6 Ways Parents Go Wrong When Leaving a Business to the Next Generation
As a financial advisor in the Nashville, TN area, I work with a fair amount of family-owned business owners. Unfortunately, I often see many of them make mistakes that could have been easily avoided. Of the most detrimental: Not properly outlining how the business will be passed on to the next generation.
Despite common belief, a family business isn’t automatically given to the owner’s loved ones.
According to reports, only 30 percent of family-owned businesses last until the second generation, and only 12 percent make it to the third generation.
Family businesses are a beautiful thing. Not only are they a great way to form generational wealth, but they are also a cornerstone of the American economy. Starting a business isn’t always easy, and maintaining a profitable one is even tougher.
Don’t put all your hard work to waste by forgetting to establish a proper succession plan. If you’re not sure where to start, schedule a no-obligation conversation with the TrustCore team. Helping family businesses is one of our specialties.
In our experience, there are 6 big mistakes parents make when passing down a business.
1. Failing to Confirm an Heir’s Interest
It may sound simple, but in order for someone to properly carry on your legacy, they have to be tapped first. Assumptions are not enough. Your intentions and their buy-in should take place early, with a clear understanding that you will eventually step away from your role, enabling them to step into their future position. Failing to do so can have serious consequences for your business and the relationship between your heirs.
If an heir already has plans of their own that don’t involve the family business, tabling their own wants to carry on your legacy can build resentment. This can lead to a lack of full commitment to the business, going only just further than the bare minimum, which can ultimately cause the entire family enterprise to suffer.
Have discussions with your heirs early and often. Make a plan with your financial planner to lead a discussion on the topic to help facilitate potential tough talking points.
2. Failing to Plan for a Smooth Transition
As financial advisors in the Nashville, TN area, we work with many family business owners, and most of them want their company to reach the next generation. But very often, there isn’t an action plan in place to make it happen, leaving succession planning to be done on the fly, which can be a messy and potentially costly process.
Without a plan, will your heirs be able to buy equity in the company? Will they know how to manage and plan for the future of the business? Spontaneity is not usually a helpful ingredient in the recipe for succession.
Take some time to hash out how the transition will take place, and what this means for day-to-day operations, the company direction and financial implications.
3. Misunderstanding Your New Role (Or Lack of One)
Once your business has more than one employee, it becomes a team. On a team, it’s important that everyone plays their position in order to win. Does your team know what position they have?
Not making this crystal clear with your team can cause a failure in leadership and trust, as well as overall confusion for the entire company. Before your heirs assume their role, be sure to communicate with them just like you would a new employee. Make it clear what is expected of them, who they report to and what your role will be going forward. Sometimes, the biggest problem in a company – and family, for that matter – is just a communication breakdown.
Read our recent blog post: 5 Ways to Avoid Conflict in a Family-Run Business.
4. Setting Improper Roles and Positions for Heirs
Giving equal parts of a business to your heirs is easy, and may seem fair. But it’s not always the best strategy. Though it may sound harsh, it’s important to evaluate each person’s ability, availability and overall commitment to the business.
Suppose you have 3 heirs, but from what you can see, only one of them is fully committed and capable of handling the business; the other two don’t appear to have the time or interest to get deeply involved.
In this situation, it may be wise to give the lion’s share of your company to the committed heir, splitting a small portion between the others, depending on what they can commit to. You can even give the heir with the largest portion the ability to reward more equity to the other two based on his or her own criteria. This can be an uncomfortable conversation. If possible, involve your financial advisor.
5. Attempting the Transition Without a Financial Advisor
Handing your financial needs on your own, though common, can be particularly egregious, as it can hurt your personal finances and family business. PWC’s U.S. Family Business Survey found that while more than 50 percent of family business owners expect to pass ownership to the next generation, only 23 percent of have an actual business succession plan in place. Even if you and your heirs are on the same page when it comes to the business, working without a financial advisor can seriously jeopardize your legacy.
Transferring ownership of any item – a car, a house, even a cell phone – has a process. Depending on your company’s size and assets, you need to keep track of numerous details surrounding ownership agreements, management and tax planning. Each of these categories has its own set of rules, deadlines, paperwork and strategy.
Let’s say one of your heirs is purchasing your ownership interest in your family business for $100,000, essentially “buying you out.” Are you prepared for your income level to jump $100,000 this year? Would creating a holding company to make the buy-out lower the tax liability of the ownership transfer?
These are difficult questions to answer and act on by yourself, and hastily making a decision can be costly, taking years to recover from. At TrustCore, our team of financial advisors is uniquely equipped with the knowledge and know-how to help you transfer your business when you’re ready. A financial advisor can be crucial to your estate planning, too.
Read our recent blog post: It is Business and it is Personal – Why Financial Planning for Business Owners is Necessary.
6. Not Having an Estate Plan
Planning for what happens after you or a loved one passes away can be another uncomfortable conversation, but discussing your plans can save your family’s financial life. Without an estate plan, all of your personal assets, such as your house, car and investment portfolios, will be in a state of flux. Adding a family business to the mix can put even more of your family’s financial future at stake.
Without an estate plan, the way your personal and business assets will be settled is left to the state you live in through probate. This can mean months of deliberation, locating paperwork, tax bills and overall difficulty while your family grieves.
Outside of probate, having an estate plan also gives you more control over who gets what, and the legal authority to designate and enforce how your assets are distributed. This can help you be a better steward for your family business and your heirs.
Read our recent blog post: Estate Planning in Tennessee: Could You Benefit from a Community Property Trust?
Successfully passing your family business to the next generation doesn’t have to be difficult. With proper planning and communication with your family members, you can cement your legacy and set your family up for generations of wealth.
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