June 13, 2017 | Patrick McFarlen
In this series of articles, EKS&H Capital Advisors Partner Patrick McFarlen explores the personal and business considerations involved in a successful business transition. In this article, he discusses the unique decisions and challenges related to family business succession and offers some questions an entrepreneur weighing this option should consider.
The significant role that family businesses play in our economy is unmistakable: As much as 50% of U.S. GDP is attributed to family businesses that include both small local “mom and pop” storefronts and Fortune 500 corporations (35% of Fortune 500 companies are family owned or run). Despite these impressive numbers, only a third of family businesses successfully transition to the second generation.
So what causes this high failure rate? Why does a business model that is clearly successful during initial and growth stages of a business fail when it comes time to transition the next generation?
Over the years, we’ve worked with countless business owners transitioning what they have built to their children and other relatives — most with great success but some with significant disappointment. Two recent situations exemplify the drastically different circumstances and outcomes:
In the first example, the client/founder was passing his business on to his daughter, who had worked for several years in the industry after graduating from college. She had achieved success in various roles in sales and operations, and the industry was clearly a passion of hers. The transition was gradual, spanning multiple years, until our client’s daughter ultimately became president and CEO. Today that business continues to grow and thrive under its new innovative and enthusiastic leadership.
In the second example, the client’s son did not have the applicable education or industry experience that would set him up for success. Unfortunately, our client was truly ready (and anxious) to retire. Within six months, the son was named CEO. Almost immediately, key management began leaving, and the business quickly lost market share and profitability. Recently, we began working with this business again, but this time it was to sell it to an outside buyer for half the value at its peak.
When comparing the two side by side, it’s easy to see why one failed and the other didn’t. Common sense can prevent many problems, but even the most clear-headed owner can lose his or her good judgment when clouded by complex and emotional relationship dynamics.
Utilizing the “five questions” model presented in our first post, and considering how those questions and answers are different for a family business transition, might help you achieve the success of our first example.
As a business owner, guiding both individuals and the organization through a second-generation succession can be a challenging and emotional process. However, achieving this kind of success might be one of the most satisfying results. To do so, it is imperative to give serious thought to these and other questions early on, gather an experienced team of advisors who know both the “soft-side” and technical elements of business transition planning, and maintain communication with all key stakeholders throughout the process.
Part three of this series will explore the transition questions and considerations related to an employee or management buyout.