Today we’re going to talk about generational family succession. Companies are sometimes passed on to the next generation. They can be the perfect vehicle for continued legacy transition. I grew up in a family business in the plastic extrusion and machining industry. I started working in the business when I was 14 I ran my own shift by the time I was 17. It was how I put myself through college, working four to midnight, and going to school during the day.
I love the business and grow up thinking I would be the owner one day. I went off to finish my master’s degree and when I came back, I found the company had been sold. Not the transition I expected nor wanted. Part of it was because it hadn’t really been discussed, but most of it was because, like most business owners, there was no thought or plan for a transition in place that addressed succession.
According to Forbes only about a third of family business survive the transition to a second generation. Fewer still make it to the third generation. Family business failures can essentially be traced to one factor. According to The Family Business Institute, that is a lack of succession planning.
Here are a couple of points I believe should be considered in evaluating family succession planning. Number one, the transition should be structured in advance and be thought of as a long term process. Just because you were born into a business does not make you the best qualified to run it. Family members should be honestly evaluated just like you would any other employee. Before being considered the recipient of the company, the family members must show a competence worthy of taking over the reins. That not only requires a succession plan but it requires a way to measure family member development and educational needs. This requires time, thoughtful milestones, and key performance indicators.
While it is important to be technically and tactically proficient on how the company operates. Family members also need to demonstrate leadership and managerial skills. If family members aren’t ready to take on all the roles necessary for success, consider outsourcing the gaps and work towards filling the voids through further training, education, or hiring practices.
Number two the company should be purchased by the next generation. The most common mistake I see in this form of transition is not treating the next generation as a true buyer for the company. If you were to ask most next generation family members that question they would unanimously agree the company should be gifted to them. That however does not create wealth for the parents. Family members should be required to buy into the company. They should have skin in the game. There is a place for gifting and the best structure actually has a component of both capital requirements and gifting.
Number three, have a system in place to handle conflicts and additional capital needs. Address in the beginning with a unilateral agreement or pact, how family members are to be treated. Establish for all members the terms and restrictions for a family member to be able to buy in, leverage, or transfer their shares of stock. Rules should be established in the beginning on how conflicts will be resolved.
Finally, establish the compensation and promotion policies of the company for all family members and how distributions will be handled in advance. In closing, transitioning your company to the next generation should be a thoughtful process designed to remove as many risks up front to avoid family conflict. There is nothing wrong with wanting to pass on your legacy to your descendants.
Sponsored in part by:
George Walden is a Managing Director and Principal in Corporate Finance Associates’ Houston office with twenty-five years experience as a middle-market investment banker. George is a member of CFA’s equipment industry practice group and an expert in the precision machining industry with special emphasis on manual machining, CNC precision machining, and gun drilling services and has been responsible for several industry-leading transactions. You can learn more about George HERE.