Keeping it in the Family: What You Need to Know About Family Succession in Business

Clinton Larson: Hello and welcome to EB & Flow. I'm your host, Clinton Larson. And today we're going to be talking about navigating the challenges of family succession in business. And joining me to talk about that topic is Chad Flanagan, a partner here at Eide Bailly. Welcome to the podcast, Chad.

Chad Flanagan: Glad to be with you Clinton.

Clinton Larson: So today's topic, you know, family owned businesses are obviously a backbone to the economy in the U.S. here. And many start those businesses, I think, with the idea that, you know, maybe one day they're going to pass that down to the next generation. And, you know, doing some research for this topic, I found that it looks like around while around 30% of family owned businesses transition to that next generation, you know, that percentage drops drastically as we get into the third or the fourth generation. So I'm curious, you work with a lot of families in this recession process. You know, like what is that typical of what you see?

Chad Flanagan: It really is. We know that if a business is successful in getting to the third or fourth generation, that they're doing something right. You know, either they have a good succession planning process or they've worked very hard to get this to the next generation. And so, you know, we like to celebrate with those clients as they get to the third or fourth, fifth generation. It's difficult. And I think that's why we see the percentage as low as they are. And so, you know, those that take on a process and get help have a much higher chance of success.

Clinton Larson: What makes that transition so difficult for a lot of families?

Chad Flanagan: It's about the emotions Clinton. So it's a very difficult process. We work with a lot of business owners that have a hard time letting go, have a hard time trusting in the next generation to pick up where they left off. And so we find that sellers and the exiting generation has a difficult time because the process is innately difficult to navigate.

So you imagine that you have to choose a new successor and you have to choose between your children or your siblings children. That's a very difficult process or you have to kind of plan the next stage of your life. And you've probably, you know, you've tied your success to your personality. You're afraid of what business or what life looks like once you pass on that business.

And so it's very important in a process like this to step back and understand the emotions involved in the process. And really, we've started to work more with business owners and ask them those difficult questions of what are you going to do as you retire? What role do you want to play in the company, if any? What are your hobbies, things like that you wouldn't think would be an important to a succession plan, but are very important.

Clinton Larson: We've been talking about succession and transition of businesses on the podcast here for the last couple episodes, and one of the things that I've been hearing through these conversations is, you know, you need time, you need to give yourself a good runway for this stuff. So I'm curious, you know, when someone's starting to think about a transition like a family succession, you know, where and how do you start that conversation? Then what's an ideal sort of timeframe? How do you get rolling on what you were just saying? Like some possibly very difficult questions?

Chad Flanagan: Yeah, that's a great question, because getting started is just it's so important and it's where a lot of business owners fall down that it is difficult to get some momentum behind it. We like to work with our clients and tell them that if they give us 3 to 5 years to work with them, we can get a good plan in place and help them be successful in the process. And that usually starts with the business owner. Not always.

Sometimes we get generation two that says, Hey, I'm ready, help me talk to my mom or my dad or G one and get a process in place. But a lot of times it is that current business owner that says, you know, I'm of this certain age and I need to start thinking about next steps. What do I do? Can you help me? And, and so that is step one. And we can kind of go through and we like to involve all the stakeholders in that process.

So that's the next generation that could be family owners. Family employees could be nonparticipating family, that it affects everybody. And so the more we can invite to the process, the more successful we think it will be. It creates buy in, you know, and I think that's the key, is that if you get everybody a chance to participate, you create buy in and plans are more successful that way.

Clinton Larson: That's good to know. Yeah, I was just thinking my next question would obviously be like, you know, you're thinking about getting all these family members together and you know, my holidays are pretty good, but I know I hear horror stories from other people, you know, so like in terms of like do you have a family like that together? You know, how do you make sure everyone's on the same page or what do you do to ensure everyone is on the same page?

Chad Flanagan: Yeah, you're right. I mean, this is why family business is so great. And why it could be so difficult is that these people are together a lot. And so it is, I think, very important to have a team, a third party facilitator. We oftentimes in this process, will interview each of the stakeholders and find out that, you know, things that they really haven't talked to each other about, you know, strain and relationships or, you know, you might find out that those that were pegged for leadership and ownership responsibility aren't interested in those things.

And you might find that the leader you thought was going to take over the business doesn't have the confidence of the rest of the team. So it is those things that I think sometimes a facilitator, third party can get from those stakeholders that maybe a family member can't. But there is a challenging part of this is that. This affects the holidays and this affects the family get togethers where obviously because closely our businesses, you don't have those same challenges.

Clinton Larson: Right. So tough conversations, but obviously necessary conversations. So what are some tips that you would have for navigating those kind of conversations? You know, when you walk into a situation where you maybe know there's some potential for some stress or some strain. You know, what are what are you doing to help mitigate that? And how do you just approach those conversations?

Chad Flanagan: I think the first step is just to appreciate that there are a lot of emotions with this process. Early in my career, Clinton, I would kind of jump into tax implications and business value and, you know, structuring notes and things that were attractive. And it was probably more quantitative analysis. And I think as we work with more and more families, we understand how important it is to understand the relationships.

We like to start a question with all those stakeholders and really ask, What is your social contract with the business? What do you want for yourself and your family from this business? And we are often surprised at the responses we get. And so we find that sometimes these individuals don't have the risk tolerance to be an owner of a business or they have other passions in life, and we're afraid to talk about it. So I think just having some one on one time with the stakeholders really understand what drives them, what excites them about the business. So what concerns they have is an important step.

Clinton Larson: And what are some of the other common challenges you see pop up as you're having these conversations? You mentioned some pretty big ones there, but what are some other ones that just, you know, that maybe people wouldn't see coming but is sort of a common challenge, you know, happens with family succession.

Chad Flanagan: Yeah, with family businesses. You have the additional stress of figuring out where everybody fits in the business. I think that's issue number one. Who should have a leadership role? Who gets opportunity in the business? You have family, you have spouses, you have non-family employees. So there is a lot of jockeying to figure out who fits and what role. And it does affect family harmony in that way. But if you think about it, there is a host of other issues that family businesses have, including compensation, promotion, eligibility. Some families have governance issues that would require you to work outside of the business for some number of years. And I think just kind of getting a plan together and navigating through those and getting on the same page is an important step there.

Clinton Larson: And I'm guessing, like a lot of parts of a transaction, there's no cookie cutter approach to this process with the family. Right. Like you're dealing with such a history there in terms of how people have lived together, how people have treated each other. You know, there must be it must always be a unique approach when you're when you're taking on this process, I would guess.

Chad Flanagan: Yeah, you're right. You're dealing with people that have known each other their whole lives. I've had discussions and interviews with stakeholders where, you know, there is conflict between parties and stories about fights on the playground come up and you just don't have that in the world where on family business. So it's important to recognize those things.

And the other thing I'd say, Clinton, is that, you know, sometimes the conflict comes from just people with different visions for the business. That's not a good thing or a bad thing. And so stepping back, going through a succession planning process, it's really as much a strategic planning process as anything to say. What are our goals? How fast do we want to grow? How aggressive do we want to be? How much risk do we want to take? We find naturally that generation one probably wants to minimize risk and protect their assets and their investment, and generation two wants to grow and conquer the world.

And so they want to take risks. And so they fight on a daily basis over operational issues because they view the direction of the company in two very different ways. So to invest in equipment, technology, people is there's two different approaches to that and it leads to conflict. So again, in preaching, a lot of get a plan together, go through a process, but a lot of good things happen from those steps.

Clinton Larson: And what does success look like in those scenarios? You know, obviously, you just mentioned there's there could be conflicting goals in terms of like, you know, where people are at in their lives. So how do you sort of define success for a family succession plan?

Chad Flanagan: That is one of the questions we would ask those stakeholders as well is just how do you see this? You know, the easy answer, I think, is that if you look two or three years after the transition, that the company successful, that people figured out their roles, that, you know, that they were properly trained and developed to fill those roles and that the business owner or generation one has let go and let the new leadership make some of their own decisions. I know that's always a touchy area. As you know, the exiting shareholder has helped create this company. They know the company in and inside and outside.

We, you know, most buyers want to continue and get their help in a transition, but that looks different for everybody. And so that's an important step. But yeah, you can't really tell until you look 3 to 5 years later and say, yep, they're off and running and growing the company in their own way.

Clinton Larson: I wanted to ask about what you were just talking about, too, of this idea of the, you know, generation one or the current owner wanting to stick around for a little bit and maybe just not be the boss, but have, you know, some hands in there and just make sure things are going smoothly. How do you navigate that sort of power transfer when you're when you're maybe they're both, you know, maybe two generations? Agree, okay, we'll do this together for a while. But, you know, I'm going to be in charge and you're just going to be like a consultant kind of deal maybe. How do you navigate those kind of discussions and that kind of plan?

Chad Flanagan: It's good to talk about it. It's good to have those parties talk about how they see this play out. I think sometimes we really like that exiting shareholder to serve on a board or have oversight at a really high level. But let the new generation be the day to day leadership and let them figure out how they want to accomplish those goals. So that's one scenario where we think that is a good path going forward. But there is oftentimes, you know, customer relationships to transition. Some know how in operations or the industry and the buyers really want to benefit from that knowledge. And so it's just good to have good communication on, you know, what each party wants because, you know, sometimes those sellers already just wash their hands clean after a couple of months and maybe that's welcomed or maybe that is a concern for the buyers. It's good to have that conversation.

Clinton Larson: You mentioned before that sometimes, you know, the person that maybe we thought was going to take over our business isn't the person that turns out is the right fit for that transition. I'm curious when you're going through this process and you get to a point where you realize like maybe family succession isn't even an option, it wasn't even a good option for the business. How do you bring up that topic? How do you talk through that when, you know, maybe like this, this generational plan is just not going to work?

Chad Flanagan: It's a very difficult conversation, but a very important one. And it really is part of our process. So the exiting shareholders generation, one would know that as part of our process, we're going to interview stakeholders and we're going to assess readiness of the next generation to lead. And it does happen. Clinton, where we find out that that family member is not ready. They're not earning the respect of their peers. They're not executing in operations. And we do need to share that with generation one.

And so that is a benefit of working with a third party that we can have some of those difficult conversations better to know upfront than to be three years into a succession plan and have people leave or not have a plan B. And so I think, you know, as we go through that process, there's things like personality PI test, there's also feedback, there's, there's things where certainly maybe they just need development and they need some training or some awareness of, of how to get to the next level. Other times they just don't have it in them. And either way, good. That's where the plan really needs to start is let's identify leadership, put the business first and identify the leadership that's going to help this business continue to grow.

Clinton Larson: I would say of this topic we're talking about it can very it can be very difficult conversations to have with people. And obviously, family members are probably also learning a lot more about each other than they ever maybe even knew. And they're also sharing that with you. So I'm curious, like, how do you build trust as the as the, you know, third party coming in as the stranger sort of at the table, so to speak? You know, how do you make sure you're building trust and a rapport with the family so that you can have these open and honest conversations?

Chad Flanagan: Clinton I always think about that before we start these processes and start having some interviews and meetings with various stakeholders. Certainly it's important for us to listen. It's important for us to be non-judgmental. I'm often very surprised by how quickly people will open up, and hopefully that is because we build trust. And I think it's mostly because nobody's really asked these questions before. What do you really want from this business? Where do you want to see it go? What do you want your career to look like? And it's an opportunity for them to share thoughts that they've been accumulating for years about opportunities for them or the business. And I think they really enjoy that process and get a chance to voice their opinion.

Clinton Larson: So the goal then, obviously, is there's that when this is done, you have a happy family, happy, happy plan. You have it just everyone's on the same page. You know, that must make you feel pretty good, too. And you get a chance to actually work through this with families.

Chad Flanagan: I'd imagine it does, because you you're pulling for them for sure. And, you know, it's a difficult process. You're excited that they're committed to it. You want to go in there and first do no harm. You set back relationships. You hope that if conflict exists or it arises, that it's healthy. And I think it's important to, you know, you can build that trust with them and with each other and then have some healthy conflict or debate about the direction of the company and who fills what role. But that at the end of the day, they're better off for it. You know, this doesn't this doesn't pop up at the Thanksgiving dinner conversation, is it? Already talked about it. They've already worked through it.

And you're right. It's a process where you feel like you can bring your experience and some of the tools in and really help. And so you're right, it's very rewarding work.

Clinton Larson: So for somebody who's considering passing their business on to the next generation, say they're thinking about it right now and they know they've got some time ahead of them to think about this. What are some of the things that they should do or they can do now to lay the groundwork for a successful family succession plan?

Chad Flanagan: I think two things. If somebody is thinking about, hey, I should really start a process like this one is think about what's most important to you. As I start conversations with business owners sometimes that the answer to that is legacy. Sometimes it's really family harmony. I worked with a client recently where the community was his number one concern.

So keeping jobs local, helping keep the community vibrant. And so think about what's most important because that might drive some of the decisions who you've run with in this process. And for those of you that say getting top dollar, I think that's an equally fair answer. So but think about what's most important for you. The next probably most important step is get a team put together. There's a lot of applications for this. Having a good attorney, having a good accountant, understanding the taxes, maybe having somebody facilitate some of this conversation, whoever you have good relationships with that have some experience in this space and there are many good professionals out there that can help.

I think once you have that team together, they can help you navigate through a process and make sure that everything's well-planned out and thought through.

Clinton Larson: Regarding what you just mentioned about getting top dollar for your business, what are some of the ways, too, that, you know, if people are thinking about this now and they have the time, how can they make sure that that that final valuation of their business is something that meets their goals and it gets them to that next phase in their life.

Chad Flanagan: We always encourage that the client look at a business valuation, whether that's a formal business valuation or something less formal. It's important to understand how buyers are going to value the business and run them through, you know, maybe a market approach or an income approach. We have a team that will look at where are multiples in the industry. What's most appropriate? Is it a multiple of revenue or earnings? Is it the is it the balance sheet that we look at? What are those value drivers? Because if you do have time, you can really focus on those value drivers and get a better sales price. And so, you know, understanding where the market is and what's driving price is a is a fruitful exercise, especially if you have a few years in front of you.

Clinton Larson: And what about those businesses that find out, as we were just talking about, that family succession is not really the best option for them and they're positioned well and the valuation is right. You know, what are some other who are some other buyers that could potentially step up and purchase that business?

Chad Flanagan: I think you think about it in terms of whether it's the current employee or family group that's going to continue to own the business or whether it's an outside party. If it is the current employee base and it's not the family, maybe an employee stock ownership plan is a good option for you. There's a lot of benefits to there, too, that there might be some tax advantages.

And so maybe you have a good management team that is non-family and that might be a mechanism for you to transfer ownership. If you're looking outside of the company and you look to third parties, they're strategic buyers. So maybe a competitor. And there's pros and cons to that, maybe somebody from outside your market, but somebody in the industry.

And then there are financial buyers, private equity groups that may be interested in getting into the industry or expanding their markets. So, you know, understanding who the buyer is might greatly impact your strategy and even how you plan for that. So I think, again, understanding who your buyer is one of the very first steps. And I think we've got teams and Clinton, we might want to talk about that in further podcast, just to talk about the advantages and disadvantages of each of those buyers.

Clinton Larson: Right. And we've had some really good conversations so far on the podcast about transitioning your business and exiting your business. And we hope to have more to come because obviously, as we just discussed, this is a complex topic. It is an important topic, and it's a big one for any business owner to have to tackle.

So, Chad, thank you so much for the insight today on the family succession process. I think this was a really good episode and thanks for being on the podcast.

Chad Flanagan: Thanks for having me.