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Family-Owned Business Transition

Family-Owned Business Transitions: The Good, the Bad, and The Ugly

Like Snowflakes,  They Vary

Transitions in family-owned businesses can take many forms and be challenging endeavors. From a change of control, as the torch is passed from one generation to the next, to the much more life-changing sale of the entire business, each transition comes with its share of the Good, Bad, and Ugly.

Types of 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 and
  • Sale of the entire entity

Each type of transition a family-owned business undertakes has its own unique dynamics, issues, and benefits. So how do you navigate the “Bad” and the “Ugly” of a family-owned business transition in order to capitalize on the “Good”?

Outside Perspective is a Good Thing

As a marriage counselor can help a couple work through the dynamics of their partnership, obtaining an outside perspective can help keep all the actors honest in a family business, and focused on what course of action will most benefit all.

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 the infusion of new ideas or perspective. Many family-owned businesses suffer from a lack of perspective caused by generations who 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 the refrain: “Because this is the way we have always done it.” The definition of “it” in this scenario does not matter. The fact that ‘it’ has not been altered in the last 20 years, though, should be more worrisome than comforting.

Gaining outside perspective on how “it” should be done offers the benefits of a completely new vantage point.

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

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

[Editor’s Note: Check out “Families in Business: Mapping Out the Future with Family Business GPS Systems”.]

Room to Advance

A transition caused by the sale or growth through acquisition can also bring about another “good” for the business: opportunity for existing employees. Larger, acquiring companies may have better compensation structures, benefits, etc. Larger companies tend to invest more heavily in training, creating additional opportunity 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 create chances for employees 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 easily 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.

Challenges

While there are many positives that can be realized by a family business planning to embark on a transition, there are issues which 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 address these issues.

Egos

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

Anyone who is strong-willed enough to look the odds squarely in the face and say, “I am going to build 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 perspective should be balanced. The same “never say die” spirit that made the business leader believe she could succeed does not always serve the owner well in a transition. Combine a lack of outside perspective with too much ego, and you have found the bane of many investment bankers’ existence as they represent family-owned businesses in transition.

This deadly combo of ego and lack of perspective can lead to an over-valuing of the business, essentially killing a transaction before it can even get started. When an individual business owner is the leader of a family-run business, a lack of perspective may be more prevalent because everyone around the business relies on the business and the decisions of its owner.

If the owner does not have a balanced perspective on valuation, or has an ego-driven valuation, the owner may set the bar to purchase the business too high for honest consideration, as would-be buyers won’t believe they are dealing with a reasonable seller.

For example, a business owner reads that her competitor just sold for 8x EBITDA. Our owner believes she makes a superior product. Consequently, she feels her business is worth way more than 8x EBITDA — never mind the fact that the competitor has doubled the revenue and worldwide distribution! In this example, our owner is too focused on product, while ignoring that scale, size, historical growth, future growth opportunities, and leverageable cash flows all determine business valuation.

This same combination of ego and lack of perspective can keep fresh ideas from non-family members or younger family members from implementation, thus stifling innovation and the company’s ability to remain relevant.

Family Dynamics

Another challenge that can be downright “ugly” for a family-owned business transition involves the behind-the-scenes family dynamics. Organizations that are multiple generations of family ownership are often full of family members who do not always agree, or do not put the success of the business operation first.

[Editor’s Note: For more information on this topic, please see our articles, “The Importance of a Family Charter in Family-Controlled Businesses,” by Pierre DuPont, and “Solving Familial Business Issues: Putting the ‘Family’ in Family Business” by Carrie Rosenbloom.]

Sins of the Past

Past indiscretions are more onerous in a change of ownership transition than a change of management control (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.

Environmental clean-up, bad accounting practices, hidden or misreported income, and tax issues are just a few of the legacy issues that can create angst. These issues are more pronounced when a company’s stock is being sold, and can ultimately derail a transaction if not addressed early in the sales process. Thorough due diligence one can  ensure that these types of legacy issues are not a surprise, as they can become costly mistakes

The truth of the matter is, 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 responsibilities that come with running a business just exacerbate many family dynamics and other issues.

Any family business preparing for a transition of any kind should consult with a professional, such as the family or business attorney and accountant who knows the family and knows the industry. The family and trusted confidant should then go about finding an independent, third-party professional to run the transitional process. The third-party professional should lean heavily on the family-trusted confidant throughout the process. With the proper team in place, and a plan for addressing all of the “Bad’s” and “Ugly’s”, there is no reason why a family-owned business cannot transition to reap all of the potential “Good” that can exist on the horizon.

A Word about ESOPs

As explained in How to Use an Employee Stock Ownership Plan (ESOP) to Meet Business Succession Objectives, an ESOP can help an owner of a family-owned business sell, yet continue to be involved post-sale. This may be an attractive option from a variety of perspectives, including estate planning matters, as the family explores options for transitions.

[Editor’s Note: This is an updated version of an article first published April 2, 2015.]

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About Ervin Terwilliger

Ervin is the Founder and Managing Partner of Three Twenty-One Capital Partners, a boutique investment banking firm that specializes in Mergers and Acquisitions for privately held companies with a specific concentration in “Storied” Situations. Ervin has been featured in manufacturing industry magazines and online publications providing financial insight on various U.S. Industry Sectors and the…

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