There was the story about two brothers starting a manufacturing company together. They got along fine, but problems arose because their wives hated each other.
The relationship got so bad they split the business in half and became competitors. One brother flourished, the other ended up selling.
Then there was another man who started an electrical distributor company. He eventually turned it over to his sons. The second generation was fine, but when the third generation took over, the new owners learned — too late — that one of the cousins “couldn’t find himself out of the room in the dark.”
“That third generation was a real tough hurdle,” says Tom Siders, partner with L. Harris Partners.
Finally, there was the father who started a manufacturing company in the Midwest. When retirement approached, he selected his oldest son to succeed him, even though his son was a forklift driver and his daughter was an accountant who was much more qualified to run the businesses.
Siders says the last group created a board of directors with non-family members who could provide unbiased advice. But the examples, he adds, shows how business issues spill into family life.
“Picture two circles,” he says. “You’ve got your family circle and your business circle. The closer those circles get pushed together, the more family issues affect business performance and the more business impacts family relationships.”
All businesses face problems and enjoy successes, but family-owned companies bring unique challenges, including dealing with that overlap.
Dealing with those challenges was the topic of a late-May workshop at the Minneapolis Club hosted by Rick Brimacomb’s Club E and Upsize magazine.
Doing it mostly right
While Siders and others shared some family business horror stories, Highland Bank CEO Rick Wall discussed the journey his family took when he and his two siblings started getting involved with the businesses owned by their father, Fred Wall.
Initially, Rick Wall says, none of the siblings intended to take over the family real estate and banking businesses. Each had already established successful careers. But as their patriarch was approaching retirement age, each separately felt pulled to come back into the fold.
His father, Rick says, had the foresight to know he needed some assistance, so he hired a consultant to help plan the transition.
While each sibling technically runs a separate business unit, they tend to be co-owners, sharing experiences and helping each other through difficult times. Initially, they formed a family council that met regularly for several years to discuss issues. That has since disbanded, but the siblings still conduct a weekly phone call.
When everyone is on the same page, he says, family members can really help each other out.
But “if somebody doesn’t understand what is going on, it’s hard for them to be with you when times are down,” Rick Wall says. “Those are things that really helped our family create and maintain some harmony.”
Planning and communication are key
The Wall family’s transition went relatively smoothly, but succession planning often is not handled nearly that well.
Sometimes business owners think they have a plan, but they never bother to communicate their wishes to anyone. One thing Wall recommends is that entrepreneurs make their plans and share them early so everyone is on the same page.
“You really benefit all generations if you’re planning your business transition in advance,” he says.
Panelists unanimously agreed that communication is an important factor in ensuring an internal family business transfer will work and often is a downfall when it doesn’t. Sean Boland, managing principal at DS+B CPAs and Business Advisors, says if a family does decide to transfer ownership to a second generation, it’s important that everyone knows their role, that compensation is discussed and that egos are in check. Communication is the key.
“It can happen at the dinner table,” he says.
But that communication needs to start early and it needs to include discussing intentions with the second generation, says Peggy DeMuse, a broker with Sunbelt Business Advisors.
“It might come down to son or daughter don’t want anything to do with the company once mom or dad are gone,” she says.
Wall says that while his family hasn’t done everything right every time, its efforts to communicate have been key to the successes it has had.
“In my experience, trust is only built through good communication,” he says. “If somebody doesn’t understand what is going on it’s hard for them to be with you during tough times.
Failing to plan is common
Whether succession will take place within the family or to a third-party, panelists say the owners need to plan ahead. Siders says he recently came across research indicating that a U.S. business owner will turn 65 every 59 seconds for the next 17 years. Yet many have not planned for retirement.
“Most have never thought about how to get out of their business,” he says. “These business owners don’t have a plan or they think they do but they haven’t checked with anybody.”
Siders says they should be more proactive because the process takes a couple of years.
It’s an ongoing discussion with Boland’s clients. His company keeps in touch with its clients three or four times a year to talk about various aspects of the business, including succession.
“We get a little bit more hands on,” he says.
Part of that planning, panelists say, involves seeking guidance from a team of tax, accounting and legal experts, preferably well in advance of finalizing a transaction.
Experienced business owners can do some of the work themselves.
“Those clients who are really knowledgeable about doing deals can get further down the process on their own, but there are some things you always want to think about,” says Lisa Holter, a shareholder with Fredrikson & Byron P.A.
Those issues include confidentiality agreements that protect proprietary information, which owners will want before a letter of intent is signed, she says. There may be legal issues surrounding the retention of key employees, appraisals and buy-sell agreements, and tax implications related to the structure of the sale.
You wouldn’t sell your car without washing it first,” she says. “Is your entity in good standing? Are your corporate records up to date? … Having the housekeeping done gives the impression your business is well run.”
Proactive transfer within the family
If the family business is going to pass to the next generation, there are several factors to consider, Boland says. Are the kids ready? If not, it would be good to get them training or to bring in upper level executives from outside who can help them run the company, either for the long-term or until they have the necessary experience.
“The kids are going to be paying you for the next 10 years, I better get them to be at the C-level,” he says. “Or, they can own it but they don’t have to show up every day, we’re going to have a council run the day-to-day operations.”
Compensation of family members also can become contentious. One solution is ignoring the family tie and using industry benchmarks to determine pay, Siders says.
Holter says if family members are not working in the business, they can receive distributions if it’s profitable, but they should not be paid.
“The decision should be made by the board as a group,” she adds. “That is treating your other employees fairly too.”
“You can still pay the kids,” Boland adds. “That’s not an issue. It’s just not called compensation.”
More generally, Siders suggests that business owners remember to try to keep business and family as separate as possible.
“Fair isn’t always equal and equal isn’t always fair,” he says. “There will be differences in ways the children are treated. The more you can do to pull those two circles apart and run the business like a business and try to pretend they are not family, the better off you will be.”
Selling outside the family
One-third of businesses don’t survive the transfer from first to second generation owners and another 50 percent don’t make it to third generation.
“It’s important that business owners understand that dynamic,” DeMuse says, adding that her firm often comes on board when owners have determined an in-family transfer is not the right answer.
“Those can be difficult conversations,” she says.
She works with the owners to figure out their options and evaluate the market to determine who would make good purchasers. That often could be an employee group, a competitor or a private equity group, she adds.
She says the business is often the founding generation’s retirement nest egg, DeMuse says. They may want their one or more of their children to take over, but they also have to look at their own best interests.
“We get one shot at this,” she says. “Selling to the first person who comes through the door is almost always not your best bet. It might be but you want to make sure.”
Maximizing value on outside sales
Out-of-family sales bring other issues, such as incenting key employees to stay and ensuring that if the exiting owner is a “rainmaker,” that person is phased out of that role before the sale.
Siders says employees can be signed to contracts and provided with incentives. Holter adds that compensation based on the performance of the company with a portion of compensation being based on individual goals is a good strategy.
“Anybody who is going to buy that business absolutely wants those key employees,” adds DeMuse. “The sellers often are worried … that the buyer won’t keep them. The buyer is actually worried that they won’t stay.”
Locking up important customers through a transition also is important, adds Boland. And so is having at least a rough estimate of what the company is worth. “If you don’t have a valuation go get one. It’s a cheap alternative to just picking the first guy,” he adds.
Maximizing the company’s value also takes advanced planning.
“It’s important that business owners understand that dynamic and plan for it in advance,” DeMuse says. “If they’ve gotten to the point where they decided for sure they aren’t going to pass it on they really need to understand what is the value of the business and who are the possible good purchasers.”
CONTACT THE EXPERTS
Sean Boland is managing principal at DS+B CPAs and
Business Advisors: 612.359.9630; sboland@dsb-cpa.com;
www.dsb-cpa.com.
Peggy DeMuse is a broker with Sunbelt Business Advisors: 651.288.1627; pdemuse@sunbeltmidwest.com;
www.sunbeltmidwest.com.
Lisa Holter is a shareholder with Fredrikson & Byron P.A.: 612.492.7082; lholter@fredlaw.com; www.fredlaw.com.
Tom Siders is a partner with L. Harris Partners: 952.944.3303; tom.siders@lharrispartners.com;
www.lharrispartners.com.
Rick Wall is CEO of Highland Bank: 952.858.4753;
rick.wall@highlandbanks.com; www.highlandbanks.com.
