The Good, the Bad, and the Ugly of Family Business Transitions and Exit Planning

Strategies for Smoother Family Business Exit Planning and Succession

Family-owned business exit planning is challenging, whether an owner is passing the torch down to the next generation or selling the entire business to an outside buyer. How can a family business transition smoothly while avoiding conflicts, retaining and developing talent, or taking on investors?

Types of Family Business Transitions

The transitions that many family-owned businesses experience typically consist of any of the following types of changes:

• Generational change of control
• Introduction of new management from the outside, i.e., non-family
• Introduction of outside investors with equity rights
• Expansion into new markets/products
• Growth through acquisition
• Sale of the entire entity

Each type of transition a family-owned business undertakes has unique dynamics, issues, and benefits. So, how do you navigate the bad and the ugly of a family-owned business transition to capitalize on the good?

The Good: Growth and Improvement

Succession and Exit Planning Require Outside Perspectives

Just as a marriage counselor can help a couple work through the dynamics of their partnership, obtaining an outside perspective on a family business transition can help keep all the actors honest and focused on the most beneficial course of action for the entire family.

A company should identify and recognize the positives in a possible transition. Chief among these is the ability to obtain a new and more well-rounded perspective on the business by infusing new ideas or perspectives. Many family-owned businesses suffer from a lack of perspective because generations have worked only for the family business.

Ask a family-run business why it operates as it does, and do not be surprised to hear that it is simply the way they’ve always done it. The definition of ‘it’ in this scenario does not matter. However, the fact that ‘it’ has not been altered in the last 20 years should be more problematic than comforting. Gaining an outside perspective on how ‘it’ should be done offers the benefits of an entirely new vantage point.

Improvements and growth flourish when groups with different experiences and perspectives are compelled to collaborate. New ways of doing things are more apt to win buy-in when ideas mix the old and new guard. As they think and strategize about the operation’s future together, the next generation is better prepared for the leadership as they benefit from the wisdom and experience of their predecessors. The company is more likely to remain profitable if the family can achieve a balanced approach.

An outside perspective can be gained when a new generation with fresh ideas takes the helm of the business, when new equity partners join the team through acquisition, or through a sale of the business. New is not always better, but outside perspectives almost always lead to fresh ideas. When fresh ideas are permitted in exit planning, processes improve and growth accelerates.

Family Business Transitions Provide Room to Advance

A family business transition through acquisition can also bring about another good for the business: opportunities for existing employees. Larger, acquiring companies may have better compensation structures and benefits. They also tend to invest more heavily in training, creating additional opportunities for employees to learn new skills and advance within the company.

New opportunities for the best employees can emerge when a family business resolves to grow through acquisition. New products or business lines require existing staff to step up as the new company is integrated. A newly formed, larger business should create career advancement opportunities for the best people, as new projects and larger responsibilities give employees chances to shine in new and more demanding roles.

Diversified or superior companies with larger balance sheets can provide access to capital that smaller or more conservative family-owned businesses cannot quickly provide. This can result in further growth and opportunities for employees. Larger companies have a greater pool of employees and, thus, a broader and deeper pool of talent.

The best employees in a family business operation will see this as a positive, as they should flourish in a more dynamic and competitive work environment. Others, who may be less dynamic or capable, can view this transition as a negative and wither amongst the changing culture and pace.

The Bad: Overconfidence

While many positives can be realized through a transition, potential obstacles should be analyzed so that the success that appears on the other side of the bridge can become a reality. These challenges, bad or even ugly, can be solved so long as the leadership team is courageous enough to look in the mirror and take any action necessary.

Egos

Lack of perspective about the business or product is a significant issue in many family-owned businesses.

Anyone strong-willed enough to look the odds squarely in the face and commit to building a business has a strong personality and entrepreneurial spirit. One needs an ego to survive in business, and business owners have the right to brandish such pride or ego proudly.

However, such a perspective should be balanced. The same ‘never say die ’ spirit that made the business leader believe they could succeed does not always serve the owner well in a transition. Combine a lack of outside perspective with too much ego, and you will find the bane of many investment bankers’ existence as they represent family-owned businesses in transition.

In a family-run business, the owner is the leader. This deadly mix of ego and lack of perspective can lead to over-valuing the business. It can kill a deal before it starts. This can limit perspective, as everyone relies on the business and its decisions. Suppose the owner does not have a balanced perspective on valuation or has an ego-driven valuation. The owner may set the purchase price too high. Buyers won’t believe they are dealing with a reasonable seller.

For example, a business owner reads that their competitor just sold for 8x EBITDA. Our owner believes they make a superior product. So, they believe their business is worth far more than 8x EBITDA. And, the competitor has doubled the revenue and global reach! In this example, our owner is too focused on the product while ignoring that scale, size, historical growth, future growth opportunities, and leverageable cash flows determine business valuation.

This mix of ego and narrow-mindedness can block new ideas. It stifles innovation and the company’s relevance.

The Ugly: Poor Family Dynamics

Another challenge that can be downright ‘ugly’ for a family-owned business transition involves the behind-the-scenes family dynamics. Organizations with multiple generations of family ownership are often full of family members who do not always agree or do not prioritize the business’s success.

Sins of the Past

Past indiscretions are more demanding in a change of ownership transition than a change of management control from one generation to the next. When a business has been run for generations by one family, with little to no outside involvement, the opportunity for legacy issues abound.

Legacy issues can cause angst. They include: environmental clean-up, bad accounting, hidden or misreported income, and tax issues. These issues are worse when a company’s stock is being sold. If not fixed early in the sales process, they can derail a deal. Through due diligence, one can ensure that these legacy issues are not surprising, as they can become costly mistakes.

The truth is that all of the things that make a family-owned business transaction good, bad, and/or ugly are prevalent in family-business life. Business stresses and the increased business responsibilities just exacerbate many family dynamics and other issues.

Consult a Trusted, Third-Party Professional

Any family business exit plan must include a professional, like an attorney or accountant, who knows the family and the industry. The family and this trusted confidant should hire a third-party to run the transition process. The third-party professional should lean heavily on the family-trusted confidant throughout the process. With a good team and a plan, a family business can reap the potential good on the horizon. It should not settle for only some of it, due to the bad and the ugly.

We think you’ll also like:

1. Tips for Creating an Effective Family Business Charter
2. How Family Business Succession Planning Becomes Succession Implementation
3. Planning and Staging a Company for Transition

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Understanding Risk Management Basics for Business Owners
2. Keys to a Successful Sales Process
3. Conducting the Mediation

This is an updated version of an article originally published in April 2019 and updated on July 2, 2021.] 

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