Succession Planning — A Critical Missing Element in Many Family-Owned Businesses

Small businesses have long been the heart and soul of the U.S. economy. According to the U.S. Census Bureau, 61% of the over 7.5 million U.S. business establishments had fewer than 10 employees in 2014. Once upon a time, many individuals dreamed of starting a business that they could pass on to the next generation; however, a recent study on succession planning for U.S. family-owned businesses by PwC found that interest among owners to pass control of the company on to the next generation is waning. In fact, the study found that among family-owned establishments anticipating an ownership change within the next five years, only 52% plan to keep the business in the family — down from 74% of companies surveyed just two years ago. This raises several major concerns for family-owned businesses, most importantly the need for properly establishing value and a plan for transitioning ownership of a business.

First, do these owners have a firm understanding of their business’s fair market value? Sadly, the answer is usually no. While hard facts are short on this topic, our experience in working with family-owned businesses is that the owner(s) tend to be overly optimistic about value and believe the business is worth far more than it will likely generate in a competitive sale process. This especially holds true for smaller companies (i.e., less than $3 million in annual revenue). Many owners are understandably emotionally attached to a business they developed and that has afforded them a relatively comfortable lifestyle. As such, it can be hard to hear that the business isn’t as valuable or easily transferable as expected.

Second, if a change in ownership is really just five years away, what steps have owners taken to prepare for the divestiture of their interests? Unfortunately, the statistics aren’t overly optimistic. According to PwC survey results, only 23% of firms have a well-documented and robust transition plan in place — down from 27% two years ago — and nearly one-third have no plan at all. Asking a CEO to plan for a future when they aren’t involved in the business can be challenging to say the least. Further complicating matters is the potential that the next generation may not want anything to do with the business and senior leadership may have no desire to own a business.

So where does this leave the business owner(s)? How can strategic consultants and transaction advisors provide guidance on the road to transitioning (or divesting) a family-owned business? By working together, the two sides can create a multi-year plan on how best to maximize value and transition ownership. The process is one that requires a high level of trust and respect, and should be conducted over a sufficiently long period of time in order to fully realize the benefits of this partnership.

We strongly suggest business owners consider the following guidelines:

• Reach out to several advisors specializing in your industry and local market to learn about their experience working with similar businesses on succession planning and sell-side advisory services. You may find that the company best positioned to provide strategic consulting and succession planning services is different from the company best equipped to value and sell your business. In cases like these, you may need to make a choice between several firms or determine if a hybrid approach is possible.
• Ask your advisor to provide you with a fair market valuation and operations assessment for your business. You want to understand the value drivers and detractors of the business, as well as the opportunities to maximize the business’s value.
• Develop and implement a strategic growth and succession planning (or sell-side) initiative several years before you actually intend on transitioning the business to a new owner. Without proper planning, you won’t have enough time to fully realize the benefits of any changes being made to the business. Generally speaking, we like to work with owners three to five years in advance of any transition in ownership to minimize the potential for disruptions, but, depending on the business and its owner(s), longer relationships may prove even more rewarding.

Ultimately, transitioning a business from one generation to the next (or to someone outside of the family) can be a stressful process. Having an advisor that works with you to prepare the business for an eventual transition in ownership, regardless of the party, by identifying and correcting potential areas of concern that could prevent you from realizing your financial and familial objectives is an important step in alleviating at least some of this stress. However, it is important to choose your advisor wisely and ensure that they have yours and your business’s best interests in mind.

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This article was originally published on the Topline Valuation Blog. 

Adam Freedenberg, CPA, CFE, CVA and Manager at Topline Valuation Group co-authored this piece.