One of the least recognized difficulties in planning for succession in the family- owned business is how to finance it, i.e., what are the capital requirements to have a succession be successful. Since many businesses don’t have a succession plan anyway, they are at an extreme disadvantage when it comes to financial considerations. For those that have a succession plan or are developing one, planning needs to take place well in advance. In fact, the planning horizon for financing succession extends for years or decades.

What are some of the problems?

  1. There will be a competition for capital in any plan developed.

Capital is often a very scarce commodity even in a successful business. If capital is needed under the plan to buy out heirs, to pay estate taxes, to pay deferred compensation to beneficiaries or for any reason under the plan, where will it come from? The businesses’ creditors and bankers, investors, and taxing authorities all have a direct or indirect say in how this issue gets addressed. It goes with saying that the next generation also has something to say about the process. They cannot so burden the capital of the business that they are unable to meet their own compensation needs.  They also do not want the plan to impact the ability of the business to pursue new opportunities for growth. Balancing all these competing needs is challenging.

  1. Leverage or Not?

One possible option at time of succession is whether or not to use leverage to accomplish the plan? Whether the leverage is internal or external leverage, it still impacts the businesses financial statements and operating condition. In the case of internal leverage, as a minimum any notes or indebtedness is necessarily reflected on the financial books of the company. If the leverage is external, i.e., a bank or other financial institution there are numerous covenants and agreements that can work directly against a plan. In the case of estate taxes, there are certain code sections that allow favorable treatment that allows redemption of stock (Section 303) or a payment plan with attractive rates and terms (Section 6166). They are complex sections of the IRS code and increase the cost of any plan and put undue restrictions on the company and shareholder/owners.

  1. Business Cycle impacts on Succession Plans.

One of the worst possible things that can occur in any succession plan is that it happens during a bad time in the Business Cycle. When the economy is in trouble and times are difficult, the financial aspects of implementing the plan may be impossible. The business may be in a survival mode. We are all veterans of 2008 and its aftermaths. Any plan needs to take into account this worst case scenario. Using leverage during this time may be impossible where banks or other financial institutions are concerned. The only positive during times like these is because of the fall in asset values, the estate tax liability may be reduced or eliminated altogether if values have fallen below the threshold where estate taxes apply.

To address these uncertainties and difficulties, we have developed a concept called the Family Capital Company. It provides a means of providing the necessary capital to address all the needs described above in a private, protected and tax efficient manner. It is analogous to a family private bank.

To summarize, we believe that succession planning is a process not a project. In keeping with that concept, we believe that this kind of financial preparation should take place well in advance of the possibility of a potential succession.

 It MUST BE an integral part of the process.