The principals in any business age, retire, or make other changes that require a succession in management and or ownership. Succession can be achieved by passing the business from one generation to the next, developing another management team, or sale of the business. Planning at an early stage is frequently ignored, and the optimal transition can be difficult to achieve.
Successor family members must have the intelligence, skills, personality, training, and desire to take over. This typically involves children starting “at the bottom” and work their way up to learn all aspects the business. Parents can be reluctant to allow their children to “fail” in their assigned tasks, and so step in to correct pending errors before they occur. The best lessons are often learned through failure rather than through success, and this often leaves the children unprepared to deal with responsibility and problems on their own without their parent help, or to fully take over the business.
Owners can transfer an equity stake to family member while retaining control. A corporation can have voting and non-voting stock (or limited liability company voting and non-voting member interests), and the owners of the voting stock are in control. Shareholders can “reorganize” and create a new class of non-voting stock. they can then distribute some or all of the non-voting stock pro-rata to the current voting stock as a tax-free distribution. Often there are disproportionately more shares of non-voting stock than voting stock created and distributed, e.g., 10 shares of non-voting stock issued for each share of voting stock owned. This results in most of the value being in the non-voting shares and the owners can gift away a large part of the corporation’s value by gifting the non-voting stock, while keeping the voting stock and control of the corporation. The gifting can be combined with an annual gifting program (gifts of stock valued at less than the annual di minimis non-taxable gift under the estate and gift tax), and allows e.g., owners can move value out of their estate while continuing to control the management of the business. The small non-control stock interests in the corporation are typically entitled to a minority / lack of control discount.
Another option is picking promising employees and letting them rise in the company through experience. this has some similar issues as with family members.
Another alternative is to hire experienced persons from other businesses, who have particular experience in the same or a similar industry, or have a desired management skill set although they lack industry specific experience.
As with family, founders are reluctant to relinquish control and all mistakes either to employees being groomed for management or outside managers brought in.
Employee equity stake
Providing an “equity” stake in the enterprise creates an incentive to work hard, either for family or non-family management staff. This introduces a new (typically) minority ownership element with possible diverse interests. Even though the majority owners can still outvote the minority, they can not be “unfair” in their dealings. For example, they cannot vote themselves a bonus to deplete earnings and avoid distributing a portion of the prohibits through a dividend distribution pro rata to shareholders including to the minority. Employee ownership also presents issues on how to handle possible termination of the employee’s employment, which must be planned for and dealt with, e.g., by requiring employees to sell their stock to the corporation on departure at appraised or formula value.
Phantom stock plan
An alternative to actual ownership is a “phantom stock plan” where the employees are given rights as if they were owners without actual ownership. Phantom share owners share in profits, or gain on sale of the company or termination of employment and “deemed” ownership sale.
An employee stock ownership plan (ESOP) allows employees to have some aspects of ownership without the employees themselves being actual owners and provides a structure than can attract financing to provide the cash to purchase shares from the owners.
Sale to outsiders
Another option is sale to outsiders. Likely purchases include other industry members seeking to grow their market, expand into a new geographic area, eliminate a competitor, or add a strategic product or service to their business, or an investor group. At least some management continuity is typically required for a financial investor. Thus development of s strong non-owner management team or staff is still important. Particularly investor purchases be fairly “hands off” and desire existing management to continue indefinitely. Another consideration with an investor group is they often are looking to further build the business and re-sell it in 5 to 7 years, possibly resulting in additional management or employee disruption.