My post this week in the New York Times deals with the thorny issue of transferring ownership of a family business from one generation to the next, or more accurately the decision not to. While family-owned businesses have impressive results, outperforming public companies in areas like stock price and return on equity, the statistics associated with ownership transfer are sobering. Less than 30 percent of family-owned businesses transfer from the first generation to the next, and less than 15 percent transfer from the second to the third.
The difficulty has less to do with business issues, and more with the emotional underpinnings of all families. Tom Deans – author and third-generation family business owner – has a fascinating and candid take on family business transfers, which he explains in his book, Every Family’s Business: 12 Common Sense Questions to Protect Your Wealth. Following is the uncut version of my recent Email interview with Mr. Deans:
BT: Which generation is most likely to sell the business?
TD: I see the second generation falling into two distinct camps when it comes to succession planning with their own children. The first camp of Gen 2’s would never want to put their kids through the same grinding issues that they endured with their parents (the founder), so the option of selling feels right on so many levels. A key point is that Gen 2’s who sell their business have typically “purchased” their business from their parents. They took on debt and worked hard to continue the legacy. Most of these Gen 2’s finally come to understand that they can’t feed their family with “legacy” — cash has always worked better. They come to understand that a business is an instrument of wealth creation: Nothing less and nothing more.
For Gen 2’s that have been “gifted” the business by the founder, the emotional struggle to “sell” a gift often means they hang on to the business much longer than they should — until the business is well past its freshness date. Driving innovation in a business that a Gen 2 never purchased is also difficult. If selling a gift is difficult, so too is changing one. These businesses often die on the vine in the hands of the second generation, which of course eliminates the need for anyone to make a decision about transferring the business to Gen 3. These Gen 2 businesses are almost always at least 30 years old and well past the average survival rate of any business. Think buggy whips and Blackberries.
BT: Why is it better to sell rather than gift the business?
TD: Too often management succession planning is confused with ownership succession planning. Lots of founders believe that if they bring their children into the business early and introduce them to many aspects of the business – i.e. operations, sales and administration — that they are ready to lead the organization. Founders fail to understand that what makes founders unique is the capital they risk from the very beginning of their enterprise. Moving a child through an organization has nothing to do with risking capital.
When a founder asks his or her child to risk their money, they take the very first step to test whether their progeny possess the entrepreneurial gene. Children who believe in their capacity to create wealth with the family business, children who believe in their own leadership abilities, will often invest in the family business.
Even the child that doesn’t risk their capital can often see that the business is at the end of its productive growth life cycle and makes the wise decision to deploy their capital outside the family business. But the child who refuses to invest in the family business, or in any business, is not an owner. When a business is “gifted” to this type of successor child, one can easily predict the last chapter of their family business story: Chapter 11.
BT: Do moms sees things differently?
TD: I often ask my business owner audience (typically 85% male) whether the initial idea of inviting their children into the business came from their spouse. About 75% acknowledge that it was. More often than not, the decision to invite children into the business is an effort by mothers to keep the family close and more importantly to gain access to grandchildren. The mother -in-law/daughter-in-law relationship is tough enough. Throw in a family business where money, children and power intersect and you have Thanksgiving dinners more reminiscent of Jerry Springer than Norman Rockwell.
BT: Do kids take over the business for the wrong reasons?
TD: Last week during the Q&A after my keynote speech at a large industry convention, I heard the story of a woman who quit her job as a medical doctor to run her father’s shoe manufacturing business after her father suffered a health event. Most children feel a strong compulsion to help parents with their business when they are in need. If helping out isn’t reason enough to join the family business, parents often use inflated salaries to attract and retain their children in the business.
Moreover, many children will join and stay in the family business since the vast majority of their parent’s wealth is sitting as retained earning in the business. To leave the business — or not join the family business — is to distance oneself from their looming inheritance. Throw in a little sibling rivalry and you can see why children join and stay in a family business for all the wrong reasons. Children who lack the passion and skills to lead and operate a family business is one of the single best explanations why so few transition successfully to the 2nd generation; ditto for the third generation.
BT: How do you know which child should run the business?
TD: Often the most confident and skilled child has what I call the “entrepreneurial gene” and has pursued a career outside the family business — often starting their own business in a similar or related field. These prodigal children are driven and have their own ideas and vision for creating wealth. They often challenge the “founder-parents” and conflict ensues. Instead of understanding that conflict is usually the sign of a confident, hard-driving leader in the making, the outspoken child leaves the family business to fulfill their entrepreneurial potential.
So who is left behind? It is often the cooperative child who is both complacent and co-dependent and happy to be infantilized (that is to say treated as a child even in their 30′s, 40′s, 50′s and sadly in their 60′s). There are lots of under-performing children who are controlled by their parents, controlled by inflated salaries, who could never replace their salaries in the open market. It’s a point that doesn’t escape everyone in and outside the family business. Businesses that don’t invite differences of opinion with respect to their operations and future vision, typically suffer at the hands of other more inventive firms.
BT: Final thoughts?
TD: Family businesses have always been easy to start, difficult to operate and nearly impossible to exit from.