What’s going on in our Family Businesses?

Why do a large percentage of family businesses fail when transferring to the next generation?

BMW, Samsung, Fisher and Paykel, Michael Hill International, Smith & Caughey and Walmart are examples of highly successful multigenerational family businesses. Although around 75% of businesses in New Zealand are family-run, the statistics paint a sombre picture for the success of these family businesses surviving into the next generation. What makes these businesses so susceptible to failure?

Although the reasons are varied, you will find several common themes.

Lack of involvement and business education of the younger generations

How can you expect your successor to take over and run your business successfully if you haven’t spent time training him or her?

  1. The failure to actively educate the younger generations around finances and business concepts have resulted in many children being ill-prepared to manage money or to step into a business management role in their parents or grandparent’s business.
    1. By not nurturing a sense of responsibility, history and core family values the next generation lack the understanding of why.
    2. With no education in the Family Business, it is more likely they will have poor decision-making skills. The result is that the family’s capital can be put at significant risk and ultimately the business could fail.
    3. Planning to move the family business between generations will have a greater chance of success if you work for a year or two with your successor(s) before you hand over the reins.
    4. There are excellent benefits for a family business if your children are encouraged to experience working in other unrelated companies, where their abilities can be grown away from the family.
Neopotism

Families who continue to promote unqualified or under qualified relatives into positions of power just because they are members of the founding family are also on a fast-track to failure.

  1. Rather than making your own decisions on who will run the business and then announcing it to the family, a technique we have found to be one of the surest ways to sow family discord, it would be wiser to look at your family realistically and plan accordingly.
    1. Examine the strengths of all possible successors as objectively as possible and think about what’s best for the business.
    2. Do your children or nieces or nephews have the business skills or even the interest to do it?
    3. Consider what happens if there are no family members capable of continuing the business. If this is the case, then your plan needs to focus on the sale of the business at a future point or at least an independent CEO reporting to a board which also contains independent, experienced directors.
    4. The moral of the lesson is to involve your family in business planning and succession discussions.
Case Study 1

One family business we were working alongside was in the process of transferring the management between generations. There was an open dialogue between the generations to ensure that the “child” wanted to acquire the business and understood the financial ramifications.  It was vital that it was the child’s wish to purchase the business and not that of their parents which were forced upon them or imputed to them.

In this case, the child’s principal concern was financial, i.e. what happens if they could not maintain the business and as a result not be able to service the repayment of the debt to the parents?  This can be handled so that perhaps the debt is limited recourse, but the negative is that then removes a valuable asset for the other children.

Typically, the family business represents a very high percentage of the wealth of Mum and Dad when we come to look at succession issues.  If they want to transfer it to some but not all of their children, then it is important that equality between the children is considered.

A lack of family governance structure

Governance issues are avoided by many families because it forces them to confront the possible need for significant changes in how they manage their business. Without a robust framework, family business are easy victims to internal discord and ownership issues down the track.

  1. Governance structures formalise precisely who does what and how.
    1. Having a structure provides a distinct line between family and business, separating family control from the daily management of the business.
    2. Independent, experienced directors and advisers need to be part of this to provide an independent, removed and unbiased perspective.
Failure to start business succession planning early.

By delaying retirement and avoiding putting in a succession plan in place can be further exacerbated by an unexpected illness or sudden death which provides real risk to the business and the family’s financial health.

  1. Planning long term is good. The longer you get to spend on succession planning, the smoother the transition process is likely to be. Consider five or ten years in advance at a minimum.
    1. Proper succession planning can take years whether you bring in outside managers or train up an internal successor.
    2. Succession must look at both planned and unplanned scenarios, the later including situations where a parent or senior family member meets an unexpected and untimely death or disability long before their planned retirement.
Trying to be fair to all 

Get over the idea that everyone must have an equal share or even an equal say. Just because you are a family member doesn’t mean you will get a top job in the company unless you are qualified and competent to do it.

  1. In any business, management and ownership are not necessarily the same thing. For example, you may decide to transfer management of your business to just one of your children but transfer equal shares in the business to all of your children, whether they’re actively involved in operating the business or not.
    1. But trying to be “fair” is a nice idea in theory, but it may not be in the best interests of your business. It may be fairer for the successor(s) you have chosen to run the business to have a larger share of business ownership than family members not active in the business. Alternatively, it may be better to transfer both management and ownership to your chosen successor and make other financial arrangements to benefit your other children.
    2. Another option would be to bring in professional managers to run the business while retaining ownership in the family as a whole. Many successful multigenerational family firms do this as it allows them to focus on diversifying and managing their wealth as well as making it easier to navigate generational transitions.
Case Study 2

In this example, the family business was a farm where the “child” that worked the land had got into the ear of Mum and Dad’s independent trustee who also happened to be his chartered accountant.  The parents, owners of the land and farm operation, were convinced to sell it to the child at a low price with extremely concessional repayment provisions including that no repayment of the principal was to be made for ten years.  While there was interest to be charged, again it was concessional.

A large part of the value of the farm was being transferred to a child without equal consideration for the other children.

At the last minute, Mum and Dad did realise there could be an issue and arranged a family conference where the whole exercise was sprung upon the other three unsuspecting children who, to say the least, were somewhat gobsmacked.

Epilogue….In a similar situation, we came across recently a “child” had been sold the family farm at a significant concessionary value. Two years later that child then turned around and sold the farm at an exorbitant profit. The sale and the significant profit made on the sale fractured the family as the first sale had no clawback provisions for subsequent sale profits built into the agreement as the expectation of the parents and the stated intention of the child was to farm for life

When you are dealing with children and potentially transferring an asset to one of them and not the others, the critical concern is to ensure that there is a perception of equality and fairness.  Even if there is to be some benefit for the child, in recognition of past service, endeavour or the like, it is essential that this is discussed openly and in a proper forum within the family or it has the potential to divide the family and poison relationships for the future.

Succession will continue to be one of the principal issues for families owning businesses.  With many baby boomers reaching retirement age, what they do with their business is increasingly weighing upon their minds.  Do they sell the business to third parties?  Do they transfer it to the next generation?  What should they do with it?

For most, there is never one single right answer to this but what is important is to work through a process so the family can see the options and understand the implications of each. 

As always, we are here to assist.

The Brave New World – What changes are likely from our Labour / New Zealand First Government

The past three months has taken New Zealand on a political roller coaster with the result being a new minority government with a new policy and social agenda for the next three years.  In our view, it was always a strong possibility that New Zealand First would go with Labour, and the exclusion of the Greens from the government is political suicide as they sit once again outside of the government and will have little to show for the same level of support that New Zealand First gives to Labour.

Labour identified a number of priorities it would be addressing in its first 100 days and is set to wind back much of the deregulation National introduced. Change is coming and what is going to be interesting is what does this change mean for you as typically a business owner in the context of the post-election New Zealand.

 Taxation
  • The promised tax cuts will not occur.
  • We would expect the top marginal individual rate and the top trust rate to increase to at least 36% and be aligned.
  • The Brightline test for residential property will extend from 2 to 5 years. What will be interesting is which properties this applies to, ie existing own properties or those bought after the law change is made.
  • A tax working group will be put together and involved in public consultation. Its report back will affect taxes from 2021 on.  It will focus on no increases in taxes, and no inheritance tax or other taxes on the family home.  That still does leave the door open for inheritance tax or other taxes on other assets and investments.  We think capital gains is unlikely as a tax, but time will tell.
  • A 12.5% tax back incentive for research and development.
  • Continued focus on multi-nationals. Nothing changes from the old government here and the BEPs programme will continue.
  • A key one will be the removing of the ability to use negative gearing losses. The question is exactly who this will apply to, ie company groups or just individuals claiming the losses in their tax returns?
  • An Auckland regional fuel tax for the Auckland Council and is expected to be implemented within 6 months.
Land
  • Foreign ownership of land is to be subject to greater restrictions and greater involvement of the OIO. The concern here is the OIO is already significantly overloaded and has to date been largely a rubber-stamping exercise anyway.
  • A rent to own scheme for low-income workers to assist them to buy their first home.
Other
  • Expect labour law reforms. Now is a good time to get rid of underperforming staff while you are still able to.
    • The 90-day trial periods, introduced by National in March 09, will be replaced with new trial periods and will require reasons for dismissal and justification.
    • Reinstatement will be the primary remedy for employment grievances.
  • The increase in the minimum wage to $16.50 from 1 April 18 and expectations for it to be moved to over $20 within the next 3 years.
  • Changes to paid parental leave increasing to 26 weeks per year, taking effect from 1 July 18.
  • Immigration restrictions targeting students and low skilled workers.
  • Superannuation to remain at age 65. With the Government resuming contributions to the New Zealand Superannuation Fund to help safeguard Universal Superannuation at 65.
  • Buy Kiwi made preference by the government.
  • Focus on regional development and rail networks, both within Auckland and in the wider sense.
  • A review of the reserve bank with an aim to lowing the New Zealand dollar.
  • Expect inflation to increase with particularly the increase in costs as a result of some of these and the added burden of the increase in the minimum wage. It can only push inflation up.

 

On the whole however, there is much for business and our clients to be happy with and excited by in terms of what Labour and New Zealand First have promising.  It creates opportunities in itself and you need to quickly focus on these to understand where they will be.

If we couple this with the trust law reform, which will still come into effect next year, even under a Labour government, it is going to be a busy year or two as we all get used to significant change in our existing environment.

As always, the Covisory team is happy to talk to you about your needs, now and going forward.  If there is anything we can do to help, please call us.

Please note that the information in this article is for informative purposes only and should not be relied on as legal advice. 

Reflection: A Tool You Need

With another 31st December rolling on by Covisory turned 10 years old. Over the holidays my youngest 20+ child quizzed me on whether I had any resolutions for 2017. This led to some interesting conversations on the concept of reflection.

I’m not one of those people who each year makes resolutions. I freely admit that the cynic in me watches to see how long the resolutions of others will last in the coming year. We all know the routine firstly you fall for the line that it’s a new year so you need to make resolutions. You start with good intentions but as life encroaches, those resolutions either drift off into the too hard basket or are just forgotten.

These easy to make, on the spur of the moment, influenced by what is the latest trends are doomed to fail. Why? New Year Resolutions have on the most part no meaning. People expect to fail with them, there are no consequences on them if the result is not achieved.

Making resolutions is not the problem it is the built-in expectation to fail. If we live our business and personal lives without reflecting on our past experiences, we are bound to make the same mistakes. We cannot break through barriers by doing more of the same. Not only must we invest in action we also should work on deep and sustained reflection on an ongoing basis and not just once a year. Reflecting will not solve all the problems but it will help move you a tiny bit closer.

Let’s face it life is busy these days. We are all guilty of spending a lot of our time chasing the immediate reward, the near-term “goal” — in short, the expedient and the convenient. We are all obsessed with doing. What we are not so good at is stopping and taking a hard look at Why and What we are doing. Reflection may be a tool talked about in education but there is little application when we move into the workforce. Why not – are we afraid of what we will find?

If a business is not doing well it is easier to cast blame for problems on difficult customers or an investor. Alternatively, maybe we look to blame the government bodies regulating the industry, or competitors and who hasn’t blamed the computer or an application for our failures? We do not automatically ask in a situation what am I doing wrong or right? How could I improve? Our culture allows us to avoid personal responsibility – we are guilty of not owning problems or to finding ways to solve them.

If we do not take time out of our week, month or year to make room for the deep questions and thinking we fail to grow. We opt for the distracting items that fill our time. It is not about working harder. We need to work smarter and this means having the time for reflection so that we can make changes and improve on past performance.

Breakthroughs to a product, a company, a market or industry do not come from being busy and jumping between multiple tasks. Change comes from an opportunity to have structured periods of reflection. We need time to ponder, to question, to model, and to research. Reflection drives experimentation and sparks innovation. By reviewing the processes and results we add to our understanding, gain insight and allow companies to respond to change. By taking the opportunity to reflect we can make our businesses radically better.

In today’s culture, we as individuals and businesses are engineered to Do, we have not been encouraged to reflect. To add reflection to our lives allows us to embed concepts and theories into our practices. It fosters constant thought and innovation that provides the means to allow us to grow as both individuals and professionals.

Within Covisory ‘Reflection’ is a core component of how we operate both internally and when we work with customers. If you need assistance, we are always happy to support you with this process. Please Contact Us. With a new year before us let 2017 be the year to not only learn from our experiences but regularly reflect on those experiences.

I will leave you with the words of Margaret J. Wheatley an American writer and management consultant:

“Without reflection, we go blindly on our way, creating more unintended consequences, and failing to achieve anything useful.”