Selling a Family Business: The Challenges
25 June 2018
Selling a business is a challenging process. Selling a family business is likely to be more so especially if the “family” is large, diverse and scattered. On top of that, more and more families are defined by second or even third marriages, adoptions, step-children, etc.
But what is the definition of a “family business”? Generally, a family business is described as a business in which decision-making is influenced by multiple generations of a family. Though there are hundreds of thousands of such business around the world, I would argue that whether there are multiple generations making decisions or not, if the business is supporting a family, it could certainly be considered a “family business”.
Based on research of the Forbes 400 richest Americans, 44% of the Forbes’ 400 member fortunes were the result of being a member of or in association with a family business. But this post is focused on multi-generational family businesses with transaction values of between $1 million and $25 million and how that multi-generational aspect impacts decision making when the time comes for the owner(s) to retire.
Transitions of family businesses in this segment are becoming ever more common. Indeed, as highlighted in JC Jones and Associates LLC’s white paper, ‘Exit Planning for the Family Owned Business Owner’, more than 70 percent of privately owned businesses in the US will change hands in the next 20 years. At an estimated total transaction value of $10 trillion, it is the largest inter-generational transfer of wealth in history.
In terms of today’s family business owners, what is required is a well-thought through, clear and realistic exit plan. “An exit plan is a strategic process detailing the financial, operational, management and ownership changes that will take place as leadership is transitioned,” states the report. “A well-thought-out plan is required to meet the personal goals and time frames of owners and to monetize their business.”
Where to Start the Process?
When the business owners decide it’s time to start thinking about leaving, there are countless issues that must be considered. But there are also only two places to start: an exit via sale to outside parties or succession, the transfer of ownership of the business to one or more family members. Each of these two options has its own challenges and pitfalls but planning for either will include asking some common questions. What will happen to the business when the owner leaves? Should the business be sold, either to a third party or to the next generation? Will the owner’s children want to carry on with the business, and, if so, is there a successor ready to assume the leadership? How can a maximum value for the business be ensured? How can taxes be minimized? These are just some of the key issues.
In many instances, a family business owner may have no choice but to pursue an exit rather than a succession, particularly if there is no next-generation family member ready, willing or able to take the helm. That said, for those owners who do have the option of transferring ownership elsewhere in the family, statistics are not encouraging.
Stephen Pascarella, of Pascarella and Gill, PC, a certified public accountancy, notes that less than one-third of family-owned businesses survive the transition from first generation ownership to second. One of the reasons for this is that it is rare to find the talent necessary to run the business in the next generation. Business ownership and business management are two very different things.
Another issue obtains when there are multiple members of the family. Do you give everyone equal shares? When multiple family members are involved, dividing a business equally may not be in the best interests of the business, to say nothing of familial harmony. This issue alone is so fraught that family relationships crumble, acrimony ensues and Holidays are forever ruined.
Who Gets What?
When a business owner decides it’s time to think about an exit and there are children employed in the business, a layer of complexity is added to the planning process. If the children do not share equal responsibility, should the equity be transferred based on the blood relationship – that is, equally – or in proportion to the management responsibility? Should children who are not working in the business be included in the transfer? Do they have any rights to determine the course of the business? How should you slice this pie?
One of the first questions the owner must ask is, is there a family successor that is ready, willing and able to take over the management of the business. If there is not, a transition can be structured to keep the business in the hands of the family but not necessarily run by the family. One way to do this is to incentivize the existing unrelated members of the management team, a topic I’ve posted about earlier.
There are numerous incentive plans, including stock options, phantom equity, distribution rights or other forms of deferred compensation that can incentivize important members of the existing management team to continue to run the business on a long term basis without actually giving up any ownership. This will allow the owner to pass ownership on to the next generation without regard to the members of that generation having the capability and willingness to step in to run the business.
This approach has its own shoals upon which the owner or the business can eventually be wrecked. Setting up the ownership so that the family members do not interfere with the management is an issue to which much time must be devoted if the business is to survive what we believe will be the inevitable conflicts that history suggests are likely to befall the family, especially as third generation members come of age and start to believe that the “cash cow” that the grandparents built is not adequately distributing that cash.
Timing – How Much is Needed?
According to Nadine Kammerlander, professor of family business at Witten/Herdecke University – Otto Beisheim School of Management in Germany, most business owners are not prepared to exit and have not given enough thought to how they’ll leave – an issue longtime subscribers to this blog have heard me gripe about often. “Family business owners often start thinking about their exit at too late a juncture and often have unrealistic expectations,” Ms. Kammerlander suggests. “Moreover, they often underestimate the difficulties of finding an individual to take over a firm, overestimate the future potential of the firm as well as its value due to emotional attachment, neglect legal, regulatory or tax issues that might impede the sale, and can be reluctant to cede control.”
We have often preached that a minimum of three years – and preferably five – is necessary to plan your exit. In nearly twenty years of advising business owners on the sale of their business, I don’t recall one that spent the necessary time to properly plan the exit, take the steps available to maximize the business’ value and think through – with the advice of the appropriate counselors – how the process is likely to go, how long it is likely to take and what the owner’s plans are for post-transition life.
Value, Taxes and What Goes into Your Pocket
Do you know what your business is worth? If you haven’t had your business valued by a professional, it is extremely unlikely that you have any idea. If you are considering a sale or intra-family transfer so that you can kick back and retire, you’d better be pretty sure that the business’ value will allow that. This requires not only a professional valuation but a clear understanding of how much money you’ll need – and when you’ll need it – to live the post-transition life you’re planning.
How complex the business is will determine the level of talent the owners will need to enlist in order to arrive at the business’ value. For example, a regional wholesale and distribution business generally is not as complex as a manufacturer with contract products at various stages of completion, facilities in multiple countries and selling or buying in various currencies. Experienced professional business brokers can generally provide a valuation of the former while several specialists might be involved in the latter.
Whatever the value of a business, the owners’ exit planning and strategic thinking must include what the tax impact will be and, in most cases, how to keep as much of the business’ value as possible. There are many ways to structure both the estate and the transaction and the owners’ decisions will be determined by whether the exit strategy is a third party sale, a sale to a competitor or an intra-family transfer. Get thee to a succession-planning expert with all appropriate haste!
We’ve put together a list of some additional ideas to consider when thinking about selling a family business. Their FREE. Just tell me where to send them.
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. For example, if you’re looking for a business to buy, what is your biggest concern about the process? Are you wondering how much to pay or how long the sales process might be, let me know. 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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