Women entrepreneur working with her successor.

March 11, 2019

Why Selecting a Successor Early is Key for Protecting Family Wealth

When it comes to family businesses, many entrepreneurs assume their children will want to keep the enterprise within the family. 

After investing their time, money and sweat equity into the business, entrepreneurs are sometimes surprised to learn their kids aren't interested in taking over the family business.

“Many business owners never talk to their kids about transitioning their business and they can't understand why someone would reject the offer to run something as wonderful as the business they started," says Paul DeLauro, a manager of wealth planning for City National Bank.

DeLauro says he sees business owners all the time who are forced into making quick business transition decisions when they discover the next generation won't be running it.

“It's heartbreaking to see things go wrong, especially over something that could have been as easy as a short conversation over dinner about whether your kids have an interest in owning your business in the future," says DeLauro.

According to the City National Small Business Report, 27 percent of all business owners surveyed plan to pass the business onto children or other family members. 

Similarly, the PwC 2017 Family Business Survey, found among the family-owned businesses anticipating a transition within the next five years, 41 percent plan to pass the business onto the next generation to run; 11 percent plan to pass onto the next generation to own but not run and 30 percent plan to sell to a third party.

When Your Kids Don't Want to Take the Reins​

Successful entrepreneurs are skilled at growing their businesses. However, their focus on the business can mean they don't always have a concrete plan for their family wealth for after they exit the company. 

According to RBC's Wealth Transfer Report 2017, less than half (39 percent) of business owners have a comprehensive plan in place for the future of their business or their family wealth and 22 percent of business owners have yet to start even minimal transition planning.

“The discussion about the future of the business can be brought up by the owners or their kids, but it's often easier for parents to bring up the topic as part of a strategic conversation," says Bill Ringham, director of private wealth strategies for RBC-Wealth Management U.S.

“Sometimes parents have always known their kids don't want to go into the business, while other times the kids change their mind after they've worked in the business for a while."

DeLauro says owners need to understand they have a duty of stewardship for their business, particularly if they have employees whose livelihood depends on them.

Ringham worked with one business owner who assumed his child was following in his footsteps. “Once he asked, it turned out that the son didn't want to work there if his father wasn't there," he says. “Ultimately, the business was sold so the patriarch could retire."

If the kids don't want the business, the default decision by parents is often to sell the business to an outside party or to current employees, says Ringham.

Preparing a Business for Sale

DeLauro says preparing a business for sale can take years of planning. Some businesses are so closely tied to the owners' intellectual or physical abilities that they cannot be sold. 

In other cases, he says, when entrepreneurs who don't develop a succession plan pass away prematurely, the business tends to “wither on the vine."

“Sometimes the company has to go on the auction block and the assets get sold for pennies on the dollar," says DeLauro. Because most owners invest their money directly back into the business, many family businesses appear to be unprofitable. When transitioning from building the business to getting it ready for sale, it's important to focus on cash flow.

A wealth manager can help business owners begin separating their personal cash flow for retirement and address how to transition their business.

“Estate planning and business planning are integrally related," says Ringham. “Sometimes parents want to continue owning the business and hire non-family members to run it. The business interest may ultimately be sold or transferred to their kids who can benefit from and oversee as board members."

Team Approach to Succession Planning

According to RBC's research, 96 percent of business owners educate themselves on financial matters. 

However, DeLauro says entrepreneurs are better served by building a team of advisors including an attorney, an accountant, a financial advisor and a wealth planner who can help them understand the decisions they need to make for their family's future as well as the future of their business.

“An attorney and an accountant are essential to discuss the infrastructure of the business and how it's incorporated, whether the business structure is conducive for a sale and how to make it attractive to buyers," says DeLauro.

Perhaps the most essential role for a wealth manager, says Ringham, is purely as a catalyst for breaking down misconceptions and starting the conversation about future financial and entrepreneurial transitions.

It's important to consult with professionals to evaluate your situation before identifying a successor and creating  a plan. City National Bank's wealth planners can help you weigh your options. To learn more, contact us.

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This article is a republication of content originally published by RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC. © 2018, Royal Bank of Canada, used with permission.

City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the report with no obligation to update or notify of inaccuracy or change. This report may not be reproduced, distributed or further published by any person without the written consent of RBC Capital Markets, LLC. Please cite source when quoting.

City National Bank is an affiliate of RBC Wealth Management and a subsidiary of Royal Bank of Canada. Products and services offered through City National Bank are not insured by SIPC.

Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested.