Family businesses make up over 35% of Fortune 500 companies. According to Businessweek, “About 40% of U.S. family-owned businesses transition into a second-generation business, approximately 13% are passed down successfully to a third generation, while 3% survive to a fourth or beyond”.
We spoke with Christine Trumball, CPA and Founder of Coach the Climb, and Judi Cunningham, Founder of the Telos Group, about the key factors that cause family successions to fail. Christine and Judi have been advising family businesses for over 26 years. With their Certified Exit Planning Advisor credential, they understand not only the dynamics of a family business succession but how to help owners through the challenges that come with planning a successful transition.
1. Family Dynamics are Not Taken Into Account
32% of family businesses surveyed by PWC in 2012 were apprehensive about the transfer of the business to the next generation and 9% saw the possibility of family conflict as the cause of this apprehension. This apprehension leads to succession plans being pushed aside for as long as possible. An owner might know they want one of their children to take over the family business after they retire. However, they have no set plan for how to transition their business to the second generation. Failing to plan has led to 47% of family business owners looking to retire in the next five years not having a successor.
Family businesses offer their own unique stresses. Judi says, “Another big challenge that occurs in family businesses is that over time, often conflicts arise, differences of opinion on how to operate the business, who should do what, how the business should grow, etc. These disagreements often go unresolved which leads to an erosion of trust. Once trust has been damaged it is difficult to restore it. And in families this is sometimes worse than working with non-family because with our family members, we think we have a lot of leeway in our relationships, so we leave things unchecked for a long time. Or we think the relationship isn’t at risk because they are family. It is often hard to come back from these situations.”
Every family has a different dynamic and when organizing a succession plan, if these dynamics are not properly considered, the business is likely to fail. Christine shares, “It can go south very quickly. The best way I’ve learned to handle it is to allow everyone their feelings and to validate as much as possible. In the end, the founder has the final say in how it all goes down.”
2. Children Do Not Want to Take Over the Family Business
As a family business owner, have you actually asked your successor if they are interested in taking over the family business? Without having tough conversations about the future of their business, family business owners will fail to have a detailed succession plan in place.
Christine shares, “The nuances of a family business succession are endless. Most founders take the business very personally, especially when it comes to the kids taking over. Often I’ve found the founder has an expectation of one if not all the children taking over the family business. But then come all the difficult and emotional questions of ‘Do they want it?’ ‘Can they run it?’”
Judi highlights that no matter who takes over the family business, it must be of value to succeed. She says, “In general, there shouldn’t be an issue if the next generation doesn’t want to take over the business. Unless the business owner has not done a good job of preparing the business and they are unable to sell.”
3. Owners Do Not Plan For Their Exit
Some family business owners think since they want to transfer the business to their children, they do not need to make an exit plan. The Family Business Center states that 43% of family business owners have no succession plan in place. This way of thinking can be detrimental to the future successes of the business – as well as family relationships.
Christine recommends family business owners begin planning for their eventual succession plans, much earlier than you might think. She says, “Sadly, most don’t begin planning soon enough. A family business owner should begin planning for succession as soon as they have a child. Honestly! When the kids are children, founders must start asking questions. ‘Will they want to take over and if so, how will that work?’ ‘What if they don’t want it, what will I do with it?’”
Obviously, these questions aren’t going to be answered at that moment. However, thinking about how things will progress is far better than just assuming. Suddenly, the founder is in their 60s and a child has been working in the business for some time. This causes the child to have the misconception they will simply be handed the business at some point. That is never a fun place for either the parent or the child to find themselves in.”
Judi offers similar advice for family business owners. She shares, “Start 10 years earlier than you think you need to. Planning doesn’t have to be onerous. If you start earlier you can begin having conversations at a reasonable pace and then after a few years, you will notice how far you have come. Start having a dialogue with family members. Even when they aren’t involved. Talk to them. Don’t assume that because they aren’t involved that they aren’t interested. I hear so often from next-generation members that they wanted to be included in the conversations.”
4. The Successors Are Not Trained in the Business
Without planning for all possible exit options, family business owners run the risk of failing to have a qualified successor in place. Many family business owners face a similar issue when selecting a successor. Do I choose to keep the business in the family, even though the next generation is not qualified? Or do I choose a successor outside of the family and fail to continue the family legacy?
Judi shares, “One of the biggest issues is the lack of preparation of the next generation. The skills and competencies required to take over the business are sometimes hard to acquire easily, especially when leadership and functional development is not taken seriously. Transitioning practical product and service knowledge is the easy part of knowledge transfer. Next-generation members can learn those things from many people in the business. The really tricky thing to transition is all the tacit knowledge. Most business owners don’t really know what they “know” and what needs to be transitioned.”
Ensure that potential successors are familiar with the ins and outs of the family business and educate the next generation before they take over. Prior to handing over the reins to a son or daughter, they should shadow all departments in the company so they gain an understanding of every aspect of the business.
5. Children Think They Get the Business Instead of Having to Buy the Business
One of the most prominent problems Christine has faced in her 26-year long career advising family business owners is the potential successors believing they will simply receive the business from their parents. She says, “The biggest issue I’ve dealt with more often, is the founder expects some form of buy out and the successor child was unaware a purchase was required.” However, if both the owners and successors are not on the same page in terms of how the business will be transitioned, they are likely to experience numerous disagreements.
Christine shares that ultimately, the children know the business is a major source of financial wealth for their parents. She states, “It is important to ensure the next generation understands the business belongs to their parents and ultimately, it’s the parent’s wealth and future at stake. Usually, the kids want what is best for the parents just as much as parents want what’s best for the kids. But, if everyone is open, honest, and respectful, often, challenges can be worked through to at the very least, a good compromise.”
How Value Acceleration Helps Organize Family Businesses
The Value Acceleration Methodology is the perfect framework for family business owners to utilize to understand the value of their company. This methodology encourages business owners to know the real information around value versus assumptions around value.
Christine shares, “The simple process of asking thought-provoking questions and having everyone involved at the same table opens the entire process. Now, everyone is on the same train going in the same direction. If you can eliminate the drama that can come with family succession, you can truly focus on growth and value acceleration. This methodology promotes and somewhat forces, open communication, planning, and education.”
Judi says, “The Value Acceleration Methodology is an excellent tool for family business owners as it can force the business owner to have a more objective look at their business. Business owners often are so emotionally caught up in their business that they cannot see it objectively. This is why when they get a valuation done they are sometimes completely shocked. They need to use this process much earlier than they typically start so they can position themselves for success. This methodology is also a fantastic tool for the next generation as it will help them learn even more about creating a valuable operating business.”
Learn how a Certified Exit Planning Advisor can help you successfully transition your Family Business to the next generation. Find a CEPA here.
