The sale or transition of a business to new ownership is a complicated and fraught experience in any situation. Throw in the family dynamics of family-owned businesses, and things can get really complicated.
At Olson Wealth Group, we work with many family businesses who are approaching a transition, and we believe from experience that taking a team approach is a recipe for success. We collaborate with a wide variety of professionals, from CPAs to estate planning attorneys to business coaches and more. I recently interviewed Erin Donovan, a partner with EY’s Private Tax Practice. For more than 20 years, Erin has worked with family business owners navigating an ownership transition. Below, we reflect together on how family businesses can successfully transition ownership to the next generation.
When to start the conversation with the next generation
We work with many families with significant wealth, and that wealth is often created from successful family businesses. The key to that success is rooted in carefully orchestrated transitions from one generation to the next. And successful transitions begin with transparent conversations from an early age. Often those conversations regarding the family business happen at the dinner table, which can be a safe (and hopefully consistent) environment to expose children to the business and its importance within the family. It presents an opportune time to talk about the values of the family, and of the business, and how they intertwine.
As Erin shared with me, EY’s research shows that more than 65 percent of family business owners want to transfer their business to the next generation, but only 25 percent succeed in doing so. One of the reasons is they don’t start the conversation soon enough. Ultimately, it depends on the family and the business and the individual family members to determine when to start the conversation. But typically, the sooner the better if you want a successful transition down the road. The key is to have age-appropriate conversations.
How to create an open, safe environment to share
It is incumbent on the current generation leading the business to foster healthy conversations with younger generations. They are the ones in the best position to start the dialogue and create an open environment for the rising generations to share their hopes and ideas. Of course, it’s important that the current business owners be clear on whether or not they want family members in the business going forward. Some don’t. The last thing you want is to set unrealistic expectations among the next generation.
Assuming the goal is to transition the business to the next generation, focus on the strengths and aptitudes of the younger generation. Ensure they have a voice in how they want to use those skills and what they believe they have to offer. No one should feel obligated to join the family business in a role they don’t want. Rather, you want them to be excited and to know they will be able to leverage their strengths. This is not a “one-and-done” discussion. Expectations evolve over time, and the family needs to recognize that and continually talk about what everyone wants for themselves and the business.
Beyond the more informal conversations, we have seen success with structured family meetings that are focused on the business. Having a consistent schedule for those meetings is important, perhaps twice a year, as is having a clear agenda and specific goals. It may seem overly formal, but it helps keep the meetings on track and everyone in the family engaged and aligned.
Family members with no interest in running the business
It is normal for certain family members not to want to join the family business. We each have our own passions in life, and those passions may not align with the focus of the business. That’s OK. Even if they don’t want to work day-to-day in the business, maybe they have interest in being an owner? That could involve making governance decisions or serving on a board of directors and hiring outside management to run the actual day-to-day business operations.
Family-owned business will often hire outsiders to be on their board of directors. So, it doesn’t have to be just the family. Again, it can be very healthy to bring in outside perspectives.
Ultimately, the issue becomes deciding what is equal and what is fair. For example, next-generation family members who will eventually run the business would likely earn a salary, but does that mean other family members receive an equal amount of equity or ownership in the business? The challenge is to ensure all family members are on the “same page” and believe they are being treated fairly when it comes to ownership in the business and distribution of profits. That can quickly become complicated and contentious, so it can be helpful to bring in an expert to navigate those discussions, such as a certified exit planning advisor (CEPA).
Finally, for those family members who don’t have the aptitude or aren’t ready to take on a role with the business, we have both found it helpful for families to develop a clear and robust set of processes and guidelines to ensure that any potential employee – family member or not – meets the criteria to be employed. Families can and should lean on those policies when faced with the difficult decision to potentially exclude or delay a family member from taking a role with the business.
Building your team with outside perspectives
Family businesses can be very insular in how they operate, which can be problematic when planning for a transition. Bringing in outside, independent professional advice early on in the transition process is very important.
Gather your trusted advisors and create the “dream team” you know you need. That team should be familiar with one another, highly compatible, and always act with your best interests front and center. That team could include your attorney, financial advisor, a CPA, a CEPA, a business coach, key management within the company, and more. These professionals can spot gaps and opportunities that could affect the long-term success of the family and the business, which can be hard for immediate family members who’ve not gone through the experience of a business transition to see. These professionals can also reinforce a decision or cause a family to reassess its plans. Both can be healthy outcomes and in the best interest of both the family and the business. Having a well-rounded group of advisors who each bring unique areas of expertise to support the family in pursuing a common goal can result in the best possible outcome for both the family and the business.
When there is no one to take over the family business
If there are no family members interested in or capable of taking over the business, it’s time for what can be a difficult decision. Does the family want to keep ownership, or is it time to sell and move on? Do you want to hire outsiders to run the business day-to-day and still retain ownership, or would you rather let go?
As both Erin and I have seen firsthand, if the company was started by a previous generation, the younger generation sometimes does not feel a connection to the business and may have no desire to continue on. In time, with the right coaching and exposure, that interest might develop. But if it doesn’t, it’s time to explore outside management or an exit.
To help position the business for possible exploratory discussions which the family may decide to engage in in the future (whether those discussions are with internal stakeholders, other family members, investment bankers, private equity firms, business valuation service providers, or otherwise), it is critical for families to develop a plan far enough in advance to allow the time needed to make the necessary improvements to the business. That can take a number of years, depending on the processes that need updating and the structural changes required. Again, it’s important to have the right team in place to guide you through the process.
Finally, preparing the next generation to take over the family business goes hand-in-hand with thoughtful estate planning. For example, we work with our clients to model what the impact of the expected sunsetting of the estate tax exemption threshold at the end of 2025 could be to them and their companies. As the potential for that eventuality is just a few years away, the time to do that planning is now.