Creating The right recipe for a successful transfer of a family business to a child, requires several special ingredients. The child needs to be well suited to run this particular company at this time in his life. The transfer should support the financial and personal goals of the owner. At its core, a handover must represent more than just a ready-made career for the child. At the time of the transition, the owner should have met all other financial and family obligations–and set himself up so that his life will be satisfying and give him peace of mind.
Advanced planning teams look at several critical details before they develop a transfer plan between an owner and children or other family members including:
o Identifying the client’s exit goals regarding financial security, equitable distribution of assets to the children, and the timeframe for leaving day-to-day management of the company;
o Value of the family business;
o The motivators that will keep key employees–some of whom may be disappointed by the succession plan–to continue building the company and support the transition;|
o Analysis of which is better for the client–transfer to one family member or to more than one and the respective roles of those family members;
o Contingency plans to protect the business in case of death, disability, or early retirement, if the transfer of management and/or ownership takes place over several years.
Once the advanced planning team has these details, they can develop the transfer strategies using the right combination of gifting and purchases, buy-sell agreements, and so on. Equalization of the estate among all of the children, charitable planning, retirement income planning, and estate tax reduction should also be a focus of the team.
A positive transfer experience occurs when a son or daughter who has worked in the business and has demonstrated the ability to adapt to change and grow the company, and has highly evolved organizational and intercommunication skills takes over. In short, the prospective new owner needs to have an excellent senior management profile. She must be able to lead siblings (if they are also working in the business) or at least effectively split the duties with them. At the same time, the new owner must maintain a solid working relationship with non-family members who may have many years working in the company and are more financially dependent on it.
Selling Outright as an Alternative
Instead of the owner giving up his desk to the next generation of family management, the outright sale of the company may actually prove more advantageous. Such a liquidity event bypasses such issues as continuing dependency on the business for income, an under-prepared child running the business, and difficult management dynamics between family members and non-members, among other issues.
If the client sold the business, would the children be in a better financial and personal position without the additional role of small business owner? The answer may be yes, but the client may not realize or have ever considered that a sale would place him and the children in a better place.
In many cases, children have taken over family businesses out of a sense of obligation–and ended up feeling tethered to it.
In Boston several decades ago, a father and mother started a very successful sound equipment company that serviced popular nightclubs and entertainers. Well-known singers and comedians became very fond of the kindly couple, who treated them more like family than customers. The son worked briefly in the business then went on to larger ventures on the West Coast. When the daughter took over after both parents died, she barely knew which end of a microphone to plug in the cable. She called her brother in Los Angeles, and told him she didn’t know what she was doing sitting at her mother’s desk in the office. She asked him to come back and run the business. He declined. “It’s for Mom and Dad, you need to run it,” he told her. Out of a sense of obligation to her parents, she managed the business with the help of employees for about another fifteen years–at times even lending it money to overcome cash flow problems–before deciding it was time she could retire.
“We’ve seen manufacturing companies, for example, that were turned over to kids that were really much better suited to be college professors,” says Ian M. Weinberg, CEO of Family Wealth & Pension Management LLC, in Woodbury, New York. “Out of obligation, guilt, greed, fear–out of all those emotions–they stay in that business. It breaks the entrepreneurial spirit of a family-owned business, when the next generation steps in and they’re not well suited for it.”
Holding onto a Business for Far Too Long?
Every advisor has met owners of family businesses who say they’ll never retire. Pride, lack of interests outside of business, and a driving entrepreneurial personality make an alternative pursuit unappealing. The other factor that keeps some owners from forming an exit plan is desire to hold onto the family business for two unrealistic reasons–1) expecting a child who isn’t in the business to develop a new interest in it; and 2) expecting the business to maintain its value or even grow, regardless of what is happening in its industry.
Weinberg notes that he’s spoken to business owners that were offered tens of millions for their firms within the last two years. The owners didn’t respond. They were operating from the assumption that if somebody offered them that kind of money now, they were on solid ground for similar, or better, offers in the future.
It’s all happened before. An online training company started in the late ’90s on the West Coast by a father and his sons found some success in its marketplace of professional education. A few years later, a major Internet player offered over $100 million for a buy-out, which represented many times the parent’s original investment. Expecting the company to garner even better offers as the value of the company continued to grow during those explosive years, the father and his sons waited. Very soon, the dot.com bust came and that original offer–and any others of that magnitude–were just memories.
“We’ve been involved with a number of clients, advising them on succession plans for businesses where the industry itself was fading away, such as the textile manufacturing business,” observes Weinberg. “I’ve seen many fathers hold on to businesses way too long, bypassing exquisite offers to sell the business for a fear of not knowing what their son or daughter’s career path would be or the children’s source of income. If someone offered a father $50 million for a manufacturing business, he would very well be able to set himself for the rest of his life and also contribute to the beginnings of something else for his kids. Something to put them on a different path, and perhaps even support them while fostering some independence.”
The Emotional Fallout of Selling a Family Business
“It can be an emotionally-charged issue,” notes Peter Carnathan, senior vice president, Fiduciary Investment Management International, in Washington, D.C. “It’s often that family business that has been the agent for the family wealth that’s under discussion. It can be very difficult at times for the patriarch or matriarch of the family who has either started the business or is a generation or two from the original founder, when they realize there just is not a viable alternative within the family to keep the business running.”
“I’ve seen reactions of great disappointment, and I’ve seen more ambivalent reactions of ‘Well, it is what it is. My kids decided to be social workers or doctors or artists.’ At that point, the time has come that they need to have an alternative on the table that is not involving a family member running the business going forward.”
Advanced planning teams addressing a client’s small-business transfer to a child or sell outright to a third party often find that the raw truth of the data and analysis won’t necessarily persuade the owner initially. Especially when much of a client’s self identity is tied to the business–and from an extra sense of obligation to parents and grandparents who started the family business–he needs to work through the emotions before implementing any plans. Otherwise, the owner will find reasons to stall. When the family name sits above the business’s doorway, more than a stock sale is involved.