"Succession planning" is a fancy lawyer’s word to describe planning for what happens to a family business when the founder is no longer around to run it. Put simply, it means planning for retirement or death.

The Small Business Administration has reported that in the long term, only 30 percent of family businesses survive the deaths of the founding generation and only 15 percent survive into the third generation. The plight of the family-owned business has become the poster child for politicians urging the repeal of federal estate and gift tax laws. My personal view is that the horror stories are greatly exaggerated, because the tax laws have special rules just for family-owned businesses that greatly soften the effect of death taxes. At the same time, though, it is true that the death taxes sometimes present a significant disincentive for children to continue to operate their parents’ businesses.

I’m not here tonight to debate the merits of death tax relief. As long as the death taxes exist, they remain a factor that must be taken into account in planning the future of a family business. At a later point, I will briefly discuss the effect of current proposals to modify or repeal the death tax laws. In the end, though, death taxes are secondary. At its core, succession planning is fundamentally a family issue and a management issue.

Today, the family business has acquired a mythic image not unlike that of the pioneers of the 19^th century. Economically, small business has always been an opportunity for upward mobility in our society, an engine driving the creation of new jobs and new wealth. But this opportunity carries a heavy price, for it requires an extraordinary commitment of resources – and most of all of time – for the small family business to succeed.

The stress that a small business places on families is well-known. For many small business owners, the only way to keep any reasonable semblance of a family life is to involve the family – spouses and offspring – in the operation of the business. But the benefits of this are not entirely unmixed, because family considerations will sometimes diverge from what is in the best interests of the business.

For many small business owners, the business becomes the central focus of their lives. Their personal and emotional investment often colors their views — and clouds their judgment – when the time comes to think about what happens to their businesses after they are gone.

These fundamental realities of family businesses often interfere with effective succession planning. It is very hard for parents to be entirely objective in evaluating their own children. My 12-year old son is just starting his final season of little league baseball. In my eyes, he is a potential all-star, despite six years of consistent, objective evidence to the contrary. Too often, parents assume or expect that when the time comes their children will step into their shoes and smoothly take over running the family business, because they think that the children can and that the children should.

Children’s views of their parents’ businesses sometimes are very different. Most outgrow their childhood disappointments when the demands of the business meant that mom or dad missed their concerts, recitals, ballgames and other important events in their lives. Some children eventually will grow to share their parents’ dedication to the family business, but others will not.

It is unfair for parents to expect their children to automatically share their passion for their businesses. It is equally unfair for parents to expect their children to subordinate their own ambitions and opportunities to participate in and eventually take over the family business. And yet this too often is exactly what happens, because the parents, having invested so much of themselves in their businesses, perceive their children’s rejection of the family business as a rejection of them.

The single most important aspect of effective succession planning is to identify who should run the family business when the current generation retires or passes on. This requires a cold, hard, objective analysis of the business itself and of those who might be chosen to run it. Sometimes, this is one or more of the children, but other times it is not. It might be one or more key employees. It might be a former employee. It might even be a competitor.

This question must be asked and answered both in the short-term and the long-term. The child who by age 40 may be expected to have grown into an effective manager might be hopelessly over his head if thrust into it at age 25. In most cases, the parents will be there to serve as mentor while the children learn the ropes and acquire sufficient experience to take on the full responsibilities of management. But sometimes the parents aren’t there, in which case a key employee might fill the position temporarily until the children are ready.

Sometimes the family dynamics run the other direction, with parents specifically choosing to exclude from management offspring whom they judge to be unwilling or incapable of effectively managing the family business. Not surprisingly, this kind of evaluation can be taken poorly by the child who, in his view, is being stripped of his legacy.

Whatever decisions are made in this area are potential family landmines, especially if the children find out about them only after the parents are gone. This can lead to the kind of bad feelings that alienate siblings from each other and to nasty and disruptive lawsuits challenging the parents’ estate plans. While these risks can never be wholly eliminated, they can be significantly reduced by open, candid communication so that the children know ahead of time what their parents have done and why.

Indeed, if the children are the ones to whom future management of the business is to be entrusted, then they must be actively involved in the planning process if it is going to work after the parents are gone. Through a trust, a parent can try to rule from beyond the grave how and when a child can receive the financial benefits of the parent’s wealth, but these kinds of restrictions simply won’t work when you are talking about the day-t0-day decisions and problems of running a small business. It is unfair for a parent to try to do so, and it is ultimately self-defeating. If the family business is to survive and prosper, the next generation of management will have to address and resolve crucial issues their parents never have had to face to and indeed may never have anticipated. Letting go is hard but necessary. And making the children who will be the next generation managers a part of the planning gives them a personal investment in the process that greatly improves their odds of success when they are the ones calling the shots.

Sometimes, the parents themselves can be sufficiently objective and dispassionate to analyze and evaluate their children’s capabilities as future managers of the business. In some cases, though, it is necessary to bring in an outsider. Sometimes, the family lawyer or accountant, if sufficiently familiar with the business and the family, can fill this role. In other cases, though, an outside consultant may be necessary.

The benefits of proper succession planning – and the consequences of failing to make proper plans – cannot be exaggerated. For most people, the family business represents their most significant financial asset. If the business fails in the next generation, as most do, it means that their descendants may have been deprived of most or all of the value of their inheritance. To add insult to injury, these heirs sometimes are faced with large death tax bills and no money left with which to pay them because the business has failed. For business owners who relinquish control during their lives to retire, the stakes are even higher: the success or failure of the business often means comfort or impoverishment during retirement.

Once the hardest issue has been resolved – identifying who should manage the business – there are still other issues to be addressed. It is common and wholly appropriate for parents to begin transferring ownership of their businesses gradually as their children reach adulthood and begin participating in the family business. But even when all of the children participate, difficult issues of equity are presented. For example, imagine an older child, age 30, who has worked in the business fulltime since graduating high school while her younger brother, who is just graduating college, has worked only part-time during his summer vacations. Should she receive some kind of equity interest now to reflect her work for the company? Should he? Should they get the same shares? And what if these various equity rights result in them having different financial or voting interests after the parents are gone?

Sometimes, less than all of the children will participate in the management of the business. Difficult equity issues are presented in deciding how the wealth is to be divided among them. In most cases, there won’t be sufficient assets to leave an equal share of wealth to the children who won’t participate in the business. Life insurance can compensate for this, but it usually has a significant financial cost. The business can be left equally to all the children while exclusive management powers are given to only some, but this too can lead to acrimonious relations between the siblings, especially among those with no voice in management whose financial interests are in the hands of the others. And compensation of those children who manage the business is often a sore point with the others, who are effectively passive investors.

There is no one "right" answer to these questions. In all cases, it depends upon the individuals, their goals and the family dynamics.

As I mentioned at the outset, estate and gift taxes must be taken into account in any succession planning for the business owner. At the same time, with proper planning, these taxes need not become a crushing financial burden that prevents children from successfully taking over their parents’ business.

The federal estate and gift taxes operate in tandem to tax the cumulative transfer of wealth during life and at death. Presently, each individual can pass $675,000 free of tax. Thus, a husband and wife can pass $1.35 million, if they plan properly. If they don’t – if they have a typical everything to the surviving spouse arrangement – they can waste the exemption of the first spouse to die. These exemptions are scheduled to increase over the next several years so that, by 2006, five years from now, the individual exemption will be $1 million, and thus potentially $2 million for a married couple.

There also is a special exemption for small businesses. Combining this with the general exemptions, a husband and wife can, with proper planning, pass a family business worth more than two and a half million dollars to their children wholly free of federal estate taxes. Estate taxes attributable to businesses of greater value can be deferred over a period of fifteen years, at a partially subsidized rate of interest. A planning technique called the estate freeze can lock in the death tax value of a business and enable parents to transfer to the children essentially all of the future appreciation in value of their business without payment of any meaningful amount of gift taxes. An estate freeze is especially useful if the parents are at the stage where it makes sense to begin actually transferring ownership to their children. An estate freeze also can be useful to generate retirement income for the parents, which can be very helpful since many small businesses are not financially able to take full advantage of tax qualified retirement programs.

At some point in the future, we may no longer have to worry about estate taxes in estate and business planning. Last year, congress passed legislation that would have repealed federal estate and gift taxes, which President Clinton vetoed. President Bush campaigned to repeal the death tax and has featured this in his recent tax proposal to congress. There remains considerable sentiment in congress for reducing the burden of estate taxes on all families and on small businesses most of all. At the same time, repeal is far from a sure thing. A number of democrats who voted for it last year did so knowing the President would veto it; this time around, a "yes" vote is no longer a painless feel-good gesture to placate affected constituents.

There is a policy argument that can be made against repeal and in favor of keeping the estate and gift taxes. These taxes are a legacy of Teddy Roosevelt’s progressive era and were enacted out of concern over the large fortunes of the wealthy industrialists of that era – the Rockefellers, Carnegies, Mellons and the like. People worried that the unrestricted accumulation of family wealth over generations would result in permanent oligarchies whose interests would considerably differ from those of society as a whole. There are people today, Republicans as well as Democrats, who still strongly believe this. The idea of allowing people like bill gates to pass their fortunes free of tax does not sit well with many who otherwise are sympathetic to small business. Charities also fear estate tax repeal, believing that if people no longer have to leave wealth to charity to avoid the taxman, they will do other things with it.

However these political decisions come out, though, estate tax repeal isn’t going to happen tomorrow. Under both the bill that President Clinton vetoed last year and the proposal that President Bush has made this year, repeal would be phased in gradually over nearly ten years. Even if it is passed this year in its present form, many business owners will die without being in a position to benefit from repeal of the death taxes.

Lawyers can help the business owners with various techniques to carry out their decisions. Some of this is basic estate planning, through wills and trusts and the like. Sometimes the work involves reorganizing the structure of the business to facilitate the planned future division of ownership. This can be particularly important if the parents are retiring and expect to receive retirement income from the family business. The lawyers can help devise a plan that minimizes death tax consequences for as long as death taxes remain a concern. In each case, though, it is essential that the lawyer’s role be to implement the underlying family decisions. One size most definitely does not fit all, because what is ideal for one family may be an utter disaster for another. In succession planning, as in all other aspects of life and business, the legal and tax concerns should follow from the fundamental economic and personal decisions, not drive them.

Yankees great Yogi Berra once said that baseball is 90 percent physical and the other half mental. Like many of his famous quotes, this reflects a more subtle truth, that success means exceeding limitations and doing more than seems possible. For small business owners, effective succession planning means taking or making the time to deal with the difficult business, family and legal issues that have to be addressed while at the same time not disrupting the business itself. I know, it is easier said than done, but it still has to be done.

Finally, I would note that effective succession planning is an ongoing process, not a one-time thing. Business and family circumstances change over time. The child who in college couldn’t balance his own checkbook may, by age 35, be a competent and successful manager, so a plan put in place when he is 18 shouldn’t exclude him when he is 35. In short, any effective succession plan should be viewed as a work in progress, flexible enough to be able to take into account changed circumstances.

There is a great deal of information available on the internet about succession planning from the SBA and from many other sources which can provide a useful starting place. Your accountants and lawyers also should have helpful information.

For those of you who are engaged in or are considering succession planning, I would urge you to take the time to do it right, just as you would any other important business decision. Indeed, this may be the single most important business decision you will ever make, for it is likely to determine whether your business will succeed or fail after you are gone. So try to get the best information and advice you can, ask questions if you don’t understand what is being presented but ultimately, you need to be prepared to make a decision and carry it out. As with other business decisions, the consequences of failing to act often will be worse than carrying out a timely but imperfect decision.