May 25, 2023

This paid piece is sponsored by Eide Bailly LLP.

A version of this article first appeared on EideBailly.com.

Family-owned businesses often possess unique qualities that make them a strong candidate for future growth and transition. The business’ brand becomes an extension of the family’s values. The owners keep an eye toward the future with a focus on who could become the next eventual owner. The company’s culture likely is influenced by the desire to create a legacy that lives on for years and years to come.

But what happens when transition to the next generation is not an option? According to the Conway Center for Family Business, only slightly less than one-third of all family-owned businesses transition to the second generation, and when it comes to the third generation, only 12 percent succeed. By the fourth generation, only 3 percent will still be operating as a next-generation family business.

Are you prepared for the next step of your family business if next-generation succession isn’t on the table?

Importance of succession planning in family-owned businesses

Transitioning your family business to the next generation can be difficult for a variety of reasons, the most common being:

• Lack of communication

Unfortunately, many family members find it difficult to have succession-related discussions, which can lead to misunderstandings, assumptions and unmet expectations. For example, parents may assume that their children are interested in taking over the business without actually consulting with them. Similarly, children may assume that their parents or grandparents will always be around to run the business, leading to stress and frustration when that turns out not to be the case.

• Fear, intimidation or disinterest

Family members may feel afraid or worried about taking on the responsibility of running the business. This can be caused by a lack of experience, expertise or confidence, or it can stem from a perception that the business is too risky or difficult to manage. For example, if conversations regarding the business often revolve around complaints or challenges, children may believe that working in the business is difficult, unpleasant or never-ending.

• Unpreparedness

You may have spent time and energy training one child on the workings of the business, but what happens if that child has a terrible accident or decides against stepping up to lead the business? Furthermore, it’s important to remember that giving family members functional roles without proper training and mentorship may not be sufficient for them to take on leadership roles effectively. They need to learn the crucial skills of management, negotiation and planning to feel prepared to take over.

To address these challenges, family-owned businesses should work to create a culture of collaboration and support within the family and the business. Establishing clear lines of communication, setting expectations, training interested family members and creating a succession plan that outlines roles, responsibilities and timelines for the transition of leadership are all crucial to the long-term success of the business.

Alternative options to next-generation family business succession

Transition planning for the next-generation family business is critical, regardless of whether it is to family or nonfamily members. Proactive, strategic transition and succession planning allows an organization to define its value, improve operations, identify leadership and put itself in the best possible position to move forward and maintain success without issues.

If a next-generation transition is not an option, you can explore alternative options to ensure your business lives on after your exit.

Nonfamily-member options include:

• ESOPs: An ESOP is a qualified retirement plan that invests primarily in employer stock, thus making all employees “owners.”
• Strategic buyers: Strategic buyers typically buy 100 percent of your business and assume all responsibility for it. Examples include outside parties like competitors or customers.
• Financial buyers: Financial buyers are organizations such as private equity groups, venture capital firms or hedge funds. Keep in mind that these organizations often require majority ownership, so you will want to ensure you share the same goals and values with financial buyers before selling.
• Family offices: These entities operate similarly to private equity groups but are unique in that they are established solely to manage a family’s wealth.

To truly align with the goals and objectives you have for exit, as well as gain optimal value for what you’ve built, you’ll need to put careful thought and consideration into each of these options.

Next steps to take with your family-owned business

Regardless of which transition option you choose, planning is key. To start, ask yourself:

• How much longer do I plan to work or stay involved in the business?
• How much control do I want after my exit?
• How do I plan to replace myself?
• How much money do I want to make from the sale of my business?
• Do I know what my business is worth?
• If I had an offer today, could I take it?

Your answers to those questions will help guide you through the following transition planning considerations:

• Business valuation

One of the first steps we encourage family-owned businesses to take when preparing for transition is to conduct a business valuation. Business valuations are helpful for companies planning two to three years out for exit to give them time to increase the business’ value, fix any processes or procedures that are not working optimally and set up gifting and estate options. It’s also helpful in identifying key value drivers, risks and opportunities.

• Merger and acquisition activity

What if you’re ready to sell your business in the next six to nine months? This is where the help of a trusted transaction adviser comes in. These professionals are trained in merger and acquisition activity and can help you understand what your company will go to market for. Specifically, a transaction adviser can help you conduct a quality-of-earnings report and pull market multiples that will show your business’ worth across areas like revenue, industry and EBITDA.

• Sell-side readiness

For family business owners, the preparation for sale might be more emotional than they initially thought. Sell-side readiness can help family businesses prepare for the personal and business impact of transition planning. Sell-side readiness involves the creation of a clear vision and goals for any transaction, as well as a road map for how to achieve those goals.

• Planning for the now – and the next

Family-owned businesses are critical to the economy. In fact, research has shown that family-owned businesses account for 70 percent of the global GDP. Yet for all their strengths, family businesses continue to lack a clear path to exit.

We believe that preparation is the key to executing a successful family business transition. While every individual journey will be unique, there are four key stages we encourage you to focus on as you plan for a successful exit. Download the Exit Planning e-Book to learn more.