PERSONAL FINANCE

Could Your Kids Run Your Company?

If you hope someday to pass your company on to your kids, you should start making plans now. Here's how to prepare yourself--and your children--for the transition.
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Business 101

If you dream of a family dynasty, it's time to start planning

Last April 73-year-old Herman Shooster flew from Florida to Texas for surgery on a stomach aneurysm, a procedure that would keep him from running his company for two months. But the chief executive of Communication Service Center (CSC), a teleservices company with more than 400 employees in Margate, Fla., felt confident that he had left his business in capable hands. After all, his children--Stephen, Frank, Michael, and Wendy Shooster Leuchter--had been practicing for years. They had, for example, run the company while their parents had gone on an extended vacation, and gradually they had become accustomed to making decisions without their father's input.

That's the way it should be. If you're thinking about leaving your business to your children, "succession is more of a process than an event," says Mary Ceynowa, consulting manager at the Family Business Group, a Minneapolis-based division of McGladrey & Pullen, a national CPA and consulting firm.

Unfortunately, too many business owners don't see it that way. According to a recent Arthur Andersen/MassMutual survey, the leadership of 43% of family businesses will change hands within the next five years. However, nearly a third of those family businesses with CEOs age 61 or older have no designated successor. That's a recipe for disaster. But whatever your age, if you're considering passing your company on to your children someday, there are some questions you should begin asking yourself. Now.

What's your vision of the company's future? Now that you've begun thinking about succession, forget about it for a minute. According to Mendy Kwestel, director of entrepreneurial services at the New York City office of Grant Thornton, a national accounting and management-consulting firm, "the first thing you need to have is a strategic plan that tells you where the business is going. That will determine the type of person you want to succeed you. Then you ask yourself who your candidates are." If you find that your kids don't make the short list--or they just aren't interested in managing the business--you may need to separate the management and the ownership of the company. According to Kwestel, you might consider setting up a voting trust, in which ownership of the company remains in the family but all voting rights are passed on to professional trust managers, who are usually a team of seasoned nonfamily advisers. If your children are management material but haven't had enough experience, consider hiring an interim CEO to smooth the transition period.

How will you groom your children for succession? There's nothing worse for your company or your employees than an ill-prepared successor. "My sons worked in the field as electrician's helpers," recalls Marvin Tibbetts, now chairman of Tib's Electrical Service, a $4-million Atlanta company. "I told the men to treat them like everyone else. They had to earn the respect of other employees." Now Mark and Todd Tibbetts both own equal shares of the company, along with Dan Phillips, a 14-year employee. "Dad did a good job of making us work for it," says Mark, who is CEO. Bringing your children through the ranks helps build confidence--their own and employees'--in their abilities.

Experts also highly recommend a family hiring policy that requires your children to work outside the company for a few years. "If they've worked in another business, they'll bring back new ideas," says Ceynowa. "And they'll also discover that much of what happens in companies is just systems dynamics--that it's not just Mom or Dad or their siblings' being difficult." If your children have already been in your company for several years, Ceynowa suggests that you pair them with mentors outside the company or require them to join the boards of other organizations.

What are your future financial needs? Preparing your heirs is just 50% of the succession equation. You also need to ready yourself, emotionally and financially. "You should create financial independence outside the business if you possibly can," says Craig Aronoff, director of the Family Enterprise Center at Kennesaw State University, in Atlanta. Doing so will help prevent you from meddling after you pass your company on to your kids. It will also give you more estate-planning options. Herman Shooster, for instance, gave company stock to his children over a period of years. "I'm not relying on the company for my retirement income, and I didn't want the IRS to get their hands on those assets," he says. Marvin Tibbetts, on the other hand, will be paid off by his successors over a six-year period; from that point on, he'll also receive annual retirement benefits from the company.

Can your children be effective partners? When Billye Ericksen, the former CEO of Capsco, now a $25-million electronics-components distributor in Sunnyvale, Calif., sold her company to her children, three years ago, it was important to her to designate one successor as CEO. Shared governance, she thought, would be a nightmare. So she put her kids through a variety of psychological tests and exercises before choosing her daughter, Kathy, as CEO. (See " Pass It On," August 1994.) Today, however, an increasing number of founders are considering shared leadership. According to the Arthur Andersen/MassMutual survey, 42% of responding founders believe that more than one family member will share CEO duties in the succeeding generation. But if you're considering such a management-by-consensus approach, be careful: unresolved conflicts among siblings tend to play themselves out in the business.

What will your role be after succession? You started it, you built it, and chances are, you aren't prepared to just walk away. To ease the transition, says Aronoff, "management succession may precede ownership succession." Often a founder steps into a role that was his or her original passion, such as sales or new-product development. Ericksen, for instance, continued to represent Capsco on the boards of a couple of community organizations after her daughter became CEO. "My role became more community oriented," Ericksen says. She also continued to meet with Kathy informally but refused to meet with anyone else in the company. "Otherwise," she reasons, "they wouldn't think that Kathy was really running it."

Donna Fenn is a contributing editor at Inc.


Passing it on

How you transfer your company to your children depends on your financial situation, your vision of the company's future, and the confidence you have in the next generation. Here are some arrangements to explore with your advisers:

1. Buy/Sell Agreement. "This is far and away the most popular, since owners often need a source of future income," says Tom Ochsenschlager, a partner in the Washington, D.C., office of Grant Thornton. Typically, an owner holds a note for his or her children, who pay over time using company profits. To protect yourself, you can include the same kinds of covenants a bank might impose, such as restrictions on salary.

2. Gifts. "If Mom and Dad are well situated for retirement, gifting may be a viable avenue," says Craig Damos, a partner in the Des Moines office of McGladrey & Pullen. You and your spouse both have the option of giving each child $10,000 a year in assets tax-free, so you could pass the business on over a period of years. Also, the Taxpayer Relief Act of 1997 allows each spouse in a family business to bequeath $1.3 million in assets tax-free--provided the spouses own the stock individually, not jointly.

3. Redemption. "If the company has a lot of cash, it can redeem the parents' shares," says Ochsenschlager. "This works well when a company has undistributed earnings and profits, but the technique is tricky and requires financial advice." As the parents' shares are redeemed the children's ownership increases.

4. Other options. Less common and more complex methods include family limited partnerships and charitable remainder trusts. Both have the effect of reducing the value of the company in the parents' estate while allowing the parents to maintain a controlling interest until their death. Both methods can raise red flags with the Internal Revenue Service, so you'll need sophisticated advice if you go either route.


Resources

Craig Aronoff and John Ward are the authors of Another Kind of Hero: Preparing Successors for Leadership and Family Business Succession: The Final Test of Greatness, both part of the Family Business Leadership series published by Business Owner's Resources (800-551-0633). These slim volumes (each $14.95) are filled with the wisdom of two established experts. Another option from the same series: Making Sibling Teams Work: The Next Generation (also $14.95), which Aronoff and Ward cowrote with Joseph H. Astrachan and Drew S. Mendoza.

Passing the Torch, by Mike Cohn, is a classic succession tome, but, alas, it's currently out of print as Cohn prepares the third edition. While you're waiting, the older versions are worth a trip to your local library. The Cohn Financial Group also produces a bimonthly newsletter, Transitions and Traditions ($30 a year; call 800-422-3883).

NetMarquee's Family Business NetCenter is a great source of one-stop Internet shopping for family-business information. You'll find links to 28 university-based family-business programs, plus articles on succession and other related topics.

Arthur Andersen's Center for Family Business has a Web site, where you'll find some useful articles and links as well as information on the company's biannual succession seminar.

Last updated: Jul 1, 1998

DONNA FENN | Inc.com Contributing Editor

Donna Fenn is the author of Upstarts! How GenY Entrepreneurs Are Rocking the World of Business and 8 Ways You Can Profit From Their Success, an exploration of the ways Gen Y is changing the entrepreneurial landscape.




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