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Managing transition in a family owned business

Chip Osborne

An episode of The Profit ran on TV recently. The subject was a family owned custom furniture store that was in trouble because of the leadership. The episode brought a number of issues to mind concerning the transition of ownership in a business between generations. Having been through one that should have worked and being friends with several men through trade associations whose transitions failed, I’ve come to understand the necessity of a simple succession plan.

There are two initial problems in family business transition. First, the child doesn’t truly want the business or wants it for the wrong reasons and second, the dad won’t let go. Too often what the son has heard growing up is how they will be making money together when the son joins the firm. Many TV shows have been written around that premise and they aren’t too far off from reality.

The originator of a business started it with an idea and a passion to make the idea work. My dad was a perfect example. He took portraits and sold them during the day and then spent nights developing them. He worked long hours seven days a week to make his dream come to fruition.

He took out mortgages on his house to invest so the business would grow. In doing all of this he knew the business from the ground up. He knew all aspects of the business: finance, marketing and production. This is typical with every sole proprietor that started from nothing. The son (could be daughter too) joining the business is handicapped because he or she has not grown through that experience and often expects to start where the dad is finishing. The child is inadequately prepared to make the correct business decisions.

Eighty percent of all family businesses fail because of the transition from the first generation to the second generation. The failure rate for the third transition is upward of 98 percent. This is sad because the solution is so simple.

To run a business successfully the leader must have a passion and confidence strong enough that he is willing to make whatever investment of time and money is necessary for the business grow. A friend of my parents retired from his business at age 56. He recognized that he was no longer willing to take the risks or do the homework necessary to make the business grow. He sold it to an employee with the passion and drive to make it work. It is up to the parent to let their child know that joining the business is a possibility and then both determining if the child really wants it. The business will not be a gift. It will be earned, which in itself will be proof of the passion.

The dad who started the business becomes its parent and the business is his baby. Teenagers grow up and through natural progression begin to make their own decisions and push back against the rules of the parent. The business has no such progression. It just does what the owner tells it to do. It is rare that the owner, like the friend mentioned earlier, is wise enough to recognize what the business needs is what he cannot or is not willing to give anymore. As the patriarch ages, his drive to compete wears out and his goal evolves into keeping the business as it is rather than adapting.

A second problem occurs when the dad won’t let go. A friend of mine in Ohio was passionate about photography and loved working in his dad’s studio and had since he was a young teen. After finishing college, Ted had a lot of ideas for growing the business, but dad squashed them all as being not worth the effort. They had always done it this way and dad saw no need to change. The business was getting by but not growing. Ted recognized that it was beginning to stagnate. As he approached age 30, he decided he had had enough and quit to take a job selling cars where he easily earned three times what his dad was paying him. His dad was shocked and prepared to close the business he loved for 40 years. He realized he couldn’t run it alone anymore. Ted made an offer dad couldn’t refuse. Ted would own and operate the studio and pay dad 20 percent of profits plus $2,000 a month as a consultant/photographer. Ted would own everything and be 100 percent boss. It worked. Ted put his ideas into action and the studio grew strong and very profitable.

The problems Ted and his dad experienced could have been avoided with a reasonable plan. The plan is organized like the requirements necessary for school graduation and linked to the son’s pay scale. (There is no free lunch). Each step in the plan is spelled out in writing including what is to be mastered. A criterion required for completion must be included. The plan should include becoming proficient at each step in the business including finance, marketing, the business plan and production. Since the son will eventually be leading the employees, it is highly beneficial that they know he thoroughly understands what they are doing in their job because he has been there in the trenches and excelled.

At some point in the learning process it would be ideal for the son to work in the same industry outside of the family business. My dad had planned for me to go to a photographic lab in Dallas, Texas, for a year to learn their business. Dad would pay half my salary and they would cover the other half. The businesses were 2,000 miles apart and not in competition so this was easy to do. I would get a great business experience and they would get a half-price employee. Two things would be gained from this plan. First, there is broad practical experience away from being the boss’s kid. Second, in a different business one can see different ways of doing things. This plan gives experience without the microscope of the family business employees.

The most important part of the succession plan is the clear transition of the business management from dad to son. Like what Ted needed in the photo studio, the job goals and responsibilities must be clear to all at every step. Past business relationships of the dad will often try to make contact through the dad from habit. Employees may still go to the dad for answers from habit or to get around the decisions of the son. And, dad will probably respond to these contacts as if he was still in charge. The lines of authority must be clear and consistent. It may be necessary for the dad to take a few months of sabbatical to break this cycle.

The procedure is simple to make a transition work, but so few family businesses develop a plan and they make other mistakes. The kid is overpaid and underworked or overworked and underpaid. The son is expected to know everything the dad knows just by being his son. Employees will hold the son to that standard before he is out of high school. And, the dad remembers all of the failures the son had growing up expecting those to continue in adulthood. The transition plan overcomes these issues.

People in small family businesses usually do not know they need help. The statistics presented on The Profit were incorrect. Eighty percent of all family businesses fail because of the transition from the first generation to the second generation. The failure rate for the third transition is upward of 98 percent. This is sad because the solution is so simple.

My dad died of cancer over a three-month period leaving the majority of company stock to my mom. She had never been in any management position in any business and only knew how to balance a checkbook. But, since the bank required her to personally guarantee any credit and she had the majority of the stock, she was now boss. The transition plan of my dad was not written down and was therefore void. She felt the need to protect her income and keep things safe. She wanted to make a change recommended by the bookkeeper to prevent a regular loss that occurred in two months of the business cycle every year. She couldn’t understand the negative economics of the idea and I was not experienced enough to overcome her determination. I was dismissed for not going along and the change made. Six months later a 45-year-old profitable business was closed and 65 people were unemployed. Any succession plan needs to be written down in detail and signed so everyone including other siblings knows exactly what is expected and who is in charge.

That is the simple of it. Of course the plan itself must cover everything for the specific business Simple Steps teaches. Too often the college business degree is accepted as knowledge enough. Anyone can memorize the texts necessary to fly an airplane. That doesn’t mean they can fly it. The thorough plan ensures the heir will know the business and the business process from experience before they take over.

Chip Osborne is a mentor with the Reno office of the Service Corps of Retired Executives.