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Don’t Strong-Arm Reluctant Heirs to Join your Franchise – it could Backfire

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Don’t Strong-Arm Reluctant Heirs to Join your Franchise – it could Backfire

Don’t Strong-Arm Reluctant Heirs to Join your Franchise – it could Backfire

One of the greatest challenges faced by a small business owner is succession planning. Franchise owners often want their kids – the “lucky sperm club”, as Warren Buffett calls it – to one day take over the business they have laboured years to build up.

Most franchise agreements contain provisions that give the franchisor the right to veto a potential successor’s ownership of the franchise. A franchisee wanting his or her family to retain the franchise after their retiring or death therefore needs to plan ahead. There are two aspects to optimally position the franchise for succession:

Getting children to take over the family business can be hard

Family Business

The ability to involve one’s entire family in the business operations is one of the strongest attractions of a franchise, but it can also be one of the toughest assignments to persuade them to work. Estate planning experts recommend one should never ‘strong-arm’ or influence one’s children to join the family business, but rather let them choose their own calling. After all, at the end of the day their choice may well be to join the family business.

A recent survey by Peking University found that 80% of potential Chinese heirs were reluctant to follow in their fathers’ footsteps. Statistically only 30% of family businesses make it to the second generation; only 12% survive into the third; and only 3% make it to the fourth generation. What often destroys these businesses is the ‘soft stuff’—parents resisting a new strategy the child proposes; a mother and daughter team frustrating the staff by pulling in different directions; and the other ways in which familial relationships interfere with the best interests of the business.

This high failure rate is most likely much improved upon in franchises, as many of these tactical decisions are made by the franchisor, reducing the potential for familial conflict.

Where there are no kids, or they are minors

Family succession in this instance is clearly off the table. It would be prudent as an alternative to try and put in place a succession plan involving one or more key staff members. This is not easy given the long-term nature of such a plan, as impatience may fester. It is also not easy to find an employee who can step up a level and in many cases this alternative may not be satisfactory, so selling the franchise may be the best exit plan. Yet it does occur, and the following steps are recommended:

  • Sell the employee/s a small shareholding during one’s lifetime, remembering to get the approval of the franchisor
  • Choose an experienced and trustworthy employee
  • There will still most likely be a need for additional coaching on the nuances of running the business
  • Enter into a shareholder’s agreement, which includes a buy and sell clause and the necessary life insurance savings plan to fund the purchase of the franchisee’s shares
  • Make it flexible enough so that if the franchisee eventually has kids, and they express an interest, this employee-option can fall away.

Once the kids reach majority

At this stage, if they have expressed an interest in joining the business, it becomes the franchisee’s objective to ensure that the business can continue in the event of their own premature death. This can be achieved through a testamentary will and a shareholder’s agreement, enabling the child to step into the franchisee’s shoes. There remains the obstacle that the child may not be ready to assume the mantle – he/she may be studying at university, for instance. One clever way to ensure that heirs are ready to inherit the franchise is to make them prove themselves outside the family firm. This all means they may not be immediately available.

Having the spouse (mother or father) involved in the business provides necessary continuity, but if not then one of the most effective methods of ensuring continuity is for the franchisee to take out a key man insurance plan on his/her life, payable to the business. The business receives a cash injection enabling it to employ someone to continue running the business, possibly with help from the franchisor, accountant or some other trusted adviser until the heir finishes studies.

In conclusion

One of the biggest problems faced by a franchisee who has sunk all his wealth into the business, and has no realistic succession plan, is what happens to his family on his death? This becomes entirely a matter of estate planning, and even if one has a valid will, it would be prudent to speak to a financial adviser to ensure adequate life policies exist outside the business to help the family cope cash flow wise until the business can be sold.

Children should be encouraged to look at joining the business, by making it fun. Once that interest is expressed, the succession plan has to incorporate management training and the potential for contributions to decision-making by the heir. One reason 80% of Chinese heirs don’t want to inherit the family business is that a successful mom or dad can be a hard act to follow—and may remain a bothersome back-seat driver long after relinquishing the steering-wheel. Don’t be a back-seat driver!

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