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Constructing a Family Business That is Transferable

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Constructing a Family Business That is Transferable

In the first article in this series on family business transfers, we discussed the three principles of transfer plan design (maintaining owner control, minimizing owner risk and maximizing value) and summarized the five-part process BEI uses to design these transfers.

  1. Create a written road map.
  2. Construct a business that is transferable.
  3. Set merit-based standards for the transfer of ownership to children.
  4. Tackle (do not avoid!) the delicate issue of fairness.
  5. Incorporate a backup plan.
     

Today we focus on that second step and your role in it: constructing a family business that is transferable. To accomplish that you must work with owners in three areas:

  • Successor ownership: Identify and (likely) train a capable successor
  • Business readiness: Prepare the business to operate without the current owner
  • Owner readiness: Prepare the owner for the transition out of the business and for life after.
     

Let’s look at each.

A Capable Successor
 

For a significant time prior to an owner’s departure, the child he or she designates as the successor must demonstrate both the capability and the willingness to run the business.

How do you assess whether a child is capable of and willing to run and own a business? An informal indicator is two-fold: 1) an owner is willing to take extended vacations without calling the business “just to check up on things,” and 2) upon returning, learns that “things” are just fine.

While this test works fairly well in a small shop for a fairly limited period of time, it is not sufficient for larger companies over long periods of time. As you know, an ability to manage daily business issues is not the same as nurturing business growth, anticipating future competition and navigating during economic downturns.

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In developing capable successor owners, time is on your side. Rarely do owners need to rush the transfer of ownership to a child, hoping that the child/successor owner will work out. Hope has no place in a parent’s decision. Instead, suggest that the owners make incremental transfers of ownership based on proven performance over a multi-year time frame. Of course, whenever we tell owners that they have time, they hear, “You don’t have to make any difficult decisions today.”

How do you help owners make good use of time to prepare their successors?
 

1. Work with owners to prepare successor(s) for future responsibilities as they would any key employee:

  • Increase their levels of responsibility.
  • Provide ongoing education.
  • Delegate authority.
  • Offer leadership training.
     

2. Suggest that the child join a peer-to-peer group or take advantage of membership in a regional family business center.

3. Create a formal management transition plan that assigns to the successor(s) duties and responsibilities of increasing importance. Base the owner’s transfer of ownership on the successor’s execution of these tasks as well as on the achievement of financial benchmarks.

Without your active assistance, suggestions and guidance, it is unlikely that your clients will independently create any ownership transfer program much less one that contains the elements summarized above. They will likely do nothing or turn to a different advisor.

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A Prepared Business
 

Yes, the responsibility for a steadily increasing level of competence and leadership rests on the shoulders of the successor child, but how well have you and your client prepared the business to function and grow without your client at the helm?

You are well aware of the need to create businesses with transferable value and the need for owners to change their role in the businesses as they grow. Transferable value is vital not only for transfers to outsiders (third parties) but equally in transfers to insiders (key employees and family members).

In the transfer of a business, that business must be capable of moving forward without the parent/owner’s guidance, leadership or access to his or her wallet.

All too often blame for the failure of family transfers is pinned on the would-be successor when most of the blame, if it were to be apportioned fairly, rests on owners and their failure to create companies with long-term viability without their continued involvement.

 Of course, saying that owners need to create transferable value and prompting them to actually do it are quite different matters. Owners don’t know what to do, and few advisors are trained to help them.

As we have repeated (too many times?) in these articles, Exit Planning is a multi-disciplinary effort. One Exit Planning advisor need not know how to address and solve every challenge a business or owner faces. What is necessary is that Exit Planning advisors create a stable of capable advisors from a wide variety of disciplines that they can call upon in addition to the owner’s existing advisors.

A Ready Owner
 

Children/successor owners must be ready, willing and able; but so must owners be ready and willing for the transition. As you begin to work with family business owners on their Exit Plans, it’s important to spend time to ensure that their departure dates are not only well-defined but also acceptable to them.

These elements—a capable successor, a prepared business and a ready owner—are essential regardless of the type of exit an owner seeks. In family business transfers, however, the possibility (or reality) of family discord makes it is easy to overlook the absolute necessity of having a transferable business. Helping owners create a roadmap that addresses these three elements increases the possibility that family business owners can achieve their goals and aspirations—even that of family harmony.

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