If we’ve learned anything from 2020, it’s that our best-laid plans don’t always turn out. As the great philosopher Mike Tyson once said: everyone has a plan until they get punched in the face.
What is your plan for exiting your Orange County family business?
You need to have a direction.
For many, it’s moving the family business towards a sale. But for many others, they want to see their work passed onto subsequent generations, and to provide an ongoing source of supply and fulfillment for their children.
That’s who I will address today.
Passing Down Your Orange County Family Business
“You can always amend a big plan, but you can never expand a little one.” -Harry S. Truman
According to the most recent data I’ve seen, only 34% of family businesses successfully pass to the second generation, and only 13% make it to the third generation. Those aren’t great numbers, considering that many family business owners (including many in the Orange County area) try to pass down their businesses to their children.
Those who are successful balance three different dynamics well: family, business and ownership — each of which have different goals and objectives, as well as rules of behavior.
Things that can be talked about with ease around a business roundtable might not go over well with family, and the kind of intimacy present within a family structure doesn’t always lend itself to wise business decisions.
So, let’s take a look at each of these areas and see how they should be approached.
The Family Role
For most Orange County family businesses, this is the most important dynamic to consider. The challenge when it comes to succession is that the older generation would want to pass on not just business sense, but also the particular ideals by which the family seeks to operate the business.
To do so, each generation has to be actively raised to the level of “peer” by the actions and attitudes of the generation before them. There are many ways to go about ensuring this happens, but my suggestion is that proven family character must be required for leadership in the family business, and some kind of outside advisory board (whether formal or not) with at least two outsiders can help keep family values intact.
The Boundaries of Business
For a business to be successful, it has to be able to make quick decisions and create change when needed. Because it needs to make a profit long term, it must (by definition) be market-oriented — which means not family-focused. As a result, family members can’t be treated equally. If one family member works part-time, while another chooses to work full-time, plus nights and weekends, the monetary incentive needs to be in proportion to the profit each brings into the business.
If a business is passed from one member of the older generation to one member of the next generation, many of these issues can be postponed or ignored. But if the business moves from a single owner to a partnership of siblings (and then to a set of cousins who are shareholders), the business must continue to run like a business — while simultaneously dealing with a possibly wicked brew of family tension. You need to plan for: leader selection, the role of non-employees, conflict resolution, and the shared control of different family branches.
Further, those actually running the business must also be trained in the financial responsibility of management, preferably before the change of ownership. There will need to be policies for fair dividend distribution for those not employed. Again, it’s a very good idea to involve outside advisors, and not just during the succession period itself.
Who Owns It?
As soon as a family business is divided into shares, there will be those working “in” the business and those who merely own shares in the business. As a result of this, you need to make a predetermined plan for buyouts, professionalized management, mentoring, and family council meetings.
The ownership component is probably the easiest to transition and transfer, but it won’t achieve your succession goals without a solid family structure AND a healthy business structure in place.
Family businesses are complex, and there are many things to consider. But to do it right, you need to make sure you are training family business leadership well, that business decisions are made for business reasons only, and that ownership transfers are made according to a good plan.
That’s the way you pass down a good family business.
Again, if you are operating a family business, make sure you get all of this straightened out.
James D. Anderson
James D Anderson CPA