Succession requires efficiency: Keep your family-owned business running smoothly

Much of our country's wealth is vested in the millions of family businesses that help drive our economy. However, only 30% of these businesses survive into the second generation and only 10% survive into the third generation. One of the primary reasons for this poor rate of generational success is the lack of effective succession planning. This problem is particularly an issue in the construction industry, where there are many family-owned businesses. When done correctly, succession planning is a two-pronged process - the management succession aspect and the equity or ownership transfer aspect. However, it is important to realize that a succession plan is not just a "will" for your business, but is also a complete plan, which includes shareholder buy-sell agreements, management plans, and any other documentation vital to the success of the business. Beyond delineating who will take over your company, the main goal of a succession plan is to keep your business running just as smoothly as when you were behind the wheel. It is in your best interest, as well as the interest of your ultimate successors, that the business is running at optimal efficiency. Therefore, before going through the succession planning process, it may be essential for you to evaluate your operations and business processes to ensure that you are passing on a business that will survive through future generations. Case Study After meeting with the owner and CEO of XYZ Construction, we learned that his 27-year-old son had expressed interest in someday owning or running the company. With this knowledge, we began discussing a possible succession plan. During the initial stages we questioned the company's operations and processes. These questions led to an organizational scan, Stage I of Grassi & Co.'s Management Advisory and Business Optimization Service Offering.An organizational scan provides a complete review of a company's operational and business processes to identify areas of risk as well as process and procedural issues that negatively impact operations and ultimately the bottom line. The scan of XYZ Construction was performed by our business advisory team and identified the follow areas of concern: * Accounting processes and financial reporting * Project management and contract administration * Technology The review of these areas indicated that there were three primary issues: management received inaccurate and untimely financial information, project management was managing change orders inefficiently and the company's software technology was outdated. This required a deeper analysis to identify the appropriate resolutions. The next step was for our Business Advisory Team to move XYZ Construction into Stage II, The Targeted Diagnosis Stage, in order to get a better understanding of the issues and recommend solutions that were in-line with the company's objectives and business operations. For example, our team analyzed the company's accounting software and determined that the company simply outgrew the application that they were using and made recommendations to management to consider upgrading to one of three possible solutions that would fit their needs. As a result of the Targeted Diagnosis, our team moved into Stage III, The Implementation Stage, where they worked with the client to implement best practices for accounting and financial reporting as well as administration and processing of change orders. In addition, our professionals aided in the selection and implementation of a new accounting software system, which was better suited for the industry and their business, thus enabling the company to manage their financials more effectively and efficiently. Once plans were put in action to resolve the issues that were impacting the company's operations, we were able to work with XYZ Construction on completing the succession planning process, which included both management and ownership discussions. Management Succession The first consideration in the succession process is to identify the candidates who are best qualified to continue to run the business while maintaining profitability. Some candidates may appear to be in this position simply because of their relationship to the owner. However, in many cases they may not be the best candidate(s) to run the company. Additionally, there are usually one or two key non-family employees who should be considered to run the business. Resolving this issue is probably the most difficult problem in the succession planning process. A candid and objective appraisal of the players and their capabilities is vital for the process to be successful. Conferring with your trusted professional advisors (accountants, attorneys and consultants) is a vital part of making this decision. Ownership Transfer There are a couple of options for the owner(s) of a business to make regarding the future ownership of the business. This phase of the process really calls into play financial and legal techniques which again, your accountant and attorney advisors are key in helping you select and implement the best strategy for ownership transfer. A straight sale of the company to family members or a combination of family and non-family members is always an option. Any significant discount of the sales price to the fair market value of the stock would be considered a "gift," so valuations of the business would be necessary. Payment terms can be extended to allow the company's future cash flow to fund the payments. In cases where estate taxes and liquidity are concerns, the two most beneficial ownership transfer strategies are a gifting program and setting up a parallel company. The gifting strategy is often the best approach with a family business where the family members are active in the business. We find that the concept of gifting corporate stock is not generally understood by many contractors, but when the significant benefits it offers are explained, many owners embrace it enthusiastically. A second strong strategy for construction business owners to transfer ownership of their companies is to start a parallel company for the key employees and/or the owners' children. This new company (Newco) could start bidding all new work, possibly as a joint venture with the main company. Alternatively, Newco may bid smaller jobs on their own. This will allow the future generation to build Newco with the guidance and financial resources of the "mother company," still allowing the "mother company" to maintain their net worth and lower their overall risk. Of course, over time, as more and more of the new business is housed within Newco, the value of the original company is diminished and this can significantly lower the estate tax liability, another strong benefit of this strategy. Developing a succession plan is essential. Having a succession plan, allows you to be proactive and outline who will have the authority to continue operations when ownership is transferred. However, a succession plan is not as valuable if the business you transferring ownership of is not sound. Working with your advisors to improve your operations so that the organization continues to thrive, will ensure that you and all stakeholders will continue to reap the rewards of all of your hard work throughout the years. Gregory Pulitano, CPA, is the director of consulting services at Grassi & Co., New York, N.Y.