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.

Family Business ~ Insight | Succession: The Good and the Bad

Over the past fortnight we have worked on two succession planning issues for families where a business is to be transferred to one child out of four in each case.

In the first situation the family is doing this as an open discussion and making sure that the child actually wants to acquire the business and understands the financial ramifications.  It is important that it is the child’s wish to acquire the business and not that of their parents which is forced upon them or imputed to them.

In that case, the child’s principle concern is financial, ie what happens if they cannot maintain the business as a result so as to enable the repayment of the debt to the parent?  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.

In the second case it involved a farm as opposed to a family business but the logic is the same.  In this case 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 very concessional price with extremely concessional repayment provisions including that no repayment of the principal was to be made for 10 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 3 unsuspecting children who to say the least were somewhat gob smacked.

When you are dealing with children and potentially transferring an asset to one of them and not the others, the key 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 very important 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 over the next 10 years.  With many baby boomers reaching retirement age, what they do with their business is increasingly weighing upon their minds and keeping them awake at night.  Do they sell the business to third parties?  Do they transfer it to children?  What should they do with it?

There is never a right answer to this but what is important is work through a process so the family can see the options and understand the implications of each.  As always, we are here to assist.

Family Business ~ Insight | The Roles of Family Business in our Economy

At Covisory we are focused upon and dedicated to family business.  We do some work for corporates but our primary focus is on family businesses and their owners.

In our experience family businesses are more innovative and often able to out perform larger more financially resourced businesses.  This is because they are nimble on their feet and able to adapt and innovate quickly.

However, family businesses still have their own challenges.  There is always a need to balance the family and business issues and we see that in the parallel planning process that we so often go through with our clients.  If a family business makes $100 of profit after tax, there are going to be a number of competing demands on that profit.  These can range from paying the owners a dividend, to reducing debt within the business or privately, to funding capital equipment purchases, working capital or research and development.

The parallel planning process is about looking at where a family is going with the business and where the business is going itself and making sure that the two are in alignment.  Often it involves a recognition from the family that they simply cannot strip all of the profits out of the business, or from the business that the owners are entitled to a fair return on the money they have invested, particularly if they are not financially independent from the business.  This is an important challenge for owners to make sure that all their wealth does not remain tied up in a single risky asset being their business.  We have all seen too many businesses fail when Mum and Dad are getting close to retirement so it is very important to ensure that Mum and Dad put other savings away along the course of the businesses life to fund their retirement.

Maintaining the family control of the business is also important.  However, in our experience there has been a greater recognition that especially for higher value businesses often the best answer for a family is to sell it at the appropriate time and deal with the family by looking at how that money is distributed not only between Mum and Dad, but the children as well.  This could include both participating and non-participating children within the business.

Grooming a business for sale is not a 5 minute job.  We remain frequently surprised at how often owners of businesses think they can simply put their business on the market, and it will be sold and they will be retired in 3 months.  While this might be achievable, in our experience too often they will leave too much money on the table and ignore a number of viable alternatives.

The sale of a business is a process, it takes at least 2 – 3 years if you want to maximise your value out of it.  We normally like to look at all your key contracts and ensure that they are well documented and in place.  A good information memorandum is a must but it is also important to make sure that the business becomes more independent of Mum and Dad, the private costs are removed, that financially the results are optimised and that even a financial audit is obtained on an annual basis from a reputable accounting firm.  Whether that needs to be a big 4 or an international firm depends on the size of the business and who the likely buyers are.

In some cases we will work with owners of businesses to sell down a part of their business and take some money off the table.  This might lead to a further sale or listing in the future, or in some cases it may simply be the sale of a part of the business to a long term co-investor.  Either way, it is a good way of Mum and Dad getting some money off the table that is safe and can provide for their retirement.

For many businesses, Mum and Dad live the dream that children will come into the business.  While this is a worthwhile dream and should not be dismissed, it can cause tensions within the family particularly if that business ends up going to the child that came in, yet other children were not given the opportunity or appropriate financial compensation.  The passing of a business to a child or children can actually blow families apart if it is not handled properly.

More than likely, there are also issues from a hand over view point as often Mum and Dad simply don’t want to pass the business on to the children and the handover is haphazard and problematic.  Careful succession planning is needed to pass a business down through the generations.

So why are we stating all of this when it is probably the obvious, simply because in our experience it is obvious but sadly most family businesses don’t actually stand back from the business and look at whether they are running it to take cash out of it, or to build up its capital value and sell it ultimately.  The business may be the goose that lays the golden egg, but in reality you have to look after the goose and not make it lay too many eggs or it may suffer ill health.  Also, if you want to sell the goose in the future, you need to make sure it is in good health and producing as many eggs as possible.

At Covisory Partners we frequently work with business owners to help them maximise their exit value on the business, but more importantly to go back a step before that and look at what the real options for their businesses are.  To often families will not know what to do with a business and will end up selling it only because they met a business broker or private equity firm that tells them that’s the best thing.  Those firms are not necessarily interested in maximising the value out to Mum and Dad.  Whereas at Covisory we will look at all the options for you.  In our experience, too much money is left on the table by families exiting their businesses.  Will you make the same mistake?