THE FAMILY RECIPE
Family businesses are the backbone of the United States economy – comprising 80 to 90 percent of all business enterprises, 64% of gross domestic product, 62% of employment, and 78% of new job creation. By 2017, it is estimated that more than 40% of family business owners are expected to retire and nearly 70% of those intend to pass the business on to the next generation, which is where trouble often begins. Only thirty percent of family businesses currently survive to the second generation and only 13% will survive to the third generation. Given these odds, a founder may actually be doing the family a disservice by transferring the business to a generation that will more than likely, it seems, run it into the ground. Accordingly, a family business owner should at least consider an exit strategy to preserve the value of a business rather than transfer it to the next generation.
TOO MANY COOKS IN THE KITCHEN
When siblings George and Caroline took over the family’s furniture business after their father’s retirement, they viewed the company only as a means of gaining additional wealth. This single-mindedness led to a series of missteps – failing to hire competent managers, overpaying themselves and related employees while underpaying other employees, and not holding “insiders” accountable in the same manner as outsiders – that ultimately doomed the business. The takeaway from George and Caroline’s story is that, for a family business to provide financial security for the next generation, a continuum must exist, requiring a combination of old school governance with new school leadership and vision. Like a good gumbo, you never know exactly how it will turn out until it’s done.
GUMBO IS ONLY AS GOOD AS THE INGREDIENTS YOU PUT IN
In deciding whether to exit or attempt to transfer the family business to the next generation, a family business owner should consider a few bad ingredients that can spoil a good gumbo. For example, aptitude is a key ingredient. Passing the family construction business to a child who is more suited to write screenplays is not a good idea. Equity and fairness are also important ingredients. Volatility may result when key employees (perhaps with more tenure and experience) or other family members are relegated to subordinate positions. Work ethic is also a significant factor. A family successor may not share the same drive or commitment to the business as the founder. You don’t always have exactly what you need at home for gumbo, so you may have to shop around to make it work.
FIRST YOU MAKE A ROUX
If all the stars align and a founder elects to pass the business down rather than exit, the next hurdle is to reestablish basic governance and management structures. These steps are mechanical and begin with the initial organization (or reorganization) of a business. For a corporation, the business’s articles of incorporation and bylaws lay the foundation for future governance. The organizational documents might define and limit the authority of each executive, establish a board of directors, require board approval of certain actions and create nonvoting classes of stock to provide equity to family members who aren’t active in the business without conferring management control. A well-designed buy-sell agreement can prevent owners from transferring their shares outside the family while providing the liquidity they need to exit the business. Prenuptial agreements can prevent married owners from losing a portion of their shares in a divorce. Owners’ estate plans would do well to use trusts or other mechanisms to restrict the ability of their heirs to transfer or encumber shares. If shares are held in trust, however, it is important to include mechanisms for providing beneficiaries with a say in the business’s affairs – particularly if they work in the business.
GUMBO IS BETTER THE NEXT DAY
A successful family business is the product of a generation and an opportunity for the next. Prior success is no guaranty of future results in the hands of another, but gumbo freezes well and the right ingredients stirred in with some hard work and a little luck can put food on the table for a long time to come. Theus Law Offices provides a complete range of business services. If you are facing an issue with a small business and need a Louisiana business attorney in Alexandria, Lafayette, Lake Charles, Baton Rouge, New Orleans, Shreveport, Monroe, or elsewhere, let our business attorneys help you and your business.
“Someone is sitting in the shade today because someone planted a tree a long time ago.” Warren Buffett