When advising family businesses, emotions and not logic can sometimes drive decision making. At TKO Miller, we have worked with over fifty family-owned businesses and have assembled some common themes that we believe owners and families should consider as their business matures.
1. Your Kids Might Not Be the Best Choice to Run the Business
Your children might be wonderful, and smart and natural business people, but we see it all too often when they are handed the reigns to a successful business and they run it right into the ground. In fact, the very thing that makes the business owner great at running his or her business (passion, drive, fear) is the thing that the children are missing. Sometimes, they are missing this because they have had a life of relative privilege, as a result of the business being successful! This is one of the most difficult conversations to have with a business owner. If you think that you cannot be unbiased when making this decision, ask a board member or trusted advisor.
2. Your Kids Might Not Want to Run the Business
This might be an equally difficult conversation but it is also important to have when you are in a family held business. Ask your children if they want to run the business. Ask them what they have planned. Ask them the difficult questions and let them know that they do not automatically get to become CEO.
3. Be Careful if You Leave All Your Children Equal Shares
Leaving all your children equal ownership in the event of your death might seem like a fair choice, but in many cases, it can lead to paralysis in a business. If there is a child that is taking a leadership role in the company, make sure you give them the ability (either through ownership or through legal documents) to make decisions.
Other challenges arise when some of the children are active in the business and others are not – yet they all have equal ownership. This can make perfect sense while parents are alive, but once they have passed, it can create havoc. If the business no longer provides a dividend to those children not active, serious disharmony can erupt. It can leave one to wonder why parents insist on giving the future risk of the business, along with the amount of work necessary to grow it, to a select group of children. It can be a disincentive for active managers to make a company more successful only to share a predetermined percentage with non-active siblings or cousins.
4. Replicating Yourself Might Mean Hiring Two (or Three) People
One thing is universally true about family and closely held businesses; owners wear a lot of hats. Sometimes, when you think about succession planning, it may mean that you must hire a couple of different people to take on the jobs that you, as owner, do.
5. What if You Need Additional Capital?
A closely held company can be a great thing when times are good. When things get rough, however, it’s good to have a plan. When your business needs capital, will all the family members contribute? Will the family consider bringing in outside equity? How comfortable is the family with debt that may or may not be personally guaranteed?
6. Family Ownership Can Create Portfolio Risk
Having your business be the biggest (or maybe only) asset in your portfolio can be risky, especially as you move closer to retirement. Many business owners feel that their business is an excellent investment because they have some control over the return. We have heard the phrase “I like investing in myself,” many times. Generally, there are benefits to putting in long hours and working hard at building your own business. When you are at the end of your working life, it makes sense to begin to diversify your assets. If there is not a new set of management ready to put in the same amount of energy you did, chances are that investment will be overly risky for this stage of your investing cycle.
7. Family Ownership Can Create Excess Risk Aversion
When a business owner nears retirement, and realizes that their portfolio may not be as diversified as some of their peers, they can begin risk avoiding behaviors. This may play out in a business owner who doesn’t invest in new technology or equipment. It may be a business owner who decides not to launch a new product line. For a business owner near retirement, looking at long-term value opportunities becomes more difficult. Short-term gains, which may not be as attractive to the overall health of the business, seem much more palatable. This behavior effectively stunts the growth of the business and can impact value going forward.
Family and closely held businesses can be immensely rewarding. However, there are some challenges when a business owner arrives at the point of retiring. Selling your business or bringing in outside capital may not be your first answer, but it is certainly an option worth considering.