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Succession Planning: How to Transition your Business to the Next Generation

Aug 24, 2023

How can business owners ensure a smooth transition to the next generation?

Sooner or later, every private business will go through some sort of a transition where the ownership will pass into other hands–in many cases, the hands of the children. However, business owners are often so focused on the running of their business that they overlook this crucial aspect: the transition of ownership of the business to the next generation.

Structuring a growth strategy, establishing a good level of corporate governance, defining the transfer of ownership… How can business owners ensure a smooth transition to the next generation of business leaders?

In this episode of Life & Legacy, Claudia Caffuzzi, Head of Latin America Wealth Advisory, and Ken DiCairano, Private Business Advisor, discuss the benefits of carefully planning for the transition of a business ownership, and share some tips on how to best get started.

See our full list of Life & Legacy episodes here.

This podcast is intended for informational purposes only, and is a communication on behalf of J.P. Morgan Securities LLC, a member of FINRA and SIPC. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.

Views may not be suitable for all investors and are not intended as personal investment advice or as a solicitation or recommendation. Outlooks and Past Performance are never guarantees of future results. This is not investment research. Please read the important information section.

Claudia Caffuzzi: Welcome to our wealth advisory series, where we discuss topics related to Life and Legacy.  In today’s episode, we are going to speak about the transition of a private business to the next generation. My name is Claudia Caffuzzi, and I am the Head of LatAm Wealth Advisory. I am here with my colleague Ken DiCairano, a senior advisor in JPMorgan’s Private Business Advisory team. 

Hi Ken – I am glad you are joining me today.  You have had a lot of experience advising business owners and families on navigating transition events for the businesses.  Sooner or later, every private business will go through some sort of a transition where the ownership will pass into other hands – in many cases, the hands of the children.  Sometimes business owners are so focused on the running of their business that they overlook this crucial aspect:  the transition of ownership of the business to the next generation.  

Ken DiCairano: Thanks for having me today Claudia.  Completely agreed. After years of developing, nurturing and building their business, it is important that owners devote similar energy to planning for the transition of the business to the next generation.  While many entrepreneurs today are planning to monetize/sell, there is still a subset of businesses that are focused on multi-generational retention, which might be the more difficult path but certainly can be very rewarding.

CFC

Let’s start today’s discussion by identifying the two main factors here. Specifically, #1, getting the business ready for the next generation, and #2, getting the next generation ready for the business.  Ken, what are the initial starting points for each?

KD

Certainly. For #1, the business: Owners should evaluate their current business position in the market as well as the future trajectory of the business, the industry dynamics and potential long-term threats/disruption. Ultimately, here the assessment should be whether the business will be profitable and, more importantly, viable into the foreseeable future.

The second factor is the next generation: Owners must objectively assess whether any of their children have the ability to manage and lead the business. If yes, then they need to have conversations with their children to ensure there is an alignment of goals and aspirations. Occasionally, owners will assume next gen wants to take over as owner-operators, when in reality the children have completely different aspirations for their careers and lives. Determining personal, family, and business goals and coming to agreement on a vision are critical pieces in the succession process.

CFC

Those initial considerations are so important Ken, especially in today’s business landscape, where innovation and disruption are becoming the norm.  Understanding the current environment around your business and getting buy-in from both generations about the transition certainly both make sense.

Assuming both those boxes have been checked, what do families do to ensure a smooth transition to the next generation?

KD

When my team discusses business transitions, there are multiple pieces of the puzzle. One of the first issues that families need to solve for is around the transfer of ownership. Typically, there are multiple members of next gen, versus say one matriarch/patriarch founder. Therefore, there needs to be thoughtful and adequate estate planning to ensure proper disposition of the assets amongst the family.

CFC

That makes a lot of sense. Some families, they are able equalize with business and non-business assets. For example, a daughter who is active in the business may receive shares of company, and the son will receive other assets of equivalent value, like cash/investments/real estate/life insurance/et cetera.

In the more typical scenario however, the value of the family business largely overshadows all other assets, so this isn’t feasible.  In the same example, if the family does not have sufficient non-business assets, the active daughter and the passive son will split the business 50/50.

KD

That’s right and that only describes the business economics. Not the actual control, which is another important component. When there is distinct next gen active in management and others that are only passive shareholders, many advisors prefer that the voting control to be retained by active participants. However, that can exacerbate sibling rivalries and be a source of conflict and tension among shareholders so there must be a system of checks and balances. For example an advisory board or a formal board of directors, and ideally with independent directors, in order to ensure that all family shareholders are treated in a manner consistent with the prior generation’s intent.

In addition, more families are establishing buy-sell agreements to ensure that the business can survive if members of the next generation want to exit their ownership. We often call these escape clauses, which have defined methodologies around valuation and repurchase of ownership. 

CFC

That’s a great point Ken and leads into a follow-up question: what are some of the corporate documents or policies that should also be considered?

KD

Most certainly. The next noteworthy item is corporate governance. Ultimately, as businesses continue to grow, at some point, the informal policies and procedures that worked for the matriarch/patriarch need to be documented, institutionalized, and communicated in order for the next generation to have an opportunity for continued success, maintain familiy harmony and provide clarity to non-family executives. It is also ideal for the next generation to be involved in drawing up these guidelines to ensure buy-in.

Now admittedly, some owners hear “bureaucracy” when we say governance or institutionalize, but that is certainly not the purpose. The idea is to establish flexible guidelines that will allow next gen to be successful while encouraging innovation and maintaining entrepreneurial vitality which have led the business to be successful thus far.

CFC

Can you give us a couple of examples of these guidelines?

First, Dividends and Compensation. As a starting point, families will often adopt a guideline for a dividend or distribution which will provide shareholders with an income expectation dependent upon the profitability of the business. Of course, these guidelines allow for flexibility in weighing the capital needs of the business against the income for the family. In addition to any distributions, those family members working in the business should be entitled to compensation for their contributions. The value of having a board with an independent member as previously discussed is that it reduces the inherent conflict in setting individual pay.

Second, Employment Policies. We have seen families institute employment policies for family, which help determine specifically how family will enter, what formal education and/or experience is required, as well as methodologies on advancement, separation, and compensation for active contributors.

CFC

Thanks, Ken, these are great examples of corporate governance policies – how about some of the actual operational considerations?

KD

The last, but certainly not least important, piece of the puzzle for our discussion today is on defining the actual succession plan. Prior to the day that mom or dad steps back from the business and/or retires, the next generation needs to have had an opportunity to learn how to be capable owners and managers. 

CFC

So right!  It reminds me of a family we work with, that has a business in its third generation of family ownership and management.  The patriarch was extremely thoughtful about how the shares would pass to his children but did not address the fact that he is the sole director of the company.  He was so focused on transferring ownership that he did not consider how it would be managed on a day-to-day basis if he was not around. 

Once we pointed this out to him, he ended up establishing a formalized rotational program for his daughter, who was slated to be the next family leader, so she could have experience in the various business lines and exposure to different operational roles.

KD

Smooth transitions to operate under new leadership and ownership rarely happen by accident. Succession plans often involve significant preparation as well as mentoring for the next generation of leaders. In addition, some transitions begin by having the next gen lead a microcosm of the business. For example, they could oversee development of a new product, expansion into a new geographic market, or even manage a line of business. Ultimately, allowing next gen to make decisions, with current gen’s guidance, allows them the opportunity to succeed or fail independently.

The last thing I will add is that the succession plan also needs to be communicated both within the family but also to the non-family executives/management, who often play a critical role in preparing the next generation.

CFC

Especially in the cases where there are active and passive owners in the next generation, the family typically needs to develop good family governance practices, which include protocols on communication, sharing of information, decision-making – a big topic, which is beyond the scope of this discussion today, but very important, nonetheless. 

We have covered a lot of ground here today. Ken, do you have any final takeaways for our audience as they potentially consider a transition of a business to the next generation?

KD

Of course!

The final takeaway is to start the process. Keep in mind that these transition plans often take place over several years, so there is often adequate time to make changes and determine what works for your family and the business. That said, these transition plans work best if the matriarch/patriarch adopt what they are trying to institute. Don’t adopt the “do as I say, not as I do” mantra as it often can lead to family disharmony in the future. 

And lastly, if you or your family ends up deciding to sell the business, this planning is not wasted effort. It will certainly provide benefit if a sale transaction is the end result, whether in this generation or the next. How? Well, increased professionalization and greater transarency will facilitate any future sale process and lead to greater extrinsic business value.

CFC

This is where we at JPMorgan can really help – we can provide insights on best practices for successful transitions and be your trusted advisor throughout the journey. 

And that brings us to the end of this episode. We hope you enjoyed the conversation. Thank you for listening to our Wealth Advisory Series on topics of life and legacy.

The statements, views, and opinions that will be expressed during the event are those of the presenters and are not endorsed by, nor do they reflect the views or positions of, JPMorgan Chase Bank, N.A. or any of its affiliates. JPMorgan Chase Bank, N.A. or any of its affiliates are not liable for decisions made or actions taken in reliance on any of the information covered during the event. Please consult with your personal tax advisor on all tax-related matters.

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JPMS is a registered foreign company (overseas) (ARBN 109293610) incorporated in Delaware, U.S.A. Under Australian financial services licensing requirements, carrying on a financial services business in Australia requires a financial service provider, such as J.P. Morgan Securities LLC (JPMS), to hold an Australian Financial Services Licence (AFSL), unless an exemption applies. JPMS is exempt from the requirement to hold an AFSL under the Corporations Act 2001 (Cth) (Act) in respect of financial services it provides to you, and is regulated by the SEC, FINRA and CFTC under US laws, which differ from Australian laws. Material provided by JPMS in Australia is to “wholesale clients” only. The information provided in this material is not intended to be, and must not be, distributed or passed on, directly or indirectly, to any other class of persons in Australia. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act. Please inform us immediately if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

This material has not been prepared specifically for Australian investors. It:

•      may contain references to dollar amounts which are not Australian dollars;

•      may contain financial information which is not prepared in accordance with Australian law or practices;

•      may not address risks associated with investment in foreign currency denominated investments; and

•      does not address Australian tax issues.

 

 

 

 

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To learn more about J.P. Morgan’s investment business, including our accounts, products and services, as well as our relationship with you, please review our J.P. Morgan Securities LLC Form CRS and Guide to Investment Services and Brokerage Products

 

JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states. Please read the Legal Disclaimer in conjunction with these pages.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

Bank deposit products, such as checking, savings and bank lending and related services are offered by JPMorgan Chase Bank, N.A. Member FDIC. Not a commitment to lend. All extensions of credit are subject to credit approval.