The COVID-19 pandemic has forced many people to think more about their health and wealth — and what the future could look like for the next generation.
And though family governance and focusing on how to transition your business to multiple owners always have been an essential part of wealth planning for global enterprising families, the health crisis has served as a gruff reminder to plan for the future.
“With COVID-19, succession planning has been more top of mind," said Angie O'Leary, head of wealth planning at RBC Wealth Management-U.S. “The environment is spawning some interesting conversations around business and estate planning, and the next generation is starting to think more about how it's all going to work."
As many families revisit wealth plans to make sure they meet the current business and family realities for all generations, many founders are seeing how their own wealth and outlooks have shifted since the last update, O'Leary said.
Keep reading to learn how successful succession planning starts with a formalized plan and can and should include the entire family.
Advisors have long recommended that family members with an ownership stake, who may also be involved in the day-to-day management of the business, have a succession plan. This keeps the company moving ahead, helps grow and preserve wealth for future generations and can help prevent disagreements that disrupt family harmony.
Still, many next-generation family members feel they don't have a formalized plan in place.
According to new research from RBC, along with Campden Wealth, 33 percent of next-generation wealth holders are either without a plan, unaware of any plans, or are in the drafting stage of creating a plan. Additionally, 44 percent say the succession plans they're aware of were put in place more than five years ago.
The Shaping tomorrow, today research also shows the biggest obstacles to succession planning are discomfort around discussing the sensitive topic of finances (33 percent) and that the main wealth holder may be unwilling to relinquish control of the business (22 percent).
Other barriers include families not knowing how to create a successful succession plan or not knowing who is willing and qualified to take over the business.
To smooth things out, O'Leary suggests regular facilitated communication and formal meetings to help families make crucial decisions. This is often referred to as family governance and can be looked at in broad terms using the three-circle model of family business.
From the model, developed at Harvard Business School, there are seven groups with their own legitimate perspectives, goals and dynamics. “The long-term success of family business systems depends on the functioning and mutual support of each of these groups," writes professor John A. Davis.
Family meetings typically should include:
One of the biggest issues around successfully transferring wealth is how prepared the next generation is, said O'Leary: “Are you having the important conversations with everyone involved? Everyone needs to be at the table for wealth to make it beyond the current generation."
The average age when Next Gens talk to their families about succession is 37, according to Campden Wealth, which is just a few years after they typically begin managing a portion of the family wealth.
For those in the next generation, O'Leary suggested broaching the topic in a holistic way, which allows for a discussion of the full picture of family wealth rather than the direct approach of simply asking about money.
“Perhaps you're working on your own family's financial planning, and planning for your own children. One way would be to involve the parents by asking for their input," said O'Leary.
Families also need to understand the tax implications of selling or transferring the business to the next generation, as well as approvals from a board or other shareholders that may be required.
“We work with the next generation to go through the plan, including all assets inside and outside of the business, and the different factors to consider," O'Leary noted. “It's where advisors can really add value holistically."
Business owners may be unprepared to transfer their companies because they don't fully understand the difference between business planning and succession planning, said Tony Maiorino, head of RBC Wealth Management Services, based in Toronto.
Business planning is more about the company's future growth, including its products and services, while succession planning deals more directly with people who will take it over.
“With business planning, a lot of owners are great at it because they're immersed in it," he said. “When it comes to succession planning they think it's the same thing, but they'll often neglect the emotional component. That's where we get into the tough conversations about who will take over and when."
The other parts to consider are the two different forms of succession: ownership structure and management structure. Both must be accounted for when preparing for succession.
Parents may have a vision of one or more of their kids taking over the business. If some children aren't involved, the plan will need to consider how to equalize the assets, Maiorino continued.
“It's a big part of what we help with," Maiorino said. “We believe it's pivotal in keeping family harmony through the family business."
One family situation could include two siblings who founded a business, each owning 50 percent. But then new questions can arise when succession planning begins: Should the ownership transfer 50 percent to one person's children (25 percent each), and 50 percent to the other's one child? Or, should it be 33 percent to each of the three members of the next generation?
These are important questions to consider and, generally, the larger the family—and the longer the legacy of the family enterprise—the more complex these decisions become, which makes formal communication even more critical.
Fifty percent of those surveyed by Campden Wealth said they found success through using regular communication. Others said regular formal meetings helped (43 percent), and 26 percent said success was achieved with documented policies and procedures.
Succession planning also may include a discussion of selling the business to a third party and whether or not the family should remain involved.
In many cases, Maiorino explained, business owners will get more for the company if they sell to a third party, but money may not be the only consideration.
For some families, it's the legacy of the business that's more important.
Families need to discuss their values and priorities for the longer term, Maiorino said. “Really getting a sense of the values and the culture of the business will help us guide them around what that next event might look like," he says. “It requires having an open and honest dialogue."
Having a succession plan is important, but an outdated plan can be just as problematic as no plan at all, Maiorino explained.
“It needs to be a living document," he said, adding that many clients are reviewing their business and succession plans only now, amid the economic downturn caused by COVID-19. “You want to make sure your plan fits, both from the perspective of a growing business and one that's in a bit of difficulty."
The result might be a change in plan, or simply leaving everything as is. But having that reassurance is important.
O'Leary said plans also need to take into account other changes, such as a divorce in the family that might change the dynamics, or a change in tax policy. All of which can impact how plans are structured. “It gets very complicated and if you're not keeping it current ... it can get very messy," she said.
Harmony across families can be maintained by having multi-generational conversations. Maiorino recommended that families have an ongoing dialogue to help see everyone's needs and considerations are brought to the table.
“What's most important around a family business and wealth is making sure everyone is aware of decisions being made and why," he said.
“We often say to parents, 'Before you transfer money, transfer your knowledge.' Make sure your values and things that are important to you have been adequately transferred to the next generation," Maiorino added. “That's going to allow for far greater success than just handing over the business."
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