The prospective successors who anticipate continuing a family business do so with expectations. Generally, children expect that when mom and/or dad retire, they will step into their parents' lifestyles. Upon retirement, parents are usually enjoying the most attractive earnings/workload/lifestyle of their careers. Successors should be given the news early on in their careers that this will probably not be the lifestyle that they will assume when their parents retire. If there are two or more successor heirs, when they divide cash flow freed by their parents' retirement, their portion of the cash flow will be less than their parents'.
Furthermore, when mom and dad retire, they will probably continue to draw some form of salary and benefits. There may also be a stock redemption that will consume the cash flow. Invariably, there is some form of payout of salary, benefits or debt that consumes cash flow that the successors might otherwise get. In the vast majority of businesses, if the successors get a pay or benefit raise shortly after their parents retire, it is because they have expanded the business or dropped expenses other than those associated with their parents. If the successors want to live the good life and take bundles of money out, they had better be prepared to put bundles of effort in. Parents who are taking more out of the business than they appear to be contributing are merely drawing upon a buildup of income earning ability that occurred when they were barely taking anything out of the business. In other words, it is payback time.
To help support this reality, parents are urged to pay children what they are really worth, not what they need to live a lifestyle that they feel they should have. Do not pay them less than they are worth, or you will create resentment that can never be erased. Also, do not pay them more. "Enabling" will promote incorrect conclusions about the input versus takeout concept of the family business.
In concert with the education about what children should expect to take out of the family business, it should also be explained that they are paid according to a compensation policy that is critical to the overall harmony of employees and productivity of the business. Further, there are two elements of earning from a family business. The first is compensation for services. The second aspect of compensation is return on equity ownership. When the children own stock via gifts or purchases, they can enjoy the second aspect of compensation from the family business.
Most family business owners are required to personally guarantee business debt. At the risk of expressing the obvious, parents should not transfer operational control to their children without being relieved of liability. History has proven that facts are stranger than fiction. There is no way to determine today what bizarre circumstances may occur in the future that converts a simple loan guarantee into a personal disaster. It is OK for children to think they are in control, but parents should maintain sufficient voting stock or contractual power to regain control if the need arises.
How do you determine what children are worth? This is difficult because of the subjective nature of the situation. You may feel they should have a nicer home or their children should go to private schools. Commonly, the income of successors is inflated to artificially support their standard of living. The best approach is to simply pay children what you would pay a non-family member. Any other compensation criteria can create problems, either with a child's entitlement attitude, or with the frustration of managers who are working hard for every dollar they earn. Do not be naive and believe that you can keep a child's compensation secret. If you feel that you need to supplement a child's cash flow, do not distort their reasonable income from the business. You can make annual spendable cash gifts or make creative equity gifts that will either enhance income or provide a specific benefit, such as a home.
In review, personal financial planning is critical to effective succession planning. Parents with rational minds must have confidence in their personal financial security before they will release their most productive asset: the family business. Transferring portions of the business during a parent's lifetime is important to minimize estate tax. Transferring management control during this lifetime is important to the development of effective business management skills and practices. The disciplined accumulation and management of assets is critical to achieving financial security and peace of mind. The senior generation's peace of mind about personal financial security is in the best interest of all benefactors (children, employees, vendors) of the business succession process.