Family Business Succession Planning: 3 Best Practices & A Review of the Statistics

If you’re reading this post, you’re probably familiar with the statistics: the failure rate for second generation family businesses is very, very high. When you consider the fact that family businesses make up about 60% of the gross domestic product in the U.S., it’s easy to see that succession planning is a major issue facing business owners across the country.

Transitioning a family owned business to the next generation is challenging for many different reasons. This post will review the statistics on family business succession planning, cover three common problem areas, and offer best practices for navigating them.

Family Business Succession Planning: The Statistics

To get us started, let’s review the statistics and examine why thoughtful succession planning for family businesses is so important.

First off, only about 30% of family businesses even make it to the second generation. 10-15% make it to the third, and 3-5% make it to the fourth. These numbers sound pretty low, but they’re only counting businesses run by families’ younger generations. Many businesses are sold or merged, which I would argue isn’t a failure at all.

Additionally, according the Conway Center for Family Business, 40.3% of family business owners expect to retire at some point. But of those planning to retire in less than 5 years, less than half have selected a successor.

That alone tells me that many failed successions are probably a result of poor planning. In fact, other research from the Conway Center for Family Business tells us that 70% of family businesses owners would like to pass their business on to the next generation. But only 30% are actually successful in doing so.

Common Succession Problems

Just to give us some context, the landscape of family businesses across the country is as diverse as our economy. Family businesses cover all corners of industry in this country, and range in size from single person sole proprietorships to Wal-Mart. There’s a lot of space in between those extremes.

Because of the large universe of companies, the specific problems impeding successful transitions is diverse as well. Nevertheless, regardless of a company’s size, industry, profitability and other nuances, succession problems are usually tied to two fundamental issues: poor planning and long term family dynamics.

Entitlement & The Fall Back Plan

Through years of effort and grind, successful companies often produce significant wealth for founders and their families. Whereas the founder may have developed his or her work habits out of necessity, their children are often brought up in a more comfortable environment.

This financial success also gives founders’ children far more options, and allows them to pursue whatever path they choose in their careers. As great as this sounds, flexibility allows the children to treat the family business as a fall back plan, rather than an objective that they’ll need to work toward.

The downside here is pretty obvious. Kids comes back to join the business, and are often propelled into management positions sooner than they should be. Not only are they inexperienced and prone to make critical errors, but their career trajectory will undoubtedly alienate other employees.

Insisting on proper training and screening is a good place to start. You can always give your kids an opportunity, but a job with the family business shouldn’t be an entitlement. Family members should go through the same formal vetting process that other employees do. Implementing a minimum education and/or experience requirement, and formalized training process is a good place to start.

Again – you can always give your kids an opportunity, but resist the temptation to thrust them into a leadership position.

Familial Ties vs. Diversity of Experience

In medium and larger businesses, it’s common for immediate family members to follow their parents to certain departments. For example, let’s say a founder’s daughter is interested in finance and spends most of her career as the company’s CFO. If her children park decide to pursue finance because of their mom’s influence, they often have a hard time developing the skills necessary for upper management. Rather than blazing their own trail in an area of interest or gathering experience in multiple areas, younger generations often tend to go with what’s familiar.

The solution here is to try and minimize the amount that family members report up to each other. All employees, family or otherwise, should be held to the same standards and expectations. Business coaches and mentors can be helpful here as well. Any way to offer outside influence, objective feedback, and accountability tends to help, and will prepare the next generation for management responsibility.

Business Size: Supporting the Family

Starting a business can be quite a challenge, and most founders spend a few years struggling to put food on their family’s plate. As the business becomes more financially successful this tends to be less of a problem. Once founders reach the point where they’re comfortable and have met all their financial objectives, many tend to take their foot off the gas, rather than continue to grow the company.

Now consider what happens when the founder’s children enter the picture. If the founder has two kids, and both kids have two of their own, all of a sudden there are a lot more mouths to feed. Whereas the founder was originally responsible for supporting four people (including the kids and his spouse), now the business needs to support 10! To stay in the family long term, the business will need to generate a great deal more revenue. If it can’t, it will need to merge, be sold, or fold.

To avoid this problem, all new employees should have a responsibility for growth. This could be in the form of direct business development or preparing the business for scaling. A good example might be a new family member that comes on board right after college. They may not be experienced enough to interact directly with clients or develop business, but they could be responsible for updating the company’s CRM system to support more efficient growth.

Successful Family Business Succession Planning

It’s no secret that succession planning is a huge challenge for family-owned businesses. Family dynamics, communication, trust issues, preparedness of the younger generations, and different expectations for family members vs other employees can all contribute to problems.

There are far more causes to the low success rates than what we reviewed in this post. The point here is that many of these issues can be solved or eliminated by prudent planning. Experienced attorneys, accountants, financial planners, and bankers can all be valuable resources who can help you reach a desirable outcome. If succession is in the cards for your business, the input of a qualified professional is often worth its weight in gold.

Woman Owned Business Tax Benefits: What’s Out There?

Several weeks ago I was in a meeting with a small business owner at my office. She’d come by to talk about her plans to transition away from her business, as she is in her 50’s and getting burnt out. She’s built a successful enterprise over the years, and stands to make a nice profit on the sale of her equity stake.

Her biggest problem in this transition? Taxes, of course! Although she stands to receive a nice chunk of change from the sale, she’ll end up owing several hundred thousands of dollars between state and federal taxes. And as we worked through the mechanics of the transition and how she might reduce her tax burden, she asked a question I hadn’t thought much about: “aren’t there tax benefits I can claim as a woman owned business?”

I hate to admit this, but woman owned business tax benefits aren’t a subject I’d looked into before. I’d always assumed there were some tax benefits for women and minority owned businesses, but I’d never looked into what they were exactly.

So I researched it. And since I’m certain there are thousands of women entrepreneurs out there wondering the same thing, I consolidated my findings into this post.

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The Defined Benefits Pension Plan: Helping Business Owners Shelter Thousands from Income Tax

Taxes are frustrating to nearly every small business owner I speak with. Most people agree that we should all pay our fair share. But after working countless thousands of hours to build a viable business, it’s easy to feel like Uncle Sam’s reaching into our pockets too far. That’s why I focus on helping my clients who own businesses make sure they’re not paying more in taxes than they need to. One great tool we can use in this endeavor is a defined benefit retirement plan. Whatever you want to call it, DB plan, defined benefits pension plan, etc., it can be a killer way to defer a huge portion of your income from taxation.

I realize you might cringe when you read the words “pension” or “defined benefit”. The idea of promising employees a monthly check throughout their retirement may not foster warm and fuzzies. But if you don’t have employees, or only have a few, a defined benefit plan can offer some pretty major tax advantages.

Read on to learn how you might take advantage of them.

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Grantor Retained Annuity Trust: An Easy Way for Business Owners to Reduce Wealth Transfer Taxes

For business owners starting to think about the next generation, the phrases”estate tax” or “transfer tax” almost seem like curse words. The bad news is that when you build an estate of a certain size, the IRS wants to get in your pockets regardless of what, when, or how you transfer your assets to beneficiaries. The good news is that there are plenty of strategies available to help you minimize these taxes. The grantor retained annuity trust is one of them, and will be the topic of today’s post. We’ll cover what they are, why they’re beneficial, and how you might go about using one.

Gift Tax Review

Ok – before we dive into the details, let’s review what taxes typically apply when you gift an asset to someone else.

First off, you’re allowed to give away $14,000 per year, per person tax free. If you’re married, you and your spouse are both allowed $14,000 per person per year, or $28,000 total. So, if you and your spouse want to gift each of your kids $28,000 for their birthday every year, you could do so tax free. (It’d be one heck of a birthday present, too).

You also have a lifetime gift exclusion. This is the amount that you can give away, either while you’re alive or after you die, without incurring any federal estate or gift taxes. Anything that exceeds the $14,000 annual limit (or doesn’t qualify) works against your lifetime exclusion. The lifetime gift exclusion in 2017 is $5.49 million, which inches higher with inflation over time. Here again you can combine your lifetime exclusion with your spouse, for a total of $10.98 million.

So let’s say that one year you and your spouse decide to gift your oldest child $128,000. The first $28,000 would be covered under your annual allowance and excluded from tax. The remaining $100,000 would work against your lifetime exclusion. Neither you nor your child would owe tax on the gift, but you’d have worked your lifetime exclusion from $10.98 million down to $10.88 million. If your future gifts (either while you’re alive or after death) exceed $10.88 million, they’ll be subject to the federal gift/estate tax:

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Using a Section 105 Medical Reimbursement Plan to Reduce Your Tax Bill

“I paid out the ears in taxes this year. How can I reduce my tax burden?”

This is a question I’m hearing a lot from business owners recently. And while it may not sound flashy, the best way to reduce taxes is to incorporate some smart planning into your decision making. More often than not, business owners simply don’t have the time to research and apply the opportunities offered in the tax code.

So to make your life a little easier, today’s post will cover an often unused tax saving opportunity: the Section 105 medical reimbursement plan.

An Overview of Section 105 Health Reimbursement Plans

A section 105 health reimbursement plan is a tax-efficient way to repay your employees for their health care costs. Rather than purchasing group coverage that your qualifying employees can opt into, you allow them to find their own coverage and then reimburse them for qualified expenses. This can include premiums, deductibles, or a wide variety of other out of pocket costs. (Side note, there are section 105 plans that combine traditional group coverage with reimbursement for qualified out of pocket costs, but that’s a subject for a future post).

Whereas this would not have been a popular way to offer benefits a decade ago, it’s more palatable now that individual health insurance is widely available through the state and federal marketplaces.

The main benefits of section 105 plans are the tax advantages. Most small businesses deduct the cost of health insurance premiums for their employees, and possibly for themselves. But when it comes to their own out of pocket health care costs, business owners normally pay for them with taxable dollars. These expenses can be deductible at the personal level, but only when they exceed 10% of your adjusted gross income.

With a Section 105 plan you can deduct your entire family’s medical expenses with without being subject to the 10% AGI floor. Even better, it’s a deduction from income tax at the state and federal levels, AND a deduction from payroll taxes. For some business owners this can be a savings of thousands of dollars per year.

The tax benefits don’t apply to all types of business entities, though. S-Corps don’t get to deduct reimbursements through section 105 plans from state or federal income tax. And if you own a sole prop, a partnership, or an LLC you aren’t considered an employee. That means you can’t be reimbursed by a plan, and would need to employ your spouse in order to reap the benefits.

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Using Business Interruption Insurance to Protect Your Income

Picture it now…

You own a thriving art supply store in your home town of New Orleans. You’ve put years of your life and thousands of dollars into building the store into what it is now. You make a nice living, and the business mostly runs itself at this point.

Then Hurricane Katrina comes to town. The building you lease is ruined. Your storefront and merchandise are ruined. You have no cash flow to pay creditors, and are forced to close the store.

This is a pretty extreme example, but is exactly what happened to thousands of businesses in the wake of the disaster in 2005. It’s also a risk that can be completely covered with business interruption insurance.

Virtually any disaster that is out of your control and risks your business’s profitability can be covered in a business interruption policy. In other words, you can protect business profits and your personal income from a fire, flooding, earthquake, or other disaster.

This post will cover the ins and outs of business interruption insurance. We’ll address what it does and doesn’t cover, when you should consider buying it, how much coverage you need, and how to purchase a policy.

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How to Hire an Accountant

Managing your financial affairs is a big job. You have to keep track of your income, manage your assets for long term growth, pay taxes, and arrange for your estate to be distributed after you die.

You can do some of these things on your own. But others, like writing a will, are jobs you’ll probably want to hire a professional for.

Since we’re in the middle of tax season, I thought it might be helpful to cover exactly what to look for when hiring an accountant. Paying taxes is a fact of life. But if you can find creative ways to reduce the amount of tax you pay, there will be more left over for you and your family. It’s for this reason that an accountant is often one of the professionals families hire for money advice.

You can certainly prepare your own taxes if you prefer. Programs like TurboTax and TaxAct provide quick and affordable ways to compile your financial records and file your taxes.

There is no program that can help you with tax planning, though. TurboTax and TaxAct are great for tax compliance, where you’re reporting on transactions that’ve already happened. But if you’d like to know how you might reduce your tax burden in the future, you’ll need some help making decisions on transactions that haven’t happened yet. This is tax planning, and something that many accountants are very good at.

I covered in a recent post how you can tell whether you need to hire a CPA. Today’s post will cover how to go about hiring one if you do.

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Entrepreneurship as a Means to Financial Independence

Today’s post is another on the topic of financial independence. We’ve had several of these recently, but since that’s the focus of this blog I guess that’s not surprising.

Rather than discuss the fundamental components of financial planning like insurance or investing, today’s focus is entrepreneurship. Specifically, how entrepreneurship can be a wonderful way to align your career with your lifestyle and become financially independent on your own terms.

Forewarning: today’s post is another that falls on the philosophical side of the spectrum. I normally don’t write too many of these posts, and realize there’s already been several to start the year. Read on if you’re OK indulging my abstract (and possibly poor quality) musings.

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Money-Centered vs. Happiness-Centered Living

Today’s post is going to fall a little more on the abstract side of the spectrum. To date, most of the posts you’ll find on Above the Canopy are somewhat technical, and oriented toward achieving financial independence.

But for many thousands of people in America, the traditional career trajectory (working for 30-40 years until fully retiring around age 65) is a poor fit for their values. The pursuit of financial independence often compromises the important parts of our lives, leaving us overworked and unhappy.

So in today’s post I’ll examine the difference between money-centered and happiness-centered living. We’ll cover what we actually need to be happy, and the role money plays in fostering a happy life. Finally, we’ll cover how you can arrange your finances to support a life focused on happiness & fulfillment. If you’re up for a “deeper” post and don’t mind me waxing philosophical, read on!

Traditional Financial Independence

Usually when we hear about financial independence, it’s used in the context of having enough assets to live off of comfortably. Whether they produce enough income to fully cover our living expenses, or the withdrawals from principal are small enough that we’re confident we’ll never run out of money, the idea is the same. Financial independence means we’re no longer beholden to employment, since we could live off our own assets if we wanted to.

This idea of financial independence also fits pretty nicely with our traditional view of retirement here in America, where there’s a stark contrast between “working” and “being retired”. Our working years start when we first enter adulthood. While we usually don’t have much to our name, we do have (hopefully) some ambition and a few skills we can use to earn a living. We go out and market these skills to potential employers and eventually get a job. If we’re lucky, it’s work that’s interesting to us and pays a decent wage.

Once we start our working years we begin to collect paychecks every other week, which we use to pay taxes, rent, and other living expenses. After the bills are paid we use anything left over to pad our retirement accounts, bank accounts or both.

At this point we’re in the phase of life affectionately known as the accumulation phase. We earn an income, use it to pay our living expenses, and save whatever is left over. Our savings grow with each paycheck, and our net worth accumulates over time.

We invest our savings in order to accelerate growth, and sooner or later we reach the holy grail – financial independence. If we wanted to, we could discontinue our employment and use income and withdrawals from our savings to pay our living expenses. We’re no longer reliant on our job for income. We can do whatever we want. We’re financially independent.

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401(k) Auto Rollovers: A Convenient Safe Harbor for Small Business Retirement Plans

OK – with a new year upon us it’s time to clean up that rusty old 401(k) plan at your small business….right? Let’s say that you work in or own a small business, and are responsible for operating the company’s 401(k) plan. To put it lightly, it’s probably a massive nuisance.

401(k) plans can be a wonderful benefit to your employees AND a great opportunity for you to put more money away for retirement in a tax deferred account. But as you may now, operating a plan can be a real bear.

I’ll be covering the finer points of operating small business retirement plans throughout the year. Today’s post will focus on what to do with departed employees. Employees will come and go to and from your business over time (hopefully not too often), and it’s not uncommon for them to leave money they’ve accumulated in your company’s qualified retirement plan.

ERISA & Fiduciary Responsibility

As you probably know, departed employees always have the opportunity to pull their money from your plan after they leave, either directly or via a trustee to trustee rollover. But many employees neglect to do so. Whether it’s because they don’t know how, don’t care, or are simply lazy, it’s very common for departed employees to “accumulate” in your 401(k) plan, long after leaving the company for greener pastures.

As you also know, as the sponsor of a qualified retirement plan you have certain fiduciary responsibilities when it comes to managing the plan on behalf of your participants. It’s for this reason – fear of repercussion – that many sponsors feel stuck when it comes to managing assets of employees who long ago left the company.

Fortunately for you, ERISA was not written with the sole intention of making your life hell. There are six safe harbors written into the law that free you from fiduciary responsibility if you follow a few step by step instructions. And one of them conveniently covers departed employees.

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