Sell a Family Business: Are the Kids an Option?
Many business owners think they’ll be able to pass their business on to their kids. Good idea? Maybe. But maybe not.
I’ve written about this before – first here and again here – describing some of the pitfalls of assuming family members will take over the business. But I’ve never written about one of the biggest challenges of selling a family business: deadbeat offspring being supported by but contributing little to the business.
Many times, business owners are dreaming when they have hopes of the kids taking over. And these dreams are recognized as such only when it’s very late in the game and they finally come to the realization that their kids are knuckleheads.
What follows is a true story – another tale from the business brokering trenches. It involves business owners – a husband and wife – that were completely unprepared to face that fact that their kids – and the slugs that they married – would be woefully unprepared to take over the business that had supported the family for years.
What is a “Family Business”?
But before we get started, let’s define what a “family business” is, at least for the purposes of this discussion.
Most small businesses can legitimately be described as a family business, at least to the extent that the business supports the family of the owner(s). Worldwide Business Brokers is a family business in that it helps support my family, though no family member works in it. My wife owns her own business which can also be described as a family business in that it, too, supports our family.
But when the term “family business’ is mentioned, most people seem to believe that what is being described is a business that employs one or more members of the immediate or extended family that either started or took over the business some years ago. That is the description we’re going with for this post.
In the Beginning…
This story begins when the young husband and wife buy a small, two-employee lawn and garden center. Over the years, they built it up, added product lines and services, hired more people and by the time they hit their early 70s, they had a very handsome business – at least it appeared that way – with about a dozen employees doing about $15 million in revenue. They had always assumed that their two kids, both girls, and their respective husbands would take over. But there was no contingency plan; no alternative exit strategy. And in this case, they needed one.
Their daughters were coddled from an early age. As they got older, they drove the nicest cars in high school and, not needing to contribute to the family, were basically spoiled rotten. As each graduated from high school, the girls started to “work” in the business but these “employment opportunities” were provided essentially as a way to keep the girls occupied during the day and out of trouble. The parents fervently hoped that one, if not both of them would show some interest in the business but it didn’t happen.
The years, as is their wont, passed by quickly. Not having to concern themselves with earning a living nor finding a husband capable of doing so, the girls got married to a couple of knuckleheads. The parents, realizing that their daughters’ choices in men will result in the kids living in poverty for the rest of their lives, hired the husbands in the hope that one of them would prove to be interested and capable. But at this point there are at least four non-productive employees.
Not having to worry about responsibility, wandering eyes (and various appendages) developed and, in due course, the girls and their husbands, having spent time canoodling with miscellaneous other talent, are divorced. The girls subsequently married their respective canoodlers, neither of whom has a decent job, and these two NEW knuckleheads also end up in the parents’ employ. There are now six deadbeats being supported by the business; roughly 50% of the workforce.
Fast forward to now.
The parents have reached their 70s and want to retire. The husband has confided to a customer that he doesn’t know what to do. Neither of his kids, nor their husbands, nor their EX-husbands, all still employed by the parents, are capable of running the business – and, in fact, none of them want it; too much responsibility. But all of them depend on it.
The parents realize that their kids – now parents themselves (and this third generation is starting to draw paychecks!) – need the business to survive. But even though they and their husbands have, at least ostensibly, been employed by the business for years, they’ve learned very little about running it and cared even less. Their work ethic, such as it is, is well know in the community. There’s no chance they’d be hired by any of the other local businesses
So, what does this mean for the owners?
In our previous discussions about Discretionary Earnings, we talked about owner benefits. As a business broker, one of your jobs is to value the businesses that you represent. In doing so, you look for Discretionary Earnings that have been expensed and move them to the “add back” column. This is one of the most meaningful steps in finding a business’ value.
In this case, the business, with revenue of about $15 million, nets roughly $2.5 million after all expenses. One of the chief benefits to the owners was that they were able – wisely or not – to keep their wayward children and their deadbeat spouses – out of trouble and “employed” (at least in theory). But assuming those relatives were making an average of $50,000 in salaries and benefits, that benefit cost the business $300,000 every year.
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If you’re a business broker, what are the parents’ options? Not much good news here, I’m afraid.
- Option 1: Sell the business for its actual worth realizing that the kids are history. The parents can set up a trust from a portion of the proceeds – a move that will diminish what they net at sale and, thus, their retirement lifestyle – and the kids each get a modest stipend. This may require on the part of the kids some belt-tightening and actually getting a job but better late than never, eh?
- Option 2: Keep the business but hire an outside manager to run it. The problem with this option is that most managers will want to be paid based on their performance; how much they increase revenue and net earnings. As they search for ways to do so, they will quickly see that the lowest hanging fruit in this case is to lop off the deadwood, presumably a condition that would be prohibited by language in the manager’s contract. Such a prohibition will not attract a manager worth much.
- Option 3: Sell the business at a price that reflects the deadwood. In this case, such a price would probably be at least $1 million lower than the business’ value without the deadwood – again impacting their retirement lifestyle. However, a buyer will certainly sunset any provision that would require continuing payments to the offspring. At that point – say three years – the kids will need to have figured out how to make a living.
- Option 4: Stay on with the business as long as you can, keep plenty of life insurance in place and insert a provision in the will stating that upon the kids getting the insurance proceeds, the business goes on the market in the hope that the parents’ legacy can be salvaged.
The Bottom Line
The old adage – “from shirtsleeves to shirtsleeves in three generations” – is meant to describe an all-too-common circumstance; the wealth created by one generation will be lost by the third.
It’s unfortunate, but most members of the “next generation” are not interested in taking over the family business and of those who are, few have the talent and necessary skills to keep it running, let alone growing.
The story I relate above, has not reached its ending yet but the parents appear to be resigned to accept the inevitable – essentially, that they’re screwed. Once they’re gone, I expect a certain amount of sibling and family squabbling, a rising level of animosity, a couple of lawsuits, fractious Thanksgivings and the eventual closing of the business. Sad.
If you’re a business broker advising a seller on developing an exit strategy and you find out that your client has hopes of the kids taking over someday, it is important that you impress these facts on your clients as part of your efforts to manage their expectations.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!
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