Timing issues

When my 16-year-old son (my only child) expressed enthusiasm about taking over my corporate finance business, I said to him: “Ok, let’s see how this would work out as far as timing. You have four more years of high school, followed by about six years of university (undergraduate and MBA), followed by eight-ten years of work experience. That means you could be ready to take over the business in about 20 years time. A lot of uncertainty there! Will you still want to take over the business in 20 years? Will I remain healthy enough to run the business for the next 20 years? In my case, an intergenerational transfer would be a very long-term strategy indeed. And a somewhat risky strategy as well: unless there was some back-up plan, the likelihood of my being in good enough health to manage a grueling business into my seventies is certainly not 100 percent.

You should therefore think through the timing issues very carefully.

Issues of competence

Would you want to transfer both the ownership and the management of your company to your offspring? If you have professional management in place, the transfer of ownership may be easier (although overseeing or eventually replacing management is fraught with difficulty as well).

In most cases, owners transfer both ownership and management to their offspring. Parents often do not realize that skills that they have accumulated over many years, sometimes decades, are not that easy to transfer to children within just a few short years.

Have you made a full and honest inventory of the competencies required in the CEO position, or whatever leadership position you wish your child to assume? Sometimes the competencies required can be quite daunting, ranging from professional qualifications to people management skills, and from excellent salesmanship to business development skills within the industry. A proven track record is always better than theoretical competencies.

Improve the likelihood of success

A psychologist that my firm has worked with very closely in the past specializes in the area of intergenerational transfers. While he cannot predict the probability that a child will succeed in following in a parent’s footsteps, he can predict, with close to 100 percent accuracy, when a child is likely to not be successful. This can be invaluable information. Why set your child up for failure? (Not to mention the financial implications, if you are expecting payments over time from your child for transferring the business).

You might also consider rotating your child through several positions within the firm before they take on leadership or ownership of the firm. Have him or her learn the business from the bottom up—marketing and sales, production, finance, etc. This will allow your child to move up the learning curve; it may then be less of a leap to the CEO/owner function. It will also allow you to gauge whether your child is capable of taking the leap, and which staff would relate well to your child. Be careful: employing children usually creates some tricky dynamics with staff, especially if the child is promoted very rapidly. You may also consider making your child CEO and minority owner, while you remain chairman and majority owner. A gradual transition allows corrective action, if required.

Taking over a business from a successful (and often domineering) parent is an intensely personal affair, and not an easy task. Family politics or intergenerational issues may also create enormous difficulties. A successful transfer requires as much effort from the parent as from the child (and sometimes restraint!)

Financial implications

An intergenerational transfer is typically driven by the fact that one or more members of the family feel strongly that the business should remain within the family. This objective often has drawbacks from a financial perspective:

1. Intergenerational transfers seldom result in the type of valuation that might be expected from a fully competitive sale process. Hence, if the owner is looking to maximize proceeds from such a transaction, he or she is likely to be disappointed.

2. Because children seldom have the liquidity necessary to purchase your business, transactions are often structured in such a way that compensation to the owner is deferred, either by way of a promissory note or an “earn-out” type transaction. In either case, if the next generation of owners drives the business into the ground or does not meet expectations, satisfying the payment obligations or expectations could be a major issue.

    

Conclusions

There is only a small subset of businesses where intergenerational transfer is the most appropriate exit mechanism for owners. If you decide that you would like to investigate intergenerational transfers more closely, tax and estate planning should also be part of your strategy.