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North Bay Business Journal

Monday, October 1, 2012, 6:20 am

David Ryan: Hard questions for next generation in business

88% want family to take over; only 30% do

By David Ryan

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    As a family-business owner, thinking you have a succession plan in place and actually having one are different beasts. I often meet people who tell me they want to leave their business to their children.

    “I have a succession plan in place,” they will say.

    I often wonder, Do they?

    According to a study conducted by the Family Business Institute, 88 percent of current family business owners believe that the same family or families will control their business in five years. The study then revealed that only about 30 percent of family businesses actually survive into the second generation, 12 percent into the third generation and only about 3 percent of all family businesses operate into the fourth generation or beyond.

    As time goes by, the odds for success go down dramatically, and the odds of failure skyrocket. Are there other options than to leave the business to a family member? There are a number of ways to leave the company intact and leave your family secure, without all the headaches of running a business.

    Business owners need to diversify to minimize risk. Business owners typically will have between 60 percent to 80 percent of their net worth tied up in business or business-related real estate. As retirement approaches, however, no more than 25 percent of a family’s net worth should be tied up in one such asset group.

    One method of asset protection and diversification is to sell either all of, or a portion of, the business to a private-equity group. This creates liquidity for the family. The proceeds from the sale can then be diversified into a collection of high-quality assets such as stocks, bonds, mutual funds, real property or other suitable investments. Proceeds can even be put into a trust, so family members can receive monthly distributions. This powerful method can create wealth for future generations.

    If a portion of the business is sold to a private-equity group, those family members still active in the business can continue to run the company, receive salaries and have an equity stake in the business. Care must be taken to ensure the equity group is well-capitalized and financially committed to seeing the business grow. In many cases, this is an ideal situation. The business will have access to the funding needed to grow and will have expert advice from the talent that grew the business to begin with. All of these factors create the potential for a successful transition.

    Initially, some owners say they do not want to have a partner — even a well-capitalized one. However, many of today’s successful companies have financial partners. In these tough economic times, it is rare to find a family that has the expertise and experience as well as the self-sufficient capital to successfully transition a business to the next generation.

    These equity partners often are not in the business of running a company. They are in the business of value creation. They need the current, experienced management to run the business. This shift is what often is needed to take many of the family-owned businesses to the next level. Personal financial risk is reduced, while opportunities for family estate-building are increased.

    Today’s economy is unforgiving and uncertain. Bankruptcies are at an all-time high. Even billion-dollar companies are failing. Customers and suppliers are consolidating. A lot of things need to go right for a business to continue and prosper. A lot of questions need to be answered.

    Does the next generation have the same passion for the business as the current generation? Will they be able to replace lost clients and continue to grow the business? Do they want to worry about litigation and product and service problems? Will suppliers continue to function, so there are no shortages or reliability problems? Will the economy continue to favor your company’s products or services? Consider all the “mom and pop” stores that used to thrive. Where are they, now that the world is filled with nationally branded operations?

    Does the next generation want to worry about liability insurance, workers’ compensation insurance and labor costs? There are many factors that can have a powerful — and sometimes negative — impact of a business. These are all reasons to consider an outside investor who has both the money and the expertise to contribute.

    While the thought of an outside partner may be an unpleasant one, not having a business at all is likely a worse thought. With the uncertainty in this economy, a well-capitalized partner may be one of the things that can help a business to prosper in the coming decade.

    Being proactive is essential. Consider if one of your competitors gets such a partner. Would your business remain competitive?

    As an example, I once worked with an owner of a mid-sized manufacturing business. He shared with me that he had been deeply frustrated by one particular competitor over the years. No matter what happened in the economy or in their industry, his competitor could bounce back. During my industry research, I discovered his major competitor had strong financial and management backing by is partial owner, Wachovia Capital. Can you imagine a family business competing against a company backed by the then-billion-dollar Wachovia Capital?

    While there is a chance for failure with any succession transaction, it is important to understand that your risks can be limited with proper structure. On this line of thinking, I am amazed how many business owners forget all the personal guarantees they have signed for vendors, landlords, bonds and lenders. These guarantees need to be examined as part of any succession plan and eliminated if you do a transaction with a private-equity group.

    So the next time you think, “I have a succession plan in place,” consider what it is and whether an alternative plan may be better for you, your business and most importantly, your posterity.

    •••

    David Ryan (707-546-7860, David@DRJCapitalAdvisors.com) is founder of DRJ Capital Advisors LLC, an SEC-registered broker-dealer and member of FINRA/SIPC that provides mergers-and-acquisitions and exit-planning services to business owners.

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