Handling Those Difficult Conversations about Business Succession
Summer is one of the most popular times of the year for multi-generational families to get together. If you’re a member of a business family, it’s often when relatives discuss who is going to take over the family business someday. Whether at the lake cottage, the beach house or on a group trip abroad, family members are away from the daily distractions of work and home. They’re in a much better frame of mind to do some collective soul-searching.
Just don’t drop this heavy topic on an unsuspecting family member when they’re lining up a putt, hooking a fish or chasing young toddlers around who may be hungry, cranky or in need of a diaper change. It needs to be a little more deliberate than that.
According to AES Nation, there are four key steps to having a successful family succession planning meeting:
Step 1: Plan the meeting.
If you’re an owner or founder, it’s a good idea to get your thoughts together ahead of the conversation. It’s okay to jot down some notes or talking points, but you don’t need to distribute them to others or type up a formal agenda. Just broach the subject of succession planning as part of a casual conversation with your heirs. To take the edge off, many clans include fun activities around their “family meetings” such as golfing, family softball games or wine-tasting events. Just don’t make the sporting activities too competitive-- emotions may already be running high during these gatherings.
I come from a business family. I still have fond memories of sitting down together to eat blue crabs in my home state of Maryland. These bonding moments are nice on their own, and they also help promote a better meeting.
Step 2: Conduct the meeting.
I recommend holding the family meeting at a resort or a tucked-away family property so you can mitigate day-to-day distractions. It’s also a good idea to bring in an objective outside professional—say the family’s CPA—to serve as both a referee and meeting facilitator to keep the discussion on point and moving along. You can also bring in the family attorney, wealth manager, multi-family office executive, or family business consultant among others. Just make sure that person is impartial.
Step 3: Follow up actions
After the meeting, it’s very important to capture each participant’s next steps and to make sure action items don’t fall through the cracks when they get back to their day-to-day routine. Before the meeting concludes, make sure everyone goes home with a written “to do” list. That way they’re held accountable--the youngest generation can’t expect the elders to do everything for them.
Step 4: Assess the outcomes
Let’s say the topic of umbrella insurance came up at the family meeting, and everyone agreed to disclose how much coverage they had—even if they didn’t have it. To make sure the collective family assets are sufficiently protected, every head of household in the extended family should have it. It may require several follow up calls and emails to each family member to get this done. I’ve found this kind of assignment is a good litmus test for the young adults in the family to see if they’re responsible enough to take over the family business. If they can’t handle a simple task like getting their insurance coverage together, how can you expect them to be responsible enough to run a successful family business?
My own family business story
My late father founded a successful concrete business. I worked for him every summer, and by the time I was finishing up college, I knew the concrete business wasn’t for me. I got along pretty well with my dad, and it had nothing to do with the physically demanding work or the intense Maryland heat. I just didn’t have the passion for it, and I think my dad recognized that, too. Also, before my dad started his own company, he worked for another concrete company where everyone resented the owner’s son who was brought in to run things. The son wasn’t a good manager, and the other employees didn’t respect him. Dad didn’t want to put me in the same position, and I’m thankful for that.
Research from Northwestern University finds that only one-third (30%) of family businesses make it to the second generation, and only one in eight (13%) make it to the third generation.
Those stats seem depressing at first, but they shouldn’t surprise you. Most founders start their businesses because they’re deeply interested in their chosen industry, plus they’re very good at it, and they see a niche in the marketplace that isn’t being filled. That’s what got them excited early on—they had a vision and saw an opportunity. However, founders can’t expect their children or grandchildren to have the same skills and passion for that industry. Moreover, even if they do, the window of opportunity might no longer be there 25 to 50 years later.
North Baltimore was booming when my dad launched his business. There was a huge need for concrete. However, now it’s not growing much so it wouldn’t have been the same opportunity for me, and I would have resented being pressured into running the company in the current environment.
After college, dad always told me to work for somebody else for a couple of years and then start my own company. That’s the model he followed, and it’s exactly what I did--just not in his industry. Ultimately, I think he respected that decision. It was the best thing for his business and our family, and he continued to run business ideas past me until he passed away last February.
Four ways to exit your business
I’ve found there are four good ways to transition out of your business when the time comes. Just make sure you are 100-percent ready to exit. More on that in a minute.
1. Family transition
Before handing over the reins to your business, it’s very important to know whether any of your children have the ability--and the desire--to take it over. It’s going to take a serious conversation with your children as they get older since the thought may have never crossed their minds. Even if do seem passionate and interested in taking over, you’ll need to be brutally honest about whether or not they have the managerial skillset to be a good leader, decisionmaker and owner.
Even if all the above boxes are checked, you also need to consider the long-term viability of your business. You don’t want to transition a dying business to your kids or put them in charge of a firm that’s mired in a slow-growth or no-growth industry—like the concrete business in North Baltimore. Performing a SWOT analysis of your Strengths, Weaknesses, Opportunities, and Threats can help you get a better handle on the long-term prospects of your business.
2. Employee Transition
If your kids don’t have the chops (or desire) to own and operate your business, you could be better off transferring it to key employees. A management buyout or other transition to key employees generally involves a sale to those employees, often over time. However, an employee transition only works when you have capable and highly motivated employees interested in owning the business. Just because they’ve been there 20-plus years, doesn’t mean they’re qualified. However, if you do have the right type of successor already on your payroll, this type of transition will provide you with cash over time.
3. Third Party Sale
Selling to an outside third party—perhaps disappointing to the owner and employees--might give you the highest multiple for your business. That’s especially true if your kids or key employees are not interested in (or capable of) taking over the business. You could sell to a competitor, or to a complementary business that might gain synergies from owning your business. That being said, there is going to have to be a transition period in which the clients meet the new owners, and the new owner works with the seller. I have found that third-party sales are by far the most common in our geographic area.
4. Wind up
Winding up the business may be the option of last resort if the business depends too heavily on you for sales or operations. Alternatively, maybe the kids and employees are not practical options for a transition. Maybe you're in a dying industry, or the business is otherwise too hard to sell.
With any option, you'll want to structure the arrangement to minimize tax by using your lifetime capital gains exemption if possible-- $866,912 for 2019. It's important to note that you don't have to claim the exemption all at once - you can carry it forward
It’s never too early to start planning
Regardless of which exit strategy you choose; you need to start planning at least five years in advance. As mentioned in my previous article, you need to get your financial and operations in order. It’s not a simple process, and it will take time. Please…don’t be a do-it-yourselfer here.
TIP: If you’re part of a family business, don’t ever use the family dinner table as a conference room. One day before my dad passed away; my teenage sons told me they didn’t want to visit their grandparents anymore. When I asked why they told me it was it was boring because all they ever did was sit around the table listening to my dad and I talk about business. Does this sound like your family?
Avoiding common succession mistakes
Here are some other errors you want to avoid when it comes to transitioning the family business:
The owner isn’t ready to give up control.
The owner has no ideas on how they’ll spend their time after leaving the business.
The owner doesn’t agree with the children’s vision for the company.
The owner doesn’t set reasonable expectations and isn’t honest about his or her concerns and fears.
The owner pressures children to take over the business when the kids aren’t passionate about it.
The owner rushes into the exit decision. As mentioned earlier, it takes at least five years of careful planning.
Conclusion
All families that own a business struggle with succession issues. There is no easy solution. You need to start early, feel out the children, see if they’re interested and assess the situation to see if they’re capable of taking over the reins. If they’re not, please review the other transition options outlined in this article. If you or someone close to you is wrestling with family business succession planning, please don’t hesitate to contact me.
Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.
The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc. The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles. Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.