Did you know that only one-in-four family businesses make it to
the second generation, and only one-in-eighteen make it to the third
generation?[1] Those are not very high odds. So, why is
the failure rate so high, and what can be done to increase your chances
of success?
Admittedly, within those failure rates is the general failure rate
for small businesses. 62.7% of small businesses fail within six
years.[2] The number of businesses failing increased by
61.3% from 1990 through 1991 alone.[3] Most family-owned
businesses can be grouped as either small or medium-sized businesses,
say from $1 million to $80 million in annual sales.
Causes of Failures
As with small business failures in general, family-owned businesses
that do not survive the next generation fail because of poor planning,
poor preparation, and a lack of separation between ownership and
management.
As an example, a family owned business I have known had always made a
profit. The business had 16 million in annual sales and was the dominant
California company in its market, that was and still is growing. The
company had been passed down from the father to his two sons. This company
should have been an excellent prospect for a new banking relationship.
However, the firm was not considered a good risk. Why? Because
the father had neglected the sons' two very different personalities
and competency levels, and he had not separated their ownership from
management. Each son managed a different part of the company. Both were
in total disagreement and did not cooperate with each other, and each
respective department actually worked against the other.
The firm still made a profit! Banks seeing the internal management
conflicts between the two brothers/owners feared the eventual undermining
of the company and refused to extend any credit to the firm.
Handling Transition
Transition questions can be summarized as how to plan, when to plan,
and how to divide the firm among several heirs. Transition planning
consists of clarifying and documenting the company's mission; choosing and
working with an outside, neutral consultant; developing a written business
plan; training any prospective management heirs; and tax planning.
This type of planning will greatly increase the company's chances of
successfully passing into the next generation. It is important that such
planning work be done long before it is expected to be needed. If the
current owner is in poor or deteriorating health, such planning should be
done as soon as possible. If a scheduled retirement is a factor, beginning
such planning ten years before such retirement is not too early.
Some family business owners have a concern about doing transition
planning early for fear that such plans will be outdated when used. All
plans are subject to change, but the basic work necessary to create the
plan in the first place will have been done. It is much easier to change
or modify an existing plan than to create one. Planning early also allows
for a testing or trial period, when appropriate, for potential management
heirs within the company.
The first step in the transition planning process is choosing
an outside advisor or consultant who can help organize the process,
brainstorm with the owner, research needed information, give an objective
viewpoint, and help family members reach agreement and avoid anticipated
or real conflicts.
The next step is writing a formal Mission Statement for the firm and
having the heirs sign it. The owner may already be quite clear on the
mission of the firm, but the heirs may not be and may not be in agreement
with each other. The success and strategy of other planning will depend
on this step.
Developing a formal Business Plan is the third step. The process of
developing a business plan forces the company to organize work flow and
information tools and clarify each key functional position within the
firm. The financial, equipment, inventory, and people needs necessary for
the firm to grow and change successfully over the next several years will
also be identified. Small Business Administration data clearly indicate
that businesses that do not grow fail at a much higher rate than those
that do.
The fourth step involves identifying who will inherit the business and
what role, if any, they will play in its management. Only those family
members who show strong maturity, judgment, and leadership qualities
should be planned for management. They should be brought into the business
at an early date to be trained and tested. If a family member doesn't
work out, there is then still time for change.
It is possible that no family members are qualified for future
management. In that case, outside professional management can be sought
and hired and the family members can still retain control and maximize
benefits through stock ownership. Some family members, while not qualified
for management, may wish to work in some non management function within
the firm.
Family members who are to inherit the firm can receive money in ways
other than working for a salary in the firm or participating in active
control over the firm (officer, board of directors). Such other means of
compensation will depend on how the firm is organized: as a corporation
or partnership if more than one owner.
The last step is tax planning. For this step, the business owner should
consult a good tax attorney. It may be to the tax advantage of the family
for heirs to acquire ownership stock through gifts over a period of years
or for the business owner to lend the heirs the money to buy stock. It
may be important for heirs to specifically limit spousal ownership
through legal agreements. Incorporation for purposes of stock as well
as protection from liabilities of the company may be advantageous.
Perhaps the most important immediate benefit from careful business
transition planning is the owner's peace of mind in knowing important
issues have been settled and everything has been done to ensure the
successful continuance of the business.
For further information on family business planning, contact James
Lansing.
