Insights
Building a Legacy: Passing Down a Family Business Successfully
Preparation and communication are keys to a smooth handover to younger generations.
Every single day, about 10,000 Baby Boomers reach retirement age. Since 4 million of them currently own and operate private businesses, that means that in the next 15 years, we will see the largest transfer ever of private businesses to the next generation. Family-owned businesses are the mainstay of Main Street in America. Some, like Tyson Foods and Wal-Mart, even rise from their humble roots to compete in multinational markets. But closer to home, it's the small- to mid-sized family-owned businesses that are the real support structure. These companies are locally anchored and depend on future generations to continue their legacy. And how they transfer their businesses will have a large impact on the nation’s economy. Yet many are not prepared to do so.
According to the nonprofit Conway Center for Family Business, 40.3 percent of family business owners expect to retire, creating a significant transition of ownership in the United States. And it reports that less than half of those expecting to retire in five years have selected a successor.
Preparing yourself and your company
Transitioning your business, from one generation to the next, isn’t easy no matter what the size of your company. “Conducting a generational hand-down of a business can be stressful for owners and having a dependable partner is critical in the process,” shares Dennis Chuang, East West Bank’s regional director of consumer and business banking. “We focus on providing beyond banking services—our managers pay closer attention to understanding the client’s needs, and work closely with their accountant and attorney to ensure a smooth succession plan is in place.”
Preparation is key, recommends Justin Goodbread, a certified exit planner advisor and a certified financial planner (CFP), who specializes in helping business owners transition their business. “It’s not a simple procedure to pass along a business to the younger generation,” he says. “The senior and junior family members should have a business plan in place, and the help of an attorney, a CPA [Certified Public Accountant] to navigate taxes, insurance agents, and a CFP to help orchestrate the business transition. If you add a CEPA (Certified Exit Planning Advisor), you really have the best team.”
Goodbread, who also authors a blog, Financiallysimple.com, adds: “Families will most likely also have to cope with emotional and psychological issues that surface during a generational transaction. I believe a 10-year period is needed to successfully navigate a family business transaction.”
Without proper planning and professionals to guide you, the less chance you have of successfully transitioning a family business over to the younger generation. Research finds that approximately 30 percent of all family-owned businesses survive into the second generation and only 12 percent survive into the third generation. It gets worse: only 3 percent operate at a fourth generation or beyond. A strong mission statement and business plan, a clear exit strategy for the senior members, and an early-on commitment from the successors are all-important hallmarks to longevity.
Goodbread recommends younger family members earn control of the business reins on a day-to-day basis. “It has to be earned or merited,” he says. “The problems start when a junior takes over a senior’s position in the company without earning it, or wanting the position.” Another pitfall is poor communication between the two related parties.
Communication roles
Chuang says the cultural differences between a first- and a second-generation business owner can be an issue. “Oftentimes, the succeeding owner has a new approach to the business that focuses on growth, while the preceding owner is more conservative. This gap requires effective communication between both parties to develop a detailed roadmap to passing down the business without sacrificing its value proposition and legacy. [You need a] clear succession plan—changing hands is a process and it shouldn’t be rushed, especially for family-owned businesses. Having an organized structure in place on the roles and responsibilities of each family member is especially important,” he adds.
Tim Williford’s father, armed with a high-school diploma, a few years of work experience, and a Small Business Administration loan, started his contracting business, SPC Mechanical Corporation, in 1965. Tim says he wasn’t interested in a role in the company, but the pull of family prevailed. After college, Georgetown law school, and five years of practicing law, Williford returned to his roots. “I decided it was time to join the family business. Working with my dad and two brothers, I was able to carve out a unique, productive role for myself,” he says. “With my background as an attorney, I designed a system to negotiate multi-million dollar contracts. I also spearheaded rebuilding the personnel and safety functions within the company to more effectively serve a rapidly growing company.”
After a few years of working at the company, Williford, who went back to get a business degree, is no longer with his father’s business, and is now a private legal consultant to family businesses. Because he has a large family, the business continues to thrive. “My brothers have worked there their entire careers, and my oldest brother has been the president of the company for 17 years,” he shares. His father is also a proud grandparent to nine grandchildren. “Seven of them work in the business, generally in the field (as contractors), or in clerical positions. None of them have, as of yet, come into the business as equity owners or even as full-time employees—not yet.”
"Having an organized structure in place on the roles and responsibilities of each family member is especially important."
Williford, whose father is still with the company, says a generational transfer down the line will depend on management succession plans, and he has concerns over how a handover will occur. “I fear that the organization will not make it through another generation of family ownership,” he says. Why? “There are nine children in the third generation, but I don’t have a clear sense that any of them want to or are able to run the business.”
The importance of an exit strategy
Most people sell their businesses in order to retire, so when a family-owned business owner gives up his position as head of the company, an exit strategy must afford both for the success of the company and retirement security for the seller.
“Some business owners will ask their child [the successor] to take out a loan to buy the business outright, but if the younger child isn’t prepared, it may be that the senior owner will have to stay on the bank note,” says Goodbread. “You could do a structured buy-out, or devise a 10-year business plan, for the successor to receive a lower salary as he works to ‘earn’ the company, and in that way, it is a systematic buyout. Or perhaps a junior member owns 30 percent of the company free and clear and the bank loans the remaining 70 percent of the value of the business. In my line of work, that’s often how businesses are handed down.”
Williford agrees that a young successor should have “skin in the game.” He says, “I think making a child pay something reasonable for their interest in the business—it incentivizes a greater commitment on their part.”
In his experience working with families, the goal of an interfamily transfer is typically not about reaping a financial windfall. He explains that most owners have three goals to “agree upon a reasonable price for their interest in the business, structure the transaction in such a fashion that the buyer and family business are able to thrive after the transfer, and minimize the tax liabilities associated with the sale.” This is when a trusted financial planner should be on speed dial. “The largest challenge is likely to be how to fund the transfer of the business ownership,” shares Williford. “Does the family member who will be purchasing an interest in the company have the financial wherewithal to buy into the organization? Is the price the parties agree upon sufficient to fund the exiting member’s retirement or other post family business plans? There are a number of ways to structure these transactions, but, ultimately, it does all come down to money.”
Having a tax attorney is important, as the taxes related to family-owned businesses can be complex to navigate. “Giving a child the family business is going to have potentially long-lasting tax implications,” Williford says.
East West Bank advisors recommend reviewing an estate plan with a both a CPA and a family attorney, “particularly to analyze tax consequences,” says Chuang. “Income taxes can be minimized in certain situations when it comes to family ownership.”
Of course, if a patriarch or matriarch is already financially secure, and money isn’t a concern, family business is about creating a legacy. “Money isn’t everything, and the older and wiser business owners are, the more they realize that tradition and history play important roles in a company,” says Goodbread.
Chuang adds, “There’s tremendous value that comes with family businesses. It’s about working together towards a common goal—sharing experiences, pride, and passing down legacy.”