The Business Owners’ Special Series (B.O.S.S.) No. 22
Your business exit plan should focus first and foremost on your desired outcomes, business and personal, putting you in front and center of the exit plan. Using your owner-defined outcomes, your exit plan should then provide detailed action steps that will lead you to help you achieve those goals.
Keep in mind: the best plan is often not the first plan that comes to mind.
The most effective exit plans will test the action plans against the desired outcomes, weigh the plans against alternative strategies, challenge the assumptions and help ensure the chosen plan will yield the best results for you and your loved ones.
As a business owner, you may believe transitioning the business to your children is the most appropriate course of action. Reasons include continuing the legacy, keeping the business under family control, and making certain the golden goose keeps laying the golden eggs for the family, long after you are gone.
It is very exciting for exit planners to see a founder transition the business to the next generation, and watch the children continued the family business’ success. However, is that what really happens in most cases? Is that always what is best for the family?
Business transitions from one generation to the next typically have a very low rate of success. Only 30% of family-owned businesses survive in the hands of the second generation. A mere 12% survive the third generation, and only 3% succeed thereafter. These numbers should make you question the idea of transitioning the business to your children before moving forward with that plan.
Transferring the Business Versus Transferring Wealth
If you are a founder who has grown your business to a significant size and value, ask yourself two critical questions: do I want to transfer the business, itself, to my children? Or do I really want to transfer the wealth I created from the business to my children?
By asking yourself these questions, you will also answer: where will my family receive the greatest long term financial benefit? Will it be from transferring the business, the benefits and all its burdens, to my children? Or should I sell the business at the highest possible price and leave my children the proceeds, which can be professionally managed in a diverse portfolio of investments?
Both options have their inherent risks, as nothing is guaranteed. It is worth considering that a professionally managed portfolio of diverse investments may have less risk than a single investment, your business, which is now managed by your children.
Should My Children Have ‘Skin in the Game’?
Let’s assume transferring the business to your children meets your business and personal goals. How will you transfer the business to them? Will the transfer be a gift of the business while you are alive? Will you have them inherit the business, when you pass? Should the children buy the business from you?
Parents rarely think of selling their business to their children, but there are significant benefits in doing this. First, you test their commitment. If the children believe the business is not worth paying for, how committed will they be at working toward its continued success? Furthermore, it is human nature to have a greater commitment toward the success of something for which you paid for.
Keep in mind, however, gift, inheritance and sale are not mutually exclusive ideas. You can use any combination of these, as long as they will achieve your goals and objectives.
How Secure Is My Retirement?
Does your retirement plan demonstrate you have sufficient assets outside of the business, so your retirement is in no way dependent on the proceeds from the sale of your business? If this is not the case, would a cash sale to a third party be more in line with your personal financial needs for the remainder of your life?
Your children will very likely not pay you full value for the business, if anything. Furthermore, if they do buy your business, they will likely pay you over time, using the income of the business to pay you. This means your ability to support yourself in retirement is dependent on your children’s ability to run the business in a manner that will fund their lifestyle, as well as fund your retirement. Is that a risk you find satisfactory or frightening? If transferring your business to your children will keep you awake at night, and puts your retirement lifestyle in jeopardy, a sale to a third party could be a better option.
Evaluate and Prepare
After considering the above, if you still believe transferring the business to your children is the optimal choice for your personal plans and goals, then begin to implement an exit plan that will increase your children’s likelihood of success. An exit plan for family businesses should include an assessment of the children’s skills and motivations. You need to be certain their head and their heart is in the game.
An assessment of your children’s aptitude should be done by a certified exit planning advisor, who can be neutral and objective about assessing their skills. Furthermore, children are more likely to disclose their true motivation and attitude to an independent third party, whereas they may only tell you what you want to hear. You need to be certain your children are sufficiently skilled and highly motivated to run your business. If they are not, their failure will be a forgone conclusion.
The second and third generation of owners will not possess the extensive knowledge and experience of the founders. Founders typically have performed every function of the business during the startup phase, and their knowledge and acumen increased as they grew through experience of creating, managing and growing every segment of the business. Subsequent generations will not have founders’ experience, as they have not lived through the growing pains, mistakes, errors in judgement and all the invaluable lessons founders have experienced.
In other words, it often takes more than one person to replace a single founder. An effective exit plan will test the children’s business knowledge, assess their skill sets, identify the gaps and then establish a plan to supply the children with experience required to expand their skills and close the gap. It is not enough to empower your children to run your business, you also have to thoroughly prepare them. This may take more time and training then you expect, but it is a necessary step for the next generation’s success.
Managing Expectations of Management
There may be conflict and business disruption when key employees who are not family members, are not considered successors to the business. If key management sees the heirs as less qualified, there may be resentment, loss of loyalty and even defection. Mangers may no longer work as hard toward the success of the company. If the animosity level is strong, key manages may leave the company and work for a competitor, or worse yet, they may stay with the company and work towards the children’s failure.
Family rivalry may arise, as siblings object to the choices their parents make as to which child becomes the CEO and which children have subordinated roles. There may also be discontent about levels of ownership and income from the business. Business owners like to believe the family business will create harmony, as the siblings are working together toward the common goal of the business’ success. The actual result could be quite the opposite, resulting in the destruction of family harmony, disagreement, rivalry and feuding among siblings.
If there is a threat of irreparable damage to family harmony, as to how ownership and management is transitioned to the next generation, you may want consider selling the business to a third party, and transferring the wealth derived from the sale of a successful business to your heirs. You will have to evaluate and decide whether you want to preserve family and the wealth, versus preserving the family business itself.
Exit Planning is Key
Since the data shows that most family business transitions fail, effective planning is necessary for a successful transition. Effective planning will identify the likelihood of success of a family transition, determine if this is the best course of action for achieving the business owners’ personal and financial goals, and if it is, establish practical transition plans to increase the next generation’s likelihood of success.
Rich Gunn leads BPM’s Value Acceleration Service Team, which helps with succession planning, transition business exit strategies and exit planning for business owners. Rich is a Certified Exit Planning Advisor and a member of the Exit Planning Institute.
The Business Owners’ Special Series (B.O.S.S.):
The Business Owners’ Special Series (B.O.S.S.) is a library of information for business owners who are proactively seeking guidance from experts on how to implement value acceleration in their business. Be sure to keep reading, if you desire to develop your business to its maximum potential value and gain an understanding of how and why beginning the process sooner results in building greater value.