Friction in the Family Business

Fri, 05/27/2022 - 08:28

Written by: mernzen

On the surface, it seems like Exit Planning for family businesses hardly requires a second thought. After all, one generation simply hands down the reigns to the next generation as that is typically the desired exit path in these situations. The family transfer process is rarely that simple, and it can potentially cause a great deal of friction.  

Business owners face several challenges when it comes to ensuring their company transitions smoothly from one generation to the next. In some cases, transferring to a family member may not be the best option. Under most circumstances, family business owners benefit from the advice of a professional Exit Planning Advisor to ensure a successful business transfer.  

Why Family Business Transfers Can Cause Friction 

According to the Family Business Institute, only 30 percent of family businesses transfer successfully into a second generation. That means that 70 percent of family businesses don’t survive the second generation taking over, leaving the families to lose control of their business and assets. More importantly, when family business transfers go wrong, personal relationships suffer too. 

Exit Planning can help first-generation owners pave the way for a smooth transition of ownership responsibilities and avoid some of the most common challenges.  

Challenge #1: Mismatched Expectations 

Many first-generation owners started their businesses because it was something they always wanted to do. They are entrepreneurial at heart, and creating a company is the most logical way to fulfil their dreams. Others started out of necessity. Owning and running a business was the best way they knew how to provide for their families.  

Most owners of family businesses have one thing in common – a purpose to leave a legacy that they can hand over to the next generation. However, even with the best intentions, there is not always a natural successor and the expectations that the owner has for the future of the company might not match the interests of their children or relatives. 

Children may not be interested in their parents’ line of business or in running a family business at all. On the other hand, business owners may have several children interested in the business. The question is, are they happy to collaborate for the good of the company? If not, the business could suffer from lengthy legal (and emotional) disputes.  

Family business ownership transfers need to consider all family members who may feel they are entitled to a share of the business. As an Exit Planning Advisor, you can suggest different options to navigate this challenge to the benefit of the family and the business. 

Challenge #2: Lack of Exit Planning 

As the saying goes, failing to plan means planning to fail. This is particularly true when it comes to successful family business transitions. As a first-generation owner, it is easy to assume that the next generation will take over when the time comes.  

This may have been true a few decades ago, but the business landscape has changed significantly. Keeping a business in the family requires careful Exit Planning and succession planning.  

Family transfers require open conversations between different generations. Owners not only need to clarify their intention to exit, but they also need to understand the next generation's intentions and how that might affect the desired timeline. Even with complete alignment between the first and second generation, you may need to help owners build in time for preparing the next generation to take over and start running the business successfully and adjust their expectations for what that does to their desired timeline. Whether an owner has several successor candidates or none of the children have expressed any interest in taking over the business, the planning process can take many years so getting a head start is ideal. 

Professional Exit Planning Advisors can help navigate these situations. When there is competition for a certain position, professional advisors can mediate to determine what leadership options make the most sense and what resources and training might be required. If there is no natural successor available, Exit Planning Advisors can work with owners to find alternative exit solutions that retain family ownership without day-to-day involvement, as well as focus on other exit objectives important to the owner.  

One of the biggest problems for family businesses is a lack of preparation. Hoping that a family member will naturally take over is not enough and puts the company’s future in jeopardy.  

Challenge #3: Preparing the Business for Growth 

Most family businesses are started by one single entrepreneur. As the company grows, restructuring the management model may be necessary and more decision makers may be needed at the table. Otherwise, there is a risk that when the sole owner leaves, the existing employees or replacement owner might alter the day-to-day operations of the business. 

Moving from a “one-man band” to a company with the potential to grow can be tricky. A larger leadership platform is one requirement to prepare a family business for successful scaling. Splitting and delegating decision-making capabilities prevents operations from stalling when one person cannot be reached.  

Moving from one generation to the next provides an excellent opportunity for a family business to make this transition. It is a natural time to expand the organization’s leadership team and allow several family members to collaborate.  

Exit Planning Advisors provide expert advice and guidance throughout that process. They are well-positioned to suggest a suitable structure that takes growth requirements into account and can provide a roadmap with the steps required to make those changes. 

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Challenge #4: Letting Go of the Business 

First-generation owners have a wealth of knowledge and experience in all aspects of a family business. Due to their longstanding investment in their company, it is often hard for them to let go and move on to their next goals post-exit. No doubt, the second generation can benefit from their experience, but it is important to have a balance in order to reach the exit goals.  

There is a difference between occasional advice and unwanted interference during the transition period. Managing this transition whilst keeping the peace in a family is challenging. The best way to prevent problems caused by (perceived) overstepping is to set clear boundaries for the handover of responsibilities.  

Owners can ease the transition by proactively handing over key business relationships. Efforts like introducing the next generation to key suppliers and long-standing clients will pay off almost immediately and avoid disruption to the business.  

Exit Planning Advisors are best placed to help avoid discord between generations by clarifying the transition process for business owners and their successors. Understanding each other’s roles, respecting boundaries, and keeping open lines of communication are key elements of a successful transition.  

Disagreements are natural, both within a family and a business. Resolving them effectively and efficiently is easier when everyone understands each other’s roles.  

 

Final Thoughts 

Family business ownership transfers are more likely to succeed with the help of experienced and knowledgeable Exit Planning Advisors. They will apply a solid, proven process to the transition and manage the tasks of the plan until its execution. Not only will Exit Planners support family businesses in avoiding common pitfalls, but they provide the insight and guidance needed to help build and sustain a legacy that will continue into the next generation.  

Takeaways:  

  • Matching expectations between generations, preparing a sustainable exit strategy, and planning early ensures a company’s long-term sustainable growth.  

  • BEI tools & resources provide you with the knowledge you need to convert one of the most difficult Exit Paths, the transfer of family ownership, into the most gratifying for everyone involved. Schedule a meeting with us today to get started! 

 

Friction in the Family Business

How to Avoid Common Family-Owned Business Challenges with Adequate Planning

In this episode of Why We Plan, John Brown, Founder of BEI, interviewed Joe Guyton, Founder and Principal of The Guyton Group, at BEI’s 2019 National Conference. Joe explains his first experience with Exit Planning was with his father. He uncovers the common mistakes his father made with his business and the negative impact it had on him and his family. With better planning, many of these common challenges could have been avoided. Joe also discusses his strategy for getting in front of clients, how to get their attention, and how to start those difficult planning conversations.

Sharing Your Exit Plan with All Parties Involved - Including Family Members

In this episode of Why We Plan, John Brown, Founder of BEI and Elizabeth Mower, President of BEI discuss the importance of coming up with a contingency plan when the owner of a business unexpectedly dies. As morbid as this topic might be, unfortunately we have to think about these kinds of situations. Elizabeth and John share their experiences of when an Exit Plan addressed planning for an unexpected death of an owner, but it was not properly executed due to ineffective communication to the owner’s family.

3 Ways to Help Family Business Owners Plan for Future Success

Fri, 11/08/2019 - 12:00

Written by: eswanson

A family business can be tricky to plan for. Lots of times, family issues bleed over into the business, making planning for future success a matter of helping owners and their families. A family business creates unique dynamics for successful planning because owners and advisors often need to consider the wants and needs of people other than the owner. Although the business owner is the advisor’s only true client in these situations, owners and advisors should still prepare themselves to tackle issues that affect the family. Here are three things owners and advisors should consider when planning for the future success of the family business.

Keep Ownership Agreements Up to Date

Many owners create ownership agreements early in the business’ life. As the business evolves, many of those owners fail to update those ownership agreements. The most common type of ownership agreement that doesn’t evolve with the business is a Buy-Sell Agreement. Having an outdated Buy-Sell Agreement is especially dangerous for family businesses, and it’s up to advisors to identify and fix the issue. Consider two examples about how outdated ownership agreements can destroy a family business.

Jake Simpson was the sole owner of a custom fabrication company. Each year, he brought in a salary of $350,000 for his family, on top of the health benefits and other perks his family enjoyed. One day, Jake had a sudden heart attack and died.

Jake had created a Buy-Sell Agreement 25 years ago that named his wife, Mary, as the owner should something happen to him. He never updated it, always telling his advisors that he’d do it later. Mary had no experience running a business. So, she immediately called Jake’s advisors and asked them to help her sell it for as much as they could. She informed the company’s key employees in an effort to be transparent.

When Mary told the key employees that she was selling the business, many of them began looking for new jobs and left. Revenue crashed, and Jake’s bank began to call in the company’s debts. Mary couldn’t find a buyer for the business, so she liquidated it for $500,000. After repaying the company’s bank debts, Mary was left with just $200,000, no health coverage, and no income.

In this example, a sole owner put his wife in an impossible situation. By failing to update his Buy-Sell Agreement, he left her stranded without direction. Had Jake’s advisors pushed him to update his ownership agreement yearly, the family business might have survived—or Mary could have at least sold it rather than liquidating it—despite his untimely death.

Now, consider a co-owned business with outdated ownership agreements.

Janelle Black and Sierra White were co-owners of Black & White Distribution. Their business was appraised at $5 million. Each brought home $375,000 in salary. According to their Buy-Sell Agreement, which they created just five years earlier, if one of them were to die, the surviving owner would purchase the remainder of ownership.

While driving home from work one night, Sierra was killed in a car crash. As 50/50 owners, Janelle and Sierra had each taken out a life insurance policy on each other. After Sierra’s untimely death, Janelle used the insurance funds to pay for Sierra’s half of the business. The $2.5 million lump sum wasn’t enough for Sierra’s family to continue living their current lifestyle. Rather than the $375,000 annual salary, Sierra’s family income fell to just $100,000 a year, based on a 4% withdrawal rate.

In this case, the Buy-Sell Agreement worked as planned, yet Sierra’s family still suffered. When an owner’s family relies on the business to maintain a lifestyle, advisors must be sure that owners understand the consequences of their untimely departure from the business. Constantly reviewing the owner’s goals, asking the right questions, and updating any ownership agreements is a good way to protect family businesses.

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Separate Fairness and Equality

When owners of family businesses have children, planning for future success becomes more complex. In many family businesses, some children decide to work in the family business while other decide not to. This can cause owners to confuse fairness and equality when planning for their post-business lives.

Consider a business owner, Joe, who has three children: Doug, Glen, and Jania. Jania has worked in the business for 20 years, growing it from a $1 million enterprise to $15 million. As Joe approached retirement, he planned to transfer ownership to Jania and leave $1 million apiece to Doug and Glen after he died. When the brothers learned how much the business was worth, they demanded an equal amount in cash from their father. They didn’t think it was fair for Jania to receive what they considered to be more money, even though the company’s value was largely illiquid and they had nothing to do with its success.

Advisors can mitigate situations like these by establishing the owner’s goals then creating plans to communicate those goals to the children involved. Advisors are independent and unbiased about fairness toward children, working to achieve the owner’s goals foremost. Advisors can also determine what’s fair in terms of how each child contributed to the business’ success and how any ownership or monetary transfers can reflect those contributions in the context of the owner’s overall planning goals.

Have a Backup Plan

Family business owners often want to keep the business in the family. While this is often possible with proper planning, advisors must encourage owners to have a backup plan.

Advisors can help business owners create a backup plan in tandem with planning for a successful future. The surest way to do so is to install Value Drivers in the owner’s business. Regardless of whom the owner wants their successor to be, all potential buyers/recipients of ownership will want Value Drivers to be present in the business.

Another way is to determine whether the owner’s chosen successor can continue to grow the business. Implementing strong incentive plans is a way for advisors to help owners determine this and reward high-performing potential successors.

Takeaways

  • Family businesses typically face more challenges to planning for future success. Advisors and owners should identify these challenges and address them early in the planning process.
  • Keeping ownership agreements up to date can prevent family businesses from facing surprising outcomes brought out by the owner’s unexpected departure from the business.
  • In planning for the future success of a family business, advisors should know how to explain the difference between fairness and equality, and implement backup plans.

11-08-19
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