Succeeding at succession
It takes work to put the success into family business succession
Just 33 per cent of family businesses make it to the second generation and only 15 per cent to the third.
In Ireland, up to three quarters of businesses are either family-owned or family-run. They account for about 50 per cent of employment in the private sector. Yet according to PwC’s Family Business Survey, 83 per cent don’t have a formal succession plan.
If you’re wondering why just 33 per cent of family businesses make it to the second generation and only 15 per cent to the third, you might have found your answer. One thing is clear, succession is hard.
The difficulties arise because family businesses are, after all, about family. Opening up the succession planning conversation can be hard because it feels freighted with death.
It can be fraught in other ways too. It may be that the younger generation is champing at the bit, and happy to bring up the topic at every occasion, but the older generation is loath to let go the reins.
The need for control and a desire to be master of your own destiny is often an innate characteristic of the entrepreneur. It should be no surprise, therefore, to find they don’t want to give it up, particularly where they feel it defines them.
The fact that people are living longer is informing decisions, causing the older generation to reassess how they are going to fund it.
The Great Recession brought new dynamics into play too. Very many older family business owners are still not in a position to retire, thanks to legacy debts not yet sorted or holes blown in their pension pot. Even where they have shored up the piggy bank, they may remain wary of inflicting such hardship on their offspring.
“A family business can be a very unforgiving place to be, with no safety nets,” says JJ O’Connell of Family Business Ireland, an information and support service for family business founders, owners and professional advisers.
Equally, very many ‘next gens’ will have seen the heroic struggles, and sacrifices, of their parents and decide it’s not for them. This may be particularly so at a time of full employment and so much talk of work-life balance, the lack of which is the Achilles heel for many family business owners.
At the same time, more family businesses are seeing their next generation off to college and adhering to best practice by encouraging them go out into the world to gain experience in other industries, and possibly other countries. That experience is now recognised as invaluable for the infusion of fresh ideas it brings. But it carries risk too – they may not come back.
Worse still, and less often discussed, is a situation where the older generation fears none of their children have the skills or aptitudes required to run it. How to say that?
One of the problems hampering succession planning is a fear of discussing things at all, particularly externally. This makes them reluctant by nature to seek third-party help, despite the fact it is often the cool expertise of an independent, impartial voice that is most required, particularly when dealing with a particularly strong or authoritarian family member.
Further impeding the smooth changeover, of course, is the fact that, by their nature, these are once-in-a-generation events. It’s not like you get to practise.
It’s precisely for that reason that one simple question should at least be asked, on an annual basis – “in the event of illness or death, what is the plan?”
Of course, family-owned doesn’t always mean family-run. It may be better to bring in management from outside the family. This in itself can be difficult, particularly as ambitious managers are put off by the fact they’ll always play second fiddle to those whose name is over the door.
Fears that the real decision-making takes place over family dinners are not unfounded either. Family businesses are notorious for not wanting “outsiders” privy to what they will always consider family business, even when it’s “business business”.
Having a formal, balanced board that includes non-family members can help ensure decisions are made strategically and in the best interests of the business. Unfortunately, it’s an area of weakness in many Irish family businesses which, if they do have formal board structures, tend to fill them with buddy-advisers of questionable objectivity.
There are of tax considerations too. The threshold at which capital acquisitions tax – which relates to inheritance – kicks in was reduced during the recession to €225,000 and raised last year to €320,000, which is good.
But while tax considerations are important in succession planning, they shouldn’t be the main driver of decision-making, particularly if it leads to bad decisions about who should succeed you. After all, if the family business goes out of business within a few short years, because it ended up in the hands of the wrong person, you’ll all pay.
It’s why one of the best investments you can make in succession planning is management training, regardless of who is managing the business. OECD research suggests investing in management capacity can reduce the failure rate of businesses by half.
Another positive step is to put in place a written document, a family charter, that deals with another significant barrier to family business succession: conflict.
As well as including details of who gets what and when, it should provide clear instruction as to what mechanism is used for dealing with rows within the family.
“The most common causes of conflict in family businesses are confusion over what is expected of individuals in terms of their roles, level of effort and time, responsibilities, remuneration, rewards and boundaries, as a result of false, unconfirmed assumptions and expectations,” says Kieran McCarthy, author of Family Business: A Survival Guide.
Feeling undervalued, a culture of entitlement, the role and rights of in-laws, lack of fairness, sibling rivalry and issues of parental control all cause problems too, he says.
Good communication isn’t just the key to resolving conflict, it’s the key to avoiding it. Says McCarthy: “Communicate and collaborate openly, honestly and often in order to resolve issues before they have a chance to escalate.”
“Tax considerations are one of the key considerations for a business owner in this situation, as capital gains tax of 33 per cent will be payable on any gains they make that are not covered by an available tax relief,” says Paddy Delaney of informeddecisions.ie, a specialist blog site.
There are four reliefs to consider here.
“Business Relief essentially reduces the taxable value of a gift or inheritance of a relevant business property by 90 per cent for capital acquisition tax. This benefits the family member receiving the assets,” he says.
“Entrepreneur relief allows you pay 10 per cent CGT instead of 33 per cent on the disposal of relevant business assets, up to the value of €1 million.
“Pension Relief, if business circumstances allow, can fund a pension pot which would provide a tax-free lump sum of €200,000, plus an annual income for life upon retirement from the business. Retirement relief can reduce your CGT liability to zero on certain business assets typically is available once you are 55 or over.”
The key is to start planning as early as possible. “We often meet owners who are on the cusp of exiting and are only starting to have conversations about the optimum exit strategy. Due to the fact that many of the reliefs require a lead-in time of at least five years in order to be of benefit, it is never too early to consider what route you might take,” says Delaney.
“You can, of course, adjust your strategy over time as your business situation changes, but having an overall plan today will help you achieve the results you seek, and to minimise unnecessary tax.”