Family-owned businesses are the backbone of the American economy. It's surprising for many to learn that the U.S. 24.2 million family businesses generated 54% of private sector GDP and 62% of employment in 2021. And the backbone may be ossifying – over 10,000 baby boomers per day will be hitting retirement age until 2030. As a result of this generational shift, many private company owners are thinking about how to exit their businesses.
For the majority of business owners, this means selling their company to an unaffiliated third-party buyer. For others, however, they hope to keep the business in the family. This can be challenging, though – experts say about 70% of family owned businesses don't make it to the 2nd generation. As the M&A market shifts from a seller's market over the last few years to a more balanced market, company valuations are decreasing relative to the past few years – potentially making it more enticing to keep the business in the family.
Successfully transitioning the business to the next generation is no simple task but there are steps that business owners can take today to ensure a successful transfer of their business to the next generation.
Clear Communication is Key to Culture and Collaboration
Open communication, particularly around company values, timing and expectations for the transfer of the business, can help build trust and cooperation and ensure that family members have similar goals for the company.
It is important to get younger family members involved in the day-to-day business operations, decision making, and growth strategy of the company well before the transition occurs to help build alignment between generations. Family members should discuss balancing the tradition and core values of the company with the need to be flexible and modernize the business. Older generations need to be willing to change with the times or risk frustrating younger family members who might see a different approach.
Company leadership and family members should consider discussing topics including company values; timeline for the transition; structure for the transaction; leadership and governance policies for future generations; growth strategies for the future; and more.
In the transfer of any business, control of the business is a frequent point of tension – and sometimes contention. Communicating early and often can help family members strike a balance between control and collaboration.
Businesses Need Both a Continuity Plan and Long-Term Succession Plan
It's important for all businesses to have both a near-term business continuity plan and a long-term succession plan. Many owners expect to let go of the reins in the next few years but, according to PWC Family Business Survey 2021, "only one-third (34%) of U.S. family businesses say they have a robust, documented and communicated succession plan in place." In this case, the old saying "Get it in writing!" is definitely applicable!
"Succession planning should include a timeline for assumption of responsibilities, and criteria on who has what authority for decision-making," according to the Harvard Business Review. In the absence of a long-term succession plan that addresses decision-making, growth strategies and investment capital, it's easier for family issues and dynamics to impact the day-to-day operations and future of the business. For example, it's critical to think ahead about succession income for retiring family members. It is also critical to address the perspectives and equity of children who aren't active in the day-to-day business.
As for continuity planning, it's important to plan ahead for unexpected disruptions or potential threats to the company. Having these conversations in advance can significantly help with the successful transfer of the business.
Experts Should Advise on How to Structure the Transaction
For the transaction itself, there are several techniques and estate planning instruments that can be used to transfer ownership to the next generation, but they require expertise from experienced advisors like attorneys and Certified Public Accountants (CPAs) as well as advance planning to ensure success.
For example, older generations may elect to transfer or sell shares of the company to children over time, or they could set up an installment sale that permits the children to buy equity in the company using seller financing and a promissory note. Future company income could be used to pay off the note and compensate retired family members.
Alternatively, a business owner could set up grantor retained annuity trust (GRAT) and receive annuity payments for a fixed number of years and transfer the assets of the company to the next generation with limited tax liability. Additionally, if the business is transferred at the time of the older generation's death, the recipients could potentially avoid capital gains taxes on the value of the business or, in some cases, use a life insurance policy to pay off the estate taxes.
For some, it might be necessary or beneficial to bring in additional sources of capital and outside investors to transfer the business to the next generation or to buy out certain members. In this scenario, it's important to strike a balance between owners and investors to ensure the next generation retains adequate control of the business and investors see the value or growth potential of the investment.
Regardless of the structure of the transaction, planning ahead and leaning on experienced advisors for professional guidance are critical. With these tips in mind, business owners can navigate remaining true to the company's culture and founding spirit while preparing the business for future success.
Learn more in BizWest's recent articlefeaturing KO partner John Gaddis.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.