Many small businesses in Massachusetts are family owned, which can present unique challenges when a consideration of succession planning inevitably comes around. A well structured and thought out succession plan can avoid the sorts of problems that could otherwise occur, such as family conflicts, leadership failures and instability within the running of the business.
This article attempts to explain why succession planning is so important for small closely held businesses such as family owned ones and how to go about preparing for a successful transition.
What is meant by succession planning?
Both the ownership and the management of a small business need to be considered at some point in the life of a family business. When either the ownership or the management of the business or both needs to be transferred from one or more individuals to another, then this is referred to succession and there are very good reasons why this process must be planned carefully, taking into consideration the unique challenges of a family run business where personal and professional relationships are intertwined much more closely than in a publicly traded company.
For successful succession to occur individuals who are best suited for the role of potential successors need to be identified and their development fostered early in the succession phase to avoid that the business continues to thrive with the least amount of disruption. In addition, particular values held by the business need to be preserved by whoever is tapped to lead the business during and after the succession phase.
Why succession planning matters
Succession planning is a particularly important process in Massachusetts small businesses because of the percentage of them that are family owned, which means that at least 50% of the business is owned by members of the same family. Over a quarter of small businesses in the state are family owned businesses.
Many small, family owned businesses fail to transition successfully to succeeding generations due to poor succession planning. Risks identified in a failure to plan properly include the following.
- Family and business relationships can be damaged when there are disagreements over who should take over leadership and management roles.
- Unforeseen financial obligations, debts and estate taxes can cause the business to collapse.
- Decision making can become unclear or even chaotic without suitable successors being identified.
How to plan succession in a small business
A workable and effective succession plan should be made well in advance of the need to transition. The following elements should be considered in succession planning for a small, family owned business:
- Successors should be identified first. Successors must be identified to take over both management roles as well as potentially ownership of the business. These decisions should be considered separately as individuals best suited as new managers do not necessarily have to be owners. In fact, successors may be chosen from the family, or be eligible employees or even individuals selected from outside the business.
- Potential successors should be trained in preparation for their new role. This involves increasing their responsibilities within the business gradually, as well as formal training and mentoring.
- Consideration of how to transfer ownership. Legal guidance will need to be sought to select an effective strategy when considering transferring ownership. Strategies that may be considered include: a sale of ownership interests, share transfer to other family members, creation of a trust or partnership, or creating an employee stock ownership plan.
- A contingency plan needs to be included in succession planning. This is basically an emergency measure to keep the business operating in case of an unexpected development such as the onset of serious disability, illness or death of key members of the family.
- Implementation of a buy-sell agreement. Having a buy-sell agreement already in place provides for smoother decision making as well as dispute avoidance in the event that an owner becomes incapacitated or dies during the lifetime of the business.
Tips for successful succession planning
The following tips help small, family owned business avoid disputes and collapse of their business during transition of ownership and management.
Tip#1: As has already been mentioned above, the earlier succession planning is considered, the smoother any transition is likely to be.
Tip#2: It would be rare for succession transition to be planned successfully without useful advice from a variety of professional sources. These would include attorneys, financial planners and accountants who could help lead the business through the legal processes involved in succession as well as maximizing tax advantages.
Tip#3: Communication between members of the family most involved in the business needs to be kept open and practiced often so that conflicts can be avoided and expectations synchronized.
Tip#4: As the succession planning develops, all aspects agreed to should be documented and made legally binding to ensure that decisions are clear and capable of being implemented.
Tip#5: While succession plans should be devised as early as possible, this doesn’t mean they should be cast in stone. The plans should be revised from time to time to reflect changes in the structure of the business or personal dynamics within the family members.
Legal matters to consider when integrating with estate planning
Succession planning and estate planning are often intertwined in a family owned business. This is because the ownership of the business is often a substantial part of assets owned by individual family members, which means that the planning of their estate must also involve planning for what happens to the business.
It is advisable when contemplating the integration of succession planning and estate planning that an attorney with experience in estate planning should be consulted for advice. Estate planning tools that may be considered include the following:
- durable powers of attorney;
- life insurance policies to provide liquidity;
- tax-efficient transfer strategies;
- wills and trusts.
There are both Massachusetts state and federal regulations which have an impact on succession planning as well as estate planning. These can be quite complex, making legal assistance advisable while navigating both processes. For example, Massachusetts has its own estate rules which influence how strategies for estate planning should be carefully considered, while rules about business structure also dictate how ownership transfer can take place.
For more information, visit our website or contact us for a free initial legal consultation today.