The first part of this interview can be found here.
Bradley J. Franc is an attorney for the Pittsburg-based Houston Harbaugh Law Office. He concentrates his practice in the areas of business planning, commercial transactions, federal and state tax issues, and estate and succession planning. Brad has structured sophisticated estate and succession plans for closely held business owners and high net worth individuals. He has worked with affluent business owners to strategically integrate their business estate and charitable planning objectives. Clients represented include closely held businesses, technology-based firms, professional athletes and affluent individuals. This two-part Q&A with Brad was a chance for Industrial Distribution to find out exactly what succession planning involves, and what some common mistakes are in the process.
ID: What would you say are some common mistakes made when planning business successions, aside from just not planning at all, or course?
I think some of the misconceptions are that you have to give control away to transfer ownership. I hear this a lot. I represented a business owner, who wanted to transfer more than 51 percent of the business to the next generation. I was surprised and I called the accountant. He was surprised, too. It was the only time it had ever happened to either of us. The business owner’s rarely want to give up control. Oftentimes they have a very valuable company that they have worked hard to build and they are scared to transfer it on down. What you can do in many companies is that you can create voting and non-voting stock. If I owned a company and I wanted to give you 99% of the company, I could give you 99% of the company and keep 1% and still have 100% of the vote by creating voting and nonvoting stock. One of the misconceptions is that people don’t understand what stock ownership can and can’t do for them. If you want to give away the equity of the company and the income of the company but still maintain management, you can do that.
ID: I suppose that would be handy for someone who wants to pass on the company but doesn’t think the next generation is quite ready to handle it yet?
The other misconception is that this stuff can happen overnight, that you can do it overnight, or over the weekend. Because you have a number of stakeholders involved, it takes a lot of time. You’ve got the next generation, you’ve got spouses, maybe a wife or a husband that is not involved in the business. You’ve got banks and manufacturers, too. It is not unusual when there is a change of control or ownership or a death in the family for a manufacturer to say that the contract terminates or that it is an event of default. Manufacturers get nervous when businesses change hands. They like who they are dealing with, and all of a sudden, if it is going to change and be Billy or Suzie, they may not want to deal with Billy or Suzie. Maybe that goes to your question about misperception: they don’t understand that the contracts that they have that are valuable to the company can be impacted by a change in control.
The other thing that people don’t realize, and I have had this happen, is that banks, when the founder passes away or the controlling owner, the banks will consider that an event of default. Or when there is a transfer of ownership, they will consider that an event of default: you will have to get their approval. On top of the emotional stress for the family members themselves, then there is the emotional turmoil of the manufacturers or the bank backing out and not honoring their agreements as written.
The other thing people fail to realize is that if dad passes it onto son and he then has majority interest in the company, if the son passes away and son’s stock is controlled by his estate, then the person that votes and controls that company now is the executor of the estate, which may very well be his wife. This is very possible someone who likely knows very little about running the business, or it may even be someone that the original founder doesn’t even like or want to run the company.
Oftentimes when there is a transfer of ownership, what I like to do besides the trusts that I talked about previously, is have some kind of shareholders agreement that the stock could be purchased back if the previous generation wants to buy it back; to do something with it so that stock doesn’t fall into the wrong hands or into an estate controlled by someone who is wrong for the business. It can be problematic, because an estate has to be open until all the taxes are paid.
ID: Let’s consider the emotional turmoil involved in this succession planning. What do you see as being the best thing for a family to do once an untimely death occurs and throws their plan into chaos? What is the best thing that a family can do to prepare themselves for the next step?
What is the best thing to do when an untimely death occurs, both on the emotion and business standpoint, is that when someone passes away, don’t panic. It may seem easy for me to say, but it really makes a difference. It has happened many, many times before and there is typically no rush to do anything. The family needs to meet with their advisors after the initial grieving period, but the states and the federal government really don’t demand that anyone make decisions immediately. They allow them some time. For instance, federal tax returns aren’t due until nine months after someone passes away.
Secondly, again, bring in the professionals, because what they can help the person with is to try to look at it with a business perspective. Someone with experience can also be sensitive during the difficult and emotional time. It is difficult to make these decisions. What you should also do is try to find one or two family friends or relatives that can be an advisor as well so that they don’t feel that they are making the decisions solely on their own, that there is another pair of eyes or ears reading or listening to everything said by the lawyer or the accountant. It is not unusual for somebody else to be there when they are meeting with the lawyer.
From a business perspective, what you need to do is to know where all the important agreements are, who is in fact in charge of the company, where the stock of the company lies as a result of the passing, and to just try to get a handle on all of the assets and liabilities of the estate or the business. The more information that you have, the less stress and anxiety there will be.
ID: Anything else you would say to a business owner that is trying to plan their succession or someone whose succession has been disruptive.
1.) I believe that the number one reason that we have such a tremendous failure rate from generation to generation is not because of taxes or because you can’t find someone competent to run the company, it is because people don’t plan. If they just spent some time planning, they would be a whole lot better off, from a business succession standpoint.
2.) The second point is that I like to try to tell the next generation is that they really ought to look at their position as stewards of the company as opposed to just owners. They have a responsibility to do the planning that their parents did for them very early on so the responsibility that their parents have bestowed upon them is able to be passed on again. What drives this country – the largest portion of its gross national product – is from closely-held business owners. If we can, as professionals, help the business owner move it from generation to generation without failure, we’ve done our job.
For more information, or to contact Bradley directly, please visit http://www.hh-law.com/attorneys/franc.aspx.