Business Insights

Should Your Child or Key Employee Take Over Your Business? Critical Questions You Must Ask Yourself Before Deciding

Private company owners who hope that their children will want to take over the family business should prepare themselves, the company, and the son(s) and/or daughter(s) methodically and as far in advance as possible. While it may seem like a long time, ten years is not an unreasonable timeline.

If you’re thinking of retiring in the next few years but are still unsure if the next generation wants to take control of the business, there are better options than family succession.

The worst outcome for both parent and offspring would be a force-fit in which the parents’ financial position is diminished and the next generation is cornered into a career poorly suited for their education, experience, temperament, and personal interests. It is unlikely to work well unless both generations are really committed to the choice, and the child taking the lead is experienced, known, and respected by the board, next tier of management, and the employees. 

What do employees in a tight job market do when they don’t believe the company is run well or no longer like their job?

When Deciding Who Should Take Over the Family Business, Seek Advice First

Professional advisors help business owners think strategically and personally about their “next step” of the ownership lifecycle, which could possibly involve a family business transfer to the next generation — but that transfer method should be considered only one of many available options. A key employee or employees could be another option. Beyond those employees, there may be several other worthy options, too.

To start, owners should assess their own personal and financial goals, the business’ value, market attractiveness, and the market conditions for transfer. 

Simultaneously, a dispassionate, candid assessment of the next generation is crucial. A qualified executive recruiter could help with this task, establishing the necessary objective analytical framework and emotional separation.

While attorneys and accountants may be critical partners in estate and financial planning, investment bankers specializing in the merger & acquisition (M&A) of closely held companies are in a better position to help with the business and market assessment, providing more directly informed analysis of transaction options.

Since a family transfer is only one option, company owners should think broadly and openly without presumption. 

When working with company owners, I ask them to complete a simple, 29-question “Business Owners’ Transition Planning Quiz” to spark reflection on their personal desires and financial needs, the abilities of family and/or employees to take over, and the business’s market position. If they choose to share the results, it can be a useful conversation catalyst. However, the tool’s greatest value is to the business owners themselves.

Statistics show that most owners do not seriously contemplate the basic but important issues associated with a major transition very far in advance of a decision. They cheat themselves of options and flexibility. By instead assessing their future business path from a strategic standpoint rather than an emotional one, they help themselves to better see all available options. 

10 Questions for Business Owners Considering Family Succession

Among the questions I typically ask business owners to consider, 10 most directly address the question of family and/or key employee succession:

  1. Would you like to sell your company to employees and/or family members?
  2. If yes, would getting less money than if the business were discreetly, but actively, marketed to other potential purchasers change that answer? 
  3. If yes, would you be willing to finance much of the sale value? 
  4. Do you have children who are ambitious and genuinely enthusiastic about taking over the business? (This question is equally applicable to a prospective employee leader.)
  5. Do they consistently demonstrate a desire to learn as much as possible about the business and its future?
  6. Considering their experience, education, personal capabilities, and drive, would they be more likely to build their own personal wealth by taking over and growing the business or by responsibly investing in a diversified portfolio of financial assets instead? Also, consider that since 1957 the S&P 500 has delivered an almost 8% average annual return.
  7. In general, would you consider this person more of a leader or a follower?
  8. Do they bring the right skills to position the business for future success, e.g. raising the company’s digital capabilities to expected competitive parity, if not market leadership?
  9. List the top three strengths and top three weaknesses of each potential successor.
  10. Is it likely that a CEO from outside the company could more effectively lead the business and position it for future growth?

A subtext to the questions should be abundantly clear: do not consider transferring the business to any family members or key employees whom you don’t feel confident will be successful in running it and thriving. 

Also, consider the capitalization needs of the business, the capital expenditures that will be important to repair, replace, and invest to move the company forward, and its ability to pay back the debt incurred to buy it, i.e. its free cash flow. This is calculated by subtracting capital expenditures from operating cash flow.

If today’s and tomorrow’s foreseeable challenges facing the business are beyond the skills, experience, and resources of the candidate you’re considering to assume leadership of the business, everyone will be better off if you sell to another company that is better equipped to fight for a prosperous future of the company.

These questions are best considered before discussion with prospective succession candidates. Emotional issues may be avoided, and owners will be better prepared for the conversation and less likely to fixate on only one exit option of several available; an option that could turn out to be the best, or the worst, one.

SOURCE: This article was written and contributed by McGavock Dickinson Bransford, CM&AA, who focuses on advanced manufacturing companies as managing director with investment bank Mid-Market Securities, LLC. He advises and writes articles pertinent to owners and shareholders of mid-sized companies. Contact him here. Image Credit: Motortion Films / Shutterstock

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