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Family Owned Business Transitions

Family-Owned Business Transitions: The Good, The Bad & The Ugly

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 generally 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 envisions has its own 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”?

Outside Perspective is a Good Thing

A company should identify and recognize the positives in a possible transition. One of the first benefits is obtaining a new and more well-rounded perspective on the business and industry by the infusion of new ideas or perspective. Many family-owned businesses suffer from a lack of perspective caused by generations of management who have only worked for the family business. Ask family-run businesses why they operate the way they currently operate and too many of the responses will sound something like, “Because this is the way we have always done “it.” Whatever “it” is, doesn’t matter. The fact that “it” hasn’t been changed in the last 20 years does.

Gaining outside perspective on how “it” should be done moving forward is the ability to look at an opportunity or issue from a completely new vantage point. Opportunities for improvement and growth flourish when groups with different experience and perspectives have the opportunity to collaborate. Old and new guard, thinking and strategizing about the future of the operation, and challenges in the industry or regulatory environment can assist a company prepare the next generation or provide the appropriate balanced approach to allow the company to remain profitable in the future.

Outside perspective can be gained when a new generation, with fresh ideas, takes the helm, 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 leads to fresh ideas. When fresh ideas are permitted, processes improve and growth accelerates.

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 should abound when a family business decides 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 larger 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. While others, who are less dynamic or capable, may 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,” by definition, has a strong personality and entrepreneurial spirit. You need 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, when everyone else said otherwise, 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. Knowing something about this competitor, 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 sometimes downright “ugly” for a family-owned business transition involves the behind-the-scenes family dynamics. Organizations that are multiple generations into family ownership are often chock-full of family members who do not fundamentally get along or put the success of the business operation first. From a no-good cousin that doesn’t carry her weight, to a 5% owner that married into the company and has since been divorced, UGLY dynamics almost always exist. If you are going to navigate through the transition, you need to think through all your family dynamics, and who has the power to push the transition to completion.

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. You need to plan for these issues before your family-owned business begins a transition process. Thorough due diligence at the onset is a must to ensure that the possibility that these types of legacy issues are not a surprise. Such surprises can become expensive mistakes, killing a transition that would have ultimately led to any of the aforementioned positive outcomes.

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.

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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