Management Succession and Risk Management Strategies in the Family Business.

Management Succession and Risk

Management Strategies in the Family Business

Copyright 2006 Prentice Hall Publishing CompanyCopyright 2006 Prentice Hall Publishing Company 22Chapter 20 Mgt Succession & Risk MgtChapter 20 Mgt Succession & Risk Mgt

Family BusinessesFamily Businesses

A vital part of the U.S. economy:A vital part of the U.S. economy: Nearly 90% of all U.S. businesses are Nearly 90% of all U.S. businesses are

family-ownedfamily-owned Generate 50% of the nation's GDPGenerate 50% of the nation's GDP Account for 60% of all employment Account for 60% of all employment

and 78% of all job creationand 78% of all job creation Pay 65% of all wagesPay 65% of all wages Average annual sales = $36.5 millionAverage annual sales = $36.5 million


The Dark Side of The Dark Side of Family BusinessesFamily Businesses

Management succession!Management succession! 70% of first-generation businesses fail 70% of first-generation businesses fail

to survive into the second generation.to survive into the second generation. Of those that do, only 12% make it to Of those that do, only 12% make it to

the third generation. the third generation. Result: Average life expectancy of a Result: Average life expectancy of a

family business is 24 years. family business is 24 years.


Management Management SuccessionSuccession

Why are the odds of succession so low? Why are the odds of succession so low?

No management succession plan!No management succession plan! 80% of all business founders intend 80% of all business founders intend

to pass their companies on to their to pass their companies on to their children.children.

But . . . 19% had not engaged in But . . . 19% had not engaged in anyany kind of estate planning.kind of estate planning.


Qualities Essential to a Qualities Essential to a Successful Family Successful Family BusinessBusiness Shared valuesShared values Shared powerShared power TraditionTradition A willingness to learnA willingness to learn Behaving like familiesBehaving like families Strong family tiesStrong family ties


Exit StrategiesExit Strategies

Selling to OutsidersSelling to Outsiders Straight saleStraight sale

Selling to InsidersSelling to Insiders Cash plus a noteCash plus a note Leveraged buyouts (LBOs)Leveraged buyouts (LBOs) Employee stock ownership plans Employee stock ownership plans

(ESOPs)(ESOPs)


Management Management SuccessionSuccession

Between 2001 and 2017, $12 trillion Between 2001 and 2017, $12 trillion in wealth will be transferred from in wealth will be transferred from one generation to the next, much of one generation to the next, much of it through family businesses. it through family businesses.

The businesses with the greatest The businesses with the greatest chance of surviving to the next chance of surviving to the next generation are those with generation are those with management succession plans.management succession plans.

Employee Stock Ownership Plans

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1975 1980 1990 1993 1996 2002 2003

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Number of ESOPs Number of Employees Covered


Management Management SuccessionSuccession For a smooth transition from one For a smooth transition from one

generation to the next, family generation to the next, family businesses need a succession businesses need a succession plan.plan.

A plan allows one generation to A plan allows one generation to pass leadership to the next just pass leadership to the next just as runners in a relay race pass a as runners in a relay race pass a baton. baton.

Stages in Management Stages in Management SuccessionSuccession


Skills a Successor Skills a Successor NeedsNeeds Financial abilitiesFinancial abilities Technical knowledgeTechnical knowledge Negotiating abilityNegotiating ability Leadership qualitiesLeadership qualities Communication skillsCommunication skills Juggling skillsJuggling skills IntegrityIntegrity Commitment to the businessCommitment to the business


Families Whose Businesses Families Whose Businesses Survive to the Next Survive to the Next Generation…Generation… Believe that owning the business helps Believe that owning the business helps

achieve their families’ mission.achieve their families’ mission. Are proud of the values on which their Are proud of the values on which their

businesses are built.businesses are built. Believe that the business is contributing Believe that the business is contributing

to society and making it a better place to to society and making it a better place to live.live.

Rely on management succession plans Rely on management succession plans to assure the continuity of the company. to assure the continuity of the company.


Developing a Developing a Management Succession Management Succession PlanPlanStep 1. Select the successor.Step 1. Select the successor.


Selecting a SuccessorSelecting a Successor

Make it clear that children are not Make it clear that children are not required to join the family business.required to join the family business.

Do not assume that the successor must Do not assume that the successor must always come from within the family.always come from within the family.

Give family members the opportunity to Give family members the opportunity to work outside the family business first.work outside the family business first.

Don’t procrastinate! Don’t procrastinate! Make the choice based on skill, ability, Make the choice based on skill, ability,

and merit rather than on gender or and merit rather than on gender or birth order. birth order.


Step 1. Select the successor.Step 1. Select the successor.

Step 2. Create a survival kit for the Step 2. Create a survival kit for the successor. successor.

Step 3. Groom the successor.Step 3. Groom the successor.

Developing a Developing a Management Succession Management Succession PlanPlan


Grooming the Grooming the SuccessorSuccessor

A founder must be:A founder must be: PatientPatient Willing to accept mistakesWilling to accept mistakes Skillful at using mistakes to teachSkillful at using mistakes to teach An effective communicatorAn effective communicator Capable of establishing reasonable Capable of establishing reasonable

expectationsexpectations Able to articulate the keys to the Able to articulate the keys to the

successor’s performancesuccessor’s performance


Step 1. Select the successor.Step 1. Select the successor.Step 2. Create a survival kit for the Step 2. Create a survival kit for the

successor. successor.Step 3. Groom the successor.Step 3. Groom the successor.

Step 4. Promote an environment of Step 4. Promote an environment of trust trust and respect. and respect.

Step 5. Cope with the financial Step 5. Cope with the financial realities realities of estate and gift of estate and gift taxes.taxes.

Developing a Developing a Management Succession Management Succession PlanPlan


Tools to Minimize Estate Tools to Minimize Estate and Gift Taxesand Gift Taxes

Buy/sell agreementBuy/sell agreement Lifetime giftingLifetime gifting TrustsTrusts

Bypass trustBypass trust Irrevocable life insurance trustIrrevocable life insurance trust Irrevocable asset trustIrrevocable asset trust Grantor retained annuity trust (GRAT)Grantor retained annuity trust (GRAT)

Estate FreezeEstate Freeze Family limited partnershipFamily limited partnership


Risk Management Risk Management StrategiesStrategies

Risk avoidanceRisk avoidance Risk reductionRisk reduction Risk anticipationRisk anticipation Risk transferRisk transfer

Figure 20.3 The Risk Pyramid.Figure 20.3 The Risk Pyramid.

Event Severity of event Probability of event Loss from event_____ A-D A-D A-D

AAA

AABABA

BAAAAC

ABBACA

BABBBA

CAAAAD

ABCACB

ADABAC

BBBBCA

CABCBADAA

ABDACC

ADB

High severityHigh severityHigh probabilityHigh probabilityHigh lossHigh loss

== High RiskHigh Risk

Low severityLow severityLow probabilityLow probabilityLow lossLow loss

== Low RiskLow Risk


Major Types of Major Types of InsuranceInsurance

Property and casualtyProperty and casualty Extra expense Extra expense

coveragecoverage Business interruptionBusiness interruption Machinery and Machinery and

equipmentequipment

Start with a basic business owner’s Start with a basic business owner’s policy (BOP); then consider adding policy (BOP); then consider adding property and casualty insurance:property and casualty insurance:

AutoAuto Electronic data Electronic data

processing processing (EDP)(EDP)

SuretySurety MarineMarine CrimeCrime


Start with a basic business owner’s Start with a basic business owner’s policy (BOP); then, consider adding life policy (BOP); then, consider adding life and disability insurance:and disability insurance:


LifeLife Key-personKey-person DisabilityDisability



Traditional indemnity plansTraditional indemnity plans Managed care plansManaged care plans

• HMOsHMOs• PPOsPPOs

Health Savings Accounts Health Savings Accounts (HSAs)(HSAs)

Self-insuranceSelf-insurance Workers’ CompensationWorkers’ Compensation

Start with a basic business owner’s policy Start with a basic business owner’s policy (BOP); then consider adding health (BOP); then consider adding health insurance and workers’ compensationinsurance and workers’ compensation


Start with a basic business owner’s Start with a basic business owner’s policy (BOP); then, consider adding policy (BOP); then, consider adding liability insurance:liability insurance:Professional liability (“errors and Professional liability (“errors and omissions” coverage)omissions” coverage) Employment practices liability Employment practices liability


48%

65%

37%

52%

23%

40%

8%

17%

10%

16%

0%

10%

20%

30%

40%

50%

60%

70%

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Product liability Medicalmalpractice

Businessnegligence

Premises liability All liabilities

Type of Case

Trends in Million-Dollar Verdicts

1996-19982001-2002


Controlling Insurance Controlling Insurance CostsCosts

Aggressively pursue a loss-Aggressively pursue a loss-control program.control program.

Increase your policies' Increase your policies' deductibles.deductibles.

Work with a qualified Work with a qualified professional insurance professional insurance broker or agent.broker or agent.

Find an agent who Find an agent who understands your needs. understands your needs.


Controlling Insurance Controlling Insurance CostsCosts

Find insurance companies that Find insurance companies that want small companies’ want small companies’ business.business.

Utilize the resources of your Utilize the resources of your insurance company. insurance company.

Conduct a periodic insurance Conduct a periodic insurance audit.audit.


Controlling Health Controlling Health Insurance CostsInsurance Costs

Increase employees’ Increase employees’ insurance contributions or insurance contributions or deductibles.deductibles.

Switch to HMOs or PPOs.Switch to HMOs or PPOs. Join an insurance pool.Join an insurance pool. Conduct a yearly utilization Conduct a yearly utilization

review.review.


Controlling Controlling Insurance CostsInsurance Costs

Make sure your company’s Make sure your company’s health plan fits the needs of health plan fits the needs of your employees. your employees.

Create a wellness program for Create a wellness program for employees.employees.

Conduct a safety audit.Conduct a safety audit. Create a safety manual and Create a safety manual and

use it.use it. Create a safety team.Create a safety team.

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Management Succession and Risk Management Strategies in the Family Business.

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