For too many business owners or operators, succession planning takes a back seat to day-to-day operations and short-term goals. For family businesses, succession planning involves additional stresses, such as deciding which relatives will actively participate in the business, what their roles and responsibilities will be, and how much the owner will be compensated. If a client (or you) is planning a transition to the next generation, consider the following questions.
How well has the business performed in recent years? – The capacity to generate a sustainable level of profit is important in determining what the business is worth. The ongoing ability to generate cash flow from normal operations is necessary to pay ordinary business expenses, service debt, invest in new equipment, pay income taxes, and provide a return on investment to the owner. If the exiting owner expects to be paid a price that will support his or her retirement needs, this could create an additional financial burden on the business.
Based on current industry conditions, customer preferences, and new technologies, is the business model still relevant and viable? – All business operators should evaluate their interactions with customers, profit margins, industry trends, and technological disruptions to their business model, and make all necessary changes. In some industries, smaller independent businesses will have trouble competing with more diversified companies that benefit from economies of scale. Understanding what the future may hold will help owners realistically assess the level of future success for the next generation operating as an independent business.
How much is the business currently worth? – This can be an eye-opening moment, because some owners have inflated expectations of what their business is worth. A business should be valued based on recent and expected ongoing financial performance. Some owners would like to be paid a premium for their dedication, sacrifice, and sweat equity put in over many years. Others hope to be paid what they believe they need to support their retirement. The “how much is it worth” revelation can impact the timing of the ownership transition and offer a reality check on whether the owner is likely to achieve certain financial objectives when exiting the business. The valuation process will identify opportunities to improve operations, thus increasing value. So, beginning the succession planning process well in advance provides more time to affect positive changes upon the business.
Does the next generation have what it takes to succeed? – When passing a business down to the next generation, it is imperative that the members of that generation received adequate training, relevant experience, and opportunities to provide leadership and a strategic vision. Preparedness to carry the baton is often dependent on the manner in which the owner handles decision-making and key customer relationships. If the next generation had the opportunity to assume management duties and were accountable for operational outcomes, this could be an indication of their preparedness to assume primary control.
All things considered, what is best for the owner and the family? – Family dynamics are complex. I have witnessed successful business owners become paralyzed by the need to make decisions regarding family business succession. A desire not to “play favorites” can be an overwhelming concern, creating tension in and out of the workplace. There are both financial and nonfinancial considerations when making this important decision.
Only 30% of family businesses transition to subsequent generations. Those that are successful follow many of the following best practices:
- Be candid with family members regarding performance expectations, and provide training and opportunities to develop leadership skills.
- Create a well-documented succession plan that lays out the opportunities for family members to interview for job openings they are qualified for and to work their way up through the organization based on performance.
- Develop well-defined standard operating procedures and policies, as well as an organizational chart that clarifies responsibilities and lines of authority.
- Require family members to work outside the family business to develop experience, achieve advancement, and gain confidence. Then they may bring their new skills and fresh ideas back to the family business.
- Bring in outside professionals to fill key management roles.
- Recruit outside business leaders to sit on the board of directors to offer feedback on the operational performance of the management team and to provide input on strategic direction.
Many owners would like to see their businesses pass on to the next generation. Beginning a succession plan early will increase the probability of a successful transition. Share the factors and best practices here to help clients carefully consider generational transition and whether or not it is right for them. As an outside adviser, you can be a valuable impartial mediator during this planning process.
John S. Stoner, CPA, CVA, is a partner in the business consulting services group of RKL. He is a member of the Pennsylvania CPA Journal Editorial Board, and can be reached at firstname.lastname@example.org.