Family-owned businesses are a force in the U.S. as they comprise 80-90% of all businesses, employ 62% of non-farm workers, contribute 64% to gross domestic product and are responsible for 78% of new job creation. These stats are all according to reports published by J.H. Astrachan and M.C. Shanker.
Over the next 10 years, a huge transition will be taking place as 40% of current family-owned firms expect to have the CEO retire or exit the business. Yet according to surveys by Mass Mutual, only 45.5% of those expecting to retire in the next five years have selected a successor. Those who expect to exit in 6-11 years are further behind with only 29% having chosen their new leader. Even scarier is the fact that only 31.4% of those firms have an estate plan other than a will, according to Mass Mutual American Family Business Survey 2007.
In corporate America, the average CEO tenure is only about six years yet family owned businesses often average 20 to 25 years. That creates two challenges as changes in technology, consumer behavior and business models can affect the profitability and even the survivorship of a closely held business. The other issue is that with such a long tenure, the CEO (often a founder) has a wealth of knowledge about the business, unique skill sets and imbued understanding of the intricacies of the various facets around the business. These are often difficult to pass on or replicate.
Family Business Transition or Sale
The old adages all too often hold true. First you may have heard “from shirtsleeves to shirtsleeves in three generations.” Another is “the first generation starts the business, the second builds it and the third kills it.” Only 30% of businesses successfully transition to the second generation. The success declines to just 12% for the third generation and less than 3% survive the fourth generation and beyond. (For related reading from the author, see: Keep the Family Business Going With a Succession Plan.)
The family patriarch or matriarch is great at running a business but all too often is ill-equipped to address the myriad issues surrounding either an outright sale or a transition to the next generation. Family members may or may not have the appropriate skill sets to take over the role as leader. Parents want to be fair to their children, so how do they allocate equity and other assets to each of their children? Do the children have cash to actually purchase the business? Can the parents afford to give most or all of the business equity without risking their future financial security?
Under-estimating taxes is another all-too-common blind spot for family-owned firms. While present estate tax rules provide each individual the ability to pass on $5.34 million in lifetime gifts to others, this may or may not be enough to allow the equity and/or the parents’ total estate to pass without federal estate taxes. Anything over this amount will be subject to a steep federal estate tax, typically 40% or more, and some states may want their share as well. (For related reading, see: Treasury Looks to Close Family Business Estate Tax Loophole.)
Building a Transition Team
Business owners should build a team of trusted professionals to assist them in navigating the future transition of their business. While owners have spent their lifetime building this wonderful asset, unfortunately many fail to take the time and steps needed to ensure a successful transition. No one wants to think about dying or perhaps their children fighting, not being up to the task of taking over the business or the possibility that children may not want to come in to the business at all. The next generation may face their own personal challenges such as divorce or special-needs children which can affect their ability to function in the business. (For related reading, see: Has Nepotism Ever Worked?)
A team of advisors is the best way for families to ensure they are taking a measured approach to transition and doing what is best for all concerned. Appointing a family business advisor as the coordinator of other experts and to help explain the steps, orchestrate the execution of the plan and shepherd along the transition is a great way to begin. (For related reading, see: 7 Steps to Selling Your Small Business.)
The other key players are typically an attorney (each generation should have counsel), an accountant, a business valuation advisor, a financial advisor for liquid assets and a CFO or internal controller to assist in execution of recommendations for the business.
Whether the best course of action is an outright sale or a transition to some or multiple family members, transition takes time and work. Allocating time to this is often a low priority for business owners who love what they do and are reticent to retire. However, preserving the asset you spent a lifetime building should be a priority. Death and ill-health often strike unexpectedly and leave no time for a smooth transition. Take the time to build the team, think about what you wish to do, and whether your next generation has both the desire and skill set to take over the enterprise.