Family Businesses – The Good, The Bad and The Ugly

 

Family businesses are vital to the US and global economies. In fact, there are approximately 5.5 million family-owned and controlled businesses in the United States alone. [1] While family-owned businesses produce much of the world’s wealth, the majority are not prepared to sell in a way that maximizes the business value for its owners.

 

Many family business owners care deeply about the legacy they have created and want it to remain in their family or with someone who will carry on with the same mission, vision, and values. This is frequently difficult because the owners lack a formal succession plan or exit strategy.

 

According to studies, one-third of family business owners never plan to retire. As a result, they lack a succession or exit strategy. In some cases, the business is forced to develop a strategy by default when the owner becomes exhausted, disabled, or worse, dies. This is clearly not the best strategy for increasing profits.

When an owner dies or becomes disabled unexpectedly an operating agreement that is regularly reviewed and updated that include a buy/sell provision can avoid massive conflicts.
A buy/sell provision is language that states what will happen with the business in the event of a death.  They can be funded, usually with life insurance on the owners, so that when one owner dies the insurance proceeds can be used to buy out the other owners estate. An unfunded buy/sell agreement does not have a life insurance component, but can detail what is to happen with the businesses assets including cash and receivables.

 

The Benefits and Drawbacks of Entrusting Your Business to Family Members

A family-owned business has a 24-year average lifespan, according to Businessweek.com. Only about 13% of family-owned businesses are successfully passed down to a third generation, while 40% are successfully passed down to a second generation. [2] The survival rate for the fourth and subsequent generations is 3% or less. Whether a family business owner intends to sell their company to a third party or keep it in the family, it is critical to maintain confidentiality and have the necessary documentation in place for a smooth transition.

If you intend to sell your business to a family member, there are some drawbacks to consider. One significant disadvantage is that a family business owner will typically receive more value for their company when selling to an independent third party. Family business owners may choose to a non-family member at a reduced price if they feel the buyer will be a good steward of the companies future.  It is critical to prepare the remaining family members for the fact that they will now have to answer to new ownership and management with the business. It is equally important that the buyer understand the relationships between family members and their roles/responsibilities in the business.

 

Managing a Large Number of Owners and/or Decision Makers

If the family-owned business has multiple owners and/or decision makers and is being sold to a third party, it is critical to appoint one family member to represent the negotiations. Having multiple decision makers at this critical stage in the process of selling the business to a third-party owner can cause a slew of problems and headaches for both the buyer and seller. Multiple decision makers frequently cause failure in the ability to transition the business to third-party ownership, as the parties involved have competing priorities with the sale of the business, preventing everyone involved in the process from being satisfied. Remember that only the control party must agree on the price, terms, and sale of the business If there is not a control party as might be the case with two 50:50 owners both will need to be in agreement or it will never happen.

 

Obtaining Third-Party Assistance

Having a third-party guide you through the process who is not emotionally involved like the various family members involved can be critical in making the deal happen. That is why a team of professionals should be assembled, including business brokers, M&A advisors, transaction lawyers, and accountants.

This article highlights just a few of the numerous issues and processes involved in transitioning your business to new ownership after you decide to retire or pursue a new venture.

If you are part of a family business insure that there is an up to date operating agreement with a funded

If you are just starting out or are actively considering transitioning your business to new ownership, please contact us for advice and assistance.

 

[1] https://www.gvsu.edu/fobi/family-firm-facts-5.htm

[2] https://www.johnson.cornell.edu/smith-family-business-initiative-at-cornell/resources/family-business-facts/

 

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