The transition of ownership in a family-owned small business doesn’t have to be stressful and emotional, but it can quickly tip in that direction if it isn’t thought through in advance.
The succession planners and financial professionals who help guide business owners through this process say one of the critical steps is to start early, before the unexpected happens and a sudden transition is required.
Janice DiPietro, the Rhode Island-based founder and CEO of Exceptional Leaders International, a Boston firm that consults on business effectiveness and ownership transitions, recommends as much as five to seven years of lead time.
This allows a thorough examination of what the owner needs post-transition, what the business itself needs in a new leadership team and what family members who are not going to be involved should receive.
Unfortunately, this isn’t the norm. A variety of surveys of family businesses have shown that while an overwhelming majority of business leaders agree that planning for succession is important, few are actively doing so.
According to the Conway Center for Family Business, of Columbus, Ohio, only 30 percent of family businesses will successfully transition to the next generation, although 70 percent of such business leaders express that as a desire.
In a survey of attendees at Family Business Magazine’s 2018 transitions conference, 96 percent said succession planning is “extremely important,” but only 13 percent had a formal plan in place.
‘Balancing emotions while developing an objective valuation is tough.’
JOSEPH CONFESSORE, The Washington Trust Co. senior vice president
The business surveys reveal something about owner psychology.
“Everyone thinks it’s really important, and then a very small percentage do it,” DiPietro said. “So why? The why is this is really hard stuff. It’s tied up not only in the family, but also in thinking about the business. For the existing leader … it’s always very difficult.”
Transitions in family-owned businesses do not always end in the next generation of the family, or “Next Gen,” running it. It’s becoming more common, she said, for the next generation to step out of the family business. Owners who are starting the transition process need to know their options.
One recent client is a small manufacturing company with less than $10 million in revenue, and six owners. “The company is owned by six siblings. Each owned the business equally,” DiPietro said.
In this family’s next generation, no one had an interest in continuing to run the business. The current CEO, when she started working with DiPietro, assumed her only option was to sell. She was the only family member working full time in the business.
“In this case, they decided to maintain their ownership of the business … and we helped them to bring in a CEO. The question is not always transitioning to sell the business.”
In a transition to a family member, the valuation of tangible business assets should follow the same process as if the company were being sold to an independent third party, said Joseph Confessore, a senior vice president at Westerly-based The Washington Trust Co., in an email.
However, every family business has a different dynamic, he said, and usually there is an emotional factor for the owner, as well as other family members.
“Balancing emotions while developing an objective valuation is tough,” Confessore wrote in an email. “The owners typically use the third-party data as a base case, then adjust depending on their unique situation.”
The issues surrounding transitions in family businesses can become complex, very quickly, depending on the structure of the company.
The easiest may involve the parent-to-child transition. But often family businesses are owned by siblings, or partnerships of other relatives. “It gets very complicated,” DiPietro said.
When the business is going to be passed down to an adult child in a nuclear family, the issue of how to be fair to other family members should be considered. The larger context of estate planning and tax considerations should be discussed. When the business, as an asset, makes up the bulk of the estate, its transition to one person or a few people in a larger family can create tension.
“Usually the business is one asset of the estate,” DiPietro said. “The current owner will look at, with their tax adviser, all the elements of the estate value. The business planning will be part of that. How do they want their assets to be distributed?”
If the business, for example, makes up 90 percent of the value of the estate, then an owner’s decision to leave it to one sibling – out of two or three – can create issues.
The transition plan needs to be considered deliberately and then communicated. And these are difficult conversations, at times.
“This is one of the biggest issues for family businesses,” she said. “If the transition is not adequately planned and communicated, you can see how it can lead to siblings feeling, ‘Daddy liked you better.’ Or ‘Why did you get the business?’ ”
Mary MacDonald is a staff writer for the PBN. Contact her at Macdonald@PBN.com.