourishing.”
Finally, remember that business succession is a lengthy process — not an event that happens overnight — so it should involve a five- to 10-year transition, Houden says. Work with your accountants, lawyers and your banker to introduce the younger generation and create those relationships. It also helps the next generation to understand all facets of the company, and gets the existing employees comfortable that the new generation is going to be ready to eventually take over.

“That is not to say that there won’t be bumps, because it’s not that easy, and it should not be done that quickly,” she says.

Estate tax planning is critical

Estate taxes are a critical hurdle in passing the family business to the next generation, says Tim Cisler, an attorney with Davis & Kuelthau in Green Bay whose law firm typically deals with businesses valued anywhere from $3 million to $10 million.

For example, if the family-owned business is part of the parents’ $10 million estate, and the business is worth $7 million, it’s hard to leave all of that to just one child, especially if cash is needed to pay the estate taxes. If the parents set it up right, they can transfer $7 million free of tax, and the remaining $3 million is subject to estate tax at 45 percent.

To accomplish this, the preferred method is a life-insurance trust that utilizes a second-to-die policy, Cisler says. It buys the stock from a revocable trust or estate and it comes in tax free, and the money is used to pay the estate tax.

“That is the uphill battle they have to get their business to the next generation,” Cisler says of estate planning. “It becomes a matter of ‘how do we do it efficiently so that there is money to pay the tax and the kids can inherit something?’ We would probably give all of the kids equal value of stock, but the ones running the business would have the right to buy out the others, and the other kids get the cash they want. This is how it frequently works.”

If the business is being left to multiple children, a buyer/seller stock agreement can be utilized to help prepare for future business ownership transition issues. If the business is turned over to three children, what happens when they die?

“If you are in a business with your sister, and she dies, you may not like her kids, so you shouldn’t have to run a business with them,” Cisler says.” So, plan for this while everyone is healthy. Who gets to make that decision? Maybe it’s by a majority vote to make sure that everyone is treated fairly.”

Some will say that if they can’t bring their child in that it’s unfair, or that it should be opened up to all family members, which Cisler calls a recipe for disaster.

“Don’t just allow people to come in for the sake of coming in,” Cisler says. “How far does family carry you? It’s always for people to decide what comes first, the success of the business, or allowing family to work together, and to me, that’s not truly running it like a business. If you were running a business, would you hire unqualified people just to make them happy?”

Consider private equity

The No. 1 reason the vast majority of family-owned businesses never make it to the second generation is the inability to separate the business and the family business issue, says Bill Krugler, a managing director with Mason Wells in Milwaukee, whose private equity firm has been an acquirer and investor in family-owned businesses for the past 25 years.

“We get involved with a business when there is some type of ownership transition,” Krugler says, adding that many family businesses looking at succession are not aware of the private equity investment option.

Private equity arrangements might just be the answer a family business is seeking. Sometimes a family business will say they don’t have a family member in place to take over, or they have concluded that the family members are not qualified, Krugler says. The business may be undergoing industry consolidation, or it may need capital to build a new plant, so they need to go in a different direction.

In a typical scenario, a family business may be struggling to compete, with family members spread throughout in management positions who are not qualified. The patriarch realizes that the business can’t succeed going forward.

“So, they bring us in and we recapitalize the business,” Krugler says. “Getting involved with us allows them to liquidate and take out value. We are able to bring in new management people and take it away from the family kind of style to more professionally managed and competitive going forward.”

By John Rondy

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