Case Study 7 - Choosing a Successor in Family Business Transitions
The first question many owners ask themselves when they start to think about the transition of their companies to successors is, “How is this going to work?” They then become so overwhelmed thinking about the pros and cons of all the possible methods, that they abandon the succession planning project altogether.
That’s not surprising since there are so many methods to consider: liquidation through public sale, private sale or auction; a sale of stock or assets to a third party; a transfer to insiders (family members, key employees or business partners) through a one-time sale of stock, assets or membership interests during lifetime or at death; a sale over time of stock assets or membership during lifetime or at death; and gifting (total or partial) during lifetime or at death.
To help owners prepare themselves to answer the question of How, we always recommend that they first ask and answer:
- Why am I transitioning my business? What objectives do I want the transition to accomplish?
- What do I have to transition? What do I want to transfer and what do I want to keep?
- Who do I want to transition my company to? Someone I know or someone I don’t?
You may recognize these as the first three of our Big 6 questions since we’ve recently written about the Why and What. Today we look at how to navigate the question of Who: Who will you choose as your successor?
We recently met “Eli,” the 55-year-old owner of metal fabrication company that specializes in products for industrial and transportation customers. Eli’s father started the company as a fabricator of decorative railings and Eli, an only child, had grown the company to 70 employees working in a 150,000sf, state-of-the-art plant.
When the conversation turned to our families, we learned that Eli had six children, ranging in age from 15 to 28. His oldest son was working in sales, and his oldest daughter in estimating. The remaining four children were still in college and high school.
“Of course I want my children to follow their dreams,” Eli said, “but I’d love for as many of them who want to, to work in the company.”
“You sound like a lot of our clients,” we responded. “They want their kids to have the same financial and career opportunities that they’ve had.”
“But how many of them have six kids?” Eli asked.
“Not many,” we admitted, “yet even those with two often struggle with the thought of how to transition their companies to one child, both or no child at all.”
“Exactly!” said Eli. “Take their situation, add the issue of a nearly 15-year spread, and you can see my dilemma.”
“Which dilemma do you mean?” we asked.
“Well, I’ve got two children working their backsides off to prove that they’d be great successors, while my youngest doesn’t even have a driver’s license,” Eli clarified.
“Meaning,” we guessed, “that she is years away from making a career decision.”
“Right. She’s totally into robotics and talks about going into engineering,” Eli explained, “which would be a great asset to the company . . . but she’s got at least six more years of school ahead of her.”
How Your Why Affects Your Who
“Before we jump into the different ways you might satisfy your older children’s desire for ownership while keeping the option open to your youngest, tell us more about why you want to transition your company to your kids,” we asked.
“When I took over from my dad, it was just me,” Eli said. “I realize that it’s not realistic—or even practical—to have six CEOs running the company, but I want to be fair to all my kids and for all of them to have the opportunity to participate—at least financially—in the business.”
“Let’s think about the transition from a generation of one to a generation of six in another way,” we suggested.
“I’m listening,” Eli said.
The Three Types of Who
“There are two issues we want you to consider,” we started. “The first is the three types of Who, and the second is the difference between family and business.”
Eli looked puzzled so we continued, “You’ve mentioned a CEO—the person best suited to operate the business—but operating a company isn’t necessarily owning it, and owning and operating aren’t the same as governing it.”
“I’m not really following,” Eli admitted.
“Think about who you could transition ownership to, who you could make responsible for running the company and who could participate in governing the company on a board of directors,” we elaborated.
“I’m not sure you’re making my decision any simpler!” Eli interjected.
“We want you to see that the question of who you will transition your company to isn’t just about who will own the company,” we explained. “Your older two might be ready to assume responsibility for the operations of the company, but that doesn’t mean that your college-age children couldn’t sit on the board with you and your wife, and your youngest couldn’t share in ownership, even if that’s via a trust.”
“That’s not any less complex,” Eli observed, “but it certainly gives me more options than I thought I had.”
Your What Affects Your Who
“You have options when it comes to your who, and even more options when you consider your What,” we added.
“Great. More complexity!”
“Think of it as more options,” we suggested. “You said your company specializes in fabricating steel for transportation and industrial customers, correct?”
“Yes,” Eli responded.
“Could one division be operated by one child and the other division by another child, and a third—let’s say robotics—be operated by even another child?” we asked.
“I see where you are going,” Eli said, “Not that you are making this any simpler!”
“We’ll admit that here’s a lot to think about when choosing who will take over your company after you leave.”
“I’m almost afraid to ask, but you said there’s another issue to consider,” Eli prompted.
Family vs. Business Considerations in Transitions
“Right,” we started, “family vs. business.”
“Meaning?” Eli asked.
“Meaning, families are about inclusion,” we responded. “As parents, we want to include all of our children—even when they sometimes make stupid decisions—in our lives.”
“True,” Eli agreed. “My wife and I want our kids and grandkids to be part of our lives. We also want our kids to have the opportunity to make money and grow in their careers and as people.”
“Making money,” we reflected, “is the primary purpose of a business, not a family. As you said, it isn’t practical to have six people sitting in the CEO’s chair, so some of your children will have to be excluded from running the company if your company is to continue to make money. And that brings us back to the three types of Who: some children may be do well in operations, some in ownership and some in governance.”
“You’ve given me a lot to think about,” Eli mused.
“This isn’t easy stuff,” we agreed. “And it’s hard for owners to investigate all their options when they don’t understand what all of them are and can’t talk to anyone involved about what they’re thinking. Even if they’re just bouncing ideas around, as soon as owners say anything about their transitions, people make assumptions and form strong opinions.”
“So I’ve noticed!” Eli agreed. “If you were me, where would you start?”
“We’d start by asking you to think about why you built the company and what you want your transition to do for you, your wife, your kids, even your employees and community. We’d ask you to tell us how you think about ownership,” we answered.
“How I think about ownership?” Eli repeated.
“For instance, do you believe that only children who actively work in the business should have an ownership interest or do all children, regardless of their involvement in the business, receive ownership?” we asked.
“Again, more complexity!”
“Again,” we countered, “more options!”
As transition guides, we frequently have conversations like this one. So frequently, in fact, that we’ve created an easy way for owners to discover options they may not have considered and bounce ideas off other owners: The Big 6 Program.
Sound interesting? Check it out here.
