Key quote: “When you have children in the business owning stock and children outside the business owning stock, there is a natural conflict.“

From Divestopedia:

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Kids Taking Over the Business? 8 Things to Consider

By Josh Patrick

Takeaway: Transferring ownership of a business is difficult. Transferring it to a family member makes it even more complicated.

Many business founders dream of the day they can transition the business to their children. But while there is much in the literature that talks about estate planning issues, there is little talk about what it takes to make a business transition successful.

We live in an entitlement society. The baby boomers as a group have done a poor job preparing the next generation to nurture and grow the family business. This is partly because we haven’t had our children work in the business growing up. It also has to do with the expectations that we’ve set for our children.

The figure that says that 36% of family businesses are being transferred to the next generation is old research. So old, in fact, that almost no one really sees those sorts of numbers. No one knows what the real number is today. I think it’s likely much lower. Here are eight rules that’ll increase the odds of a successful business transition if your kids are taking the helm.

#1 Start with Rules for Joining the Business

Too many companies allow their children to join the business right after they finish their formal education. I think this is a huge mistake. How are you going to know that your children are competent? If they haven’t worked for another company and gotten several promotions, you probably don’t want them in your company.Treat children like any other potential team member in your company. Make sure your children pass the test for hiring in your company. Have them go through a hiring process just like any other potential team member might.

Put together a family constitution where you have rules for what it takes to join the business. Don’t have a zillion rules. Just a few will do. Make sure you follow the rules once you set them.

#2 Have a Real Job

Too many times children join a business and a job is made up for them. You don’t want to be one of those people. Instead, only bring a family member into the business if there is a real job that they’re qualified to fill.

You can’t have your child join the business as the chief operating officer when they’ve only been a salesperson in another company. They should not be allowed to have a senior role in the business until they’ve earned that right.

#3 Pay Needs to be Competitive

One of two things happens when children join the family business. They are either overpaid or they’re underpaid. Rarely do I see a situation where they’re paid the going rate for the job that they’re doing.

The biggest problem with this is that your other employees notice how your children are being treated. Pay needs to be on your company scale. No more, no less.

#4 Make Sure Your Children Can Grow the Business

A business that’s not growing is one that’s dying. If your children can’t grow the business and increase its value, you’re not doing your children a favor if you sell it to them. You’re not even doing them a favor if you give it to them.

Sometimes, the industry you’re in isn’t very good. If so, think about selling to a third party. Sometimes the economy is poor. That doesn’t last forever.

If your child is running the company and hasn’t grown the value within a five-year period, you should think twice before selling or transferring the business to them.

#5 Who Should Own Stock?

I’m a believer that only children who work in the business should be allowed to own stock in a business. I’ve yet to see a family business where it ends well when children outside the business own stock.

When you have children in the business owning stock and children outside the business owning stock, there is a natural conflict. The children in the business want to re-invest and the children outside want cash. This likely will not be a problem while you’re around. It often becomes a big problem once you’re either retired or deceased.

#6 Only Sell the Business, Don’t Give It

There are lots of fancy tax maneuvers available for transferring a family business to the next generation. Some of them make sense. They only work when they involve actual cash going from the junior generation as buyers to the senior generation as sellers.

Businesses that are gifted have no value to the recipient. Your children haven’t worked to pay for the business. They haven’t earned the business. This is one of the major reasons I see family businesses become less valuable. The buyers haven’t paid for it.

From an estate planning point of view, I can understand how children would resent their siblings being given the business. If your children buy the business from you, your estate planning becomes simple. You just split what you’ve got left between your children. When you start giving shares in your family business away, you’ve complicated your estate planning dramatically.

#7 You’ve Got to Let Go

This might be the hardest thing for you to do. You’ve gotten used to answering questions when people ask them. Your pride and your ego is likely tied up in your company. As you start to answer fewer questions, your phone will ring less. When you finally retire you’ll become a non-person in your company as well as your industry. These are hard things to handle.

It’s important that as you transition out of your business you transition into something else that engages you. Seller’s remorse increases when you don’t have a good plan for what’s next.

#8 Your Children Will Change How Things are Done

It’s important that you look at outcomes. Your children will do things differently than you. They’re starting when the business is in a different place than you. They’ve been given a big head start. They’re not trying to start a business from scratch.

If your children aren’t growing value and systematizing the business for growth, you have a problem. If they are growing enterprise value and they are being strategic and you don’t like it, they might have a problem. You’re just going to have to accept that things are different. It’s the way of the world.

Family Matters

Transferring ownership of business is difficult, at best. Transferring to family members is even more difficult. These rules are a good starting place. Your family is different from other families. You’ll find challenges that I’ve not covered. Be prepared, get good advice and have wise counselors while going through the process. You’ll be glad you did.