Originally published on Canadian Metalworking, August 22, 2016. www.canadianmetalworking.com.

As a career banker, my expertise on succession planning has been mainly restricted to financing transitions for management buyouts (MBO). For next-generation family business owners, however, it can be an emotional transition.

When it’s time to pass the baton to Junior, some founding business owners do what’s intuitive: hand over the business with little or no monetary exchange. After all, Junior has worked in the business for the past 20 years. His sister has a career of her own, she’s not interested, and she has not spent a day of her life building the business. Well, she might have worked in it for a summer or two, but they don’t really count. Junior’s deliberation only confirms his sense of entitlement. I may add that this scenario has been proven to destroy value.

Upon retirement at 65, Dad would have done well, but still is far from being filthy rich. If the business valuation was done by a third party, Dad could retire comfortably, allowing him to pursue life-fulfilling passions he has deprived himself of for decades. But the valuation — and whatever amount Junior intends to pay — has been validated by the firm’s accountant of over 30 years.

This story, although fictional, happens in many next-generation succession plans. Lack of communication and clarity, sense of entitlement, and mismanagement of expectations are among the worst culprits.

Succession planning often is a taboo subject at the family dinner table.

In his best-selling family business book Every Family’s Business, Tom Deans emphasizes the importance of having a “family blueprint” several years before the sale of the business.

He highlights 12 questions aimed at building consensus. One of them is a straightforward question from parent to child: Are you interested in buying stock and acquiring control?

Open Discussion

While not everyone may buy into Deans’ idea that pursuing family business longevity destroys value, I share his opinion when it comes to having parents and children pull in the same economic direction. Thus, an honest discussion between both parties must take place to determine and achieve goals that will have equitable monetary benefit for both the founder and the next generation.

Business owners should ask several questions when contemplating a succession plan. They are:
1.How much do I need to retire?

Understanding your financial needs and what exactly you want to do after running a business will help you design a succession plan. It will also set the framework for how you will create value in the business while still actively managing it.
2.What family dynamics do I need to deal with prior to and during succession?

Passing a business to the next generation is easier if only one person is standing in line. Having two or more children involved in the process complicates the situation, especially if the children are pulling in opposite directions. Family dynamics have caused founders so much agony, defeating the purpose of preserving wealth for the next generation.
3.Is my child willing to take over the business?

Most founders have the “grit” that made them successful in running the business. If your child is somewhat interested but his or her passion is not in it, it’s time to look for an alternative exit strategy.
4.Is my child capable of taking over the business?

They may be passionate about the business but lack business acumen and leadership skills. Your instinct should be to hand control to a capable party or have your child take minority ownership and remain in the business. There’s nothing worse than handing over a business to someone you suspect will take what you worked hard for to the ground.
5.Do I have an objective business valuation?

Has there been an offer to buy from a third party? The only way to decipher the real value of your business is to get a third-party valuation. Better yet, test the market for potential buyers. Understand industry multiples that similar businesses have been sold for.
6.Assuming a third-party valuation was done, can my child afford to acquire some shares or 100 per cent of the company’s shares?

I always caution business owners that gifting your business away destroys value very quickly. If a child can’t afford the full amount, he or she can secure financing by leveraging the business. If the next-generation owners don’t have real skin in the game, it’s much easier for them to walk away during difficult times. No business has ever been free from challenges, as we all know.

Alma Johns is president, Bench Capital Advisory, 416-238-2204, www.benchcapital.ca.