Parenting Pointers: How to hand down the family business (One generation to Another)

By Jonathan Pellegrin

There are four distinct periods in the generational transfer of ownership and management of a family company.  They are:

1. Exploration Period
2. Decision Making Period
3. Execution Period
4. Aftershocks—Post Sale Period.

These periods provide structure for going through the process of considering and making an ownership change.

Exploration Period

Answering the following questions helps to arrive at a rational decision of whether or not to embark on a generational transfer at this time.

• What are the trigger points causing consideration of handing down the company now?
• Are the controlling shareholders in favor of passing the company to the next generation now…or ever?
• Is there a plan for monetizing the value of the senior’s ownership interests as the stock is passed to the next generation?  Does the senior generation have adequate financial resources to provide a comfortable retirement and sustained standard of living?
• Does the senior generation want to pass ownership in equal amounts to next generation members?
• Is there a management succession plan in place?
• Is there a process of selecting the next CEO?
• How will a successor CEO be selected?
• Is the senior generation operating under the illusion that the company can be managed by a committee of siblings—with ownership and management responsibilities shared equally?
• What happens to the ownership mix as management is passed from one generation to another?
• Is the current CEO really willing to step aside and give up the reins of leadership?
• Do the senior family members understand that everything might not be equal in a generational transition?
• It’s best to engage the help of your lawyer and accountant as well another business owner who went through the same process to serve as your sounding board when you are going through the process.

It seems that every situation is somewhat different, however the process and the accompanying templates and checklists in virtually every ownership and management transfer are useful tools that will help families achieve their objective or reach a satisfactory alternative given the facts and circumstances at the time.  Open, candid communications among family members are imperative for reaching an optimum result.

First, some critical checkpoints:

1. Is the senior generation CEO really ready to step aside?
2. Is there an obvious successor to the CEO?
3. Are there adequate financial resources available, including debt capacity that are sufficient to provide a living to the retiring family shareholder/leaders?
4. Is there an appetite in the next generation to raise the requisite funds to provide for the retiring shareholders?

If the answers to these questions are all “yes”, the decision making and execution processes are pretty straight forward.

Complications may occur when:

1. There is more than one family member with the desire to own and manage the company in the next generation.
1. Is the successor leader a clear choice?
2. Will the new leader have support of his/her siblings?
3. Will shares of the company be offered equally to all the siblings regardless of what their level of job responsibilities are, or will stock be divided unequally based on other factors.

1. Some of the family members who are not interested in the business may want fairness and equality in the distribution of the value of the company in the generational transition. 

1. Are there other family assets that can be provided in the estate plan of the senior generation in lieu of company shares for the benefit of those who aren’t interested in the business?
2. Can career interests of siblings not interested in working in the family firm be encouraged and supported in other ways? 

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This is a difficult process and should be done with care.  It’s one thing, if there is just one next generation member who is interested in taking over the business.  It’s another if more than one next generation member are   interested in operating the company.  And nothing will happen if the senior generation member is not fully committed to passing the company to the next generation…or it’s a half-way measure that is not likely to turn out well.

If there are two senior generation partners who want to pass the business to the next generation it can get messy with cousins trying to figure out how to mediate issues and resolve differences with a committee of family members.  

I personally believe that next generation members who want to take over the family company need to have skin in the game.  They need to mortgage personal assets, raise debt or bring in outside capital to finance the purchase.

The senior generation members need to be monetized for their shares and the risks of ownership need to be assumed by the next generation family members who want ownership and involvement in the company.  

It’s necessary to know and understand the extent of financing that can be provided by the company in facilitating the generational transfer.  And it must be clear how much debt can be carried by the company without affecting its ability to perform.  Too much leverage can be dangerous.

Decision Making Period

Considering all of the factors and information accumulated during the exploration period, including the short, intermediate and long term outlook for the company and its ability to effectively operate in the served markets of the company, a decision must be reached before moving to the next period.  

Do the benefits outweigh the risks for both the sellers (the senior generation members) and the buyers (the succeeding generation members) in completing this transaction?  Or should the company be sold or should any decision about ownership changes be postponed?  Will the new owners of the company be able to withstand the cyclicality of the business and the industry in which it operates?

It’s possible that the owners may reach a decision to sell the company and provide encouragement to the next generation to explore their interests and do something else.  If that’s the case the process of executing a sale of the business is different from a generational transfer.

All of these factors weigh in the decision of what to do.  If the decision is to do nothing at this time or not to sell, there should be a commitment to increasing the value of the company over time.  Merely going through the analysis, can be very motivating to the owners to make decisions that will improve the profitability of the business as well as its value.  

If the decision is made to proceed with the generational transfer, the process moves to the execution period.

Execution Period

A generational transfer is an inside sale, more like doing an Employee Stock Ownership Plan.  There are good firms that specialize in doing ESOPs.  The benefit of this structure is that the senior generation is able to take a chunk of money out of the company, leaving bulk of the ownership to the next generation and employees of the company.

No matter what is done, at this point it’s important to get an independent valuation of the business.  Analyzing the financial structure of the business and its earnings record, will provide an idea of how much leverage can be put into the company to help finance the purchase of stock from the retiring senior generation.

Naturally, the senior generation will receive less from inside sales rather than going to market with an outside sale to a strategic or financial buyer.

Execution of an “inside sale” is much easier than executing a sale to a strategic or financial buyer.

Post-Sale Period—Aftershocks

Little changes in the case of inside sales.  The culture of the company remains the culture of the company and the same people are and will be involved in the company as it goes forward, with the exception of senior generation members who are being cashed out and retire.  The future of the business belongs to the next generation and the seniors are rewarded for their early efforts building the company.  

Formerly Chairman and Chief Executive Officer of Johnson Hill Press, JONATHAN PELLEGRIN is the author of The Art of Selling the Family Business.