Owning a family business is as much a part of the American dream as having the house with the front porch swing and white picket fence. It’s a fine dream to have, and for many, it can be a reality. However, owning a family business is hard. You’re dealing with all of the normal problems business owners face while adding family dynamics to the mix. Things can grow even more complicated when it’s time to leave the business. In today’s entry, we’re going to explore some of the problems that come with your kids taking over the family business.
Follow Along With The Financially Simple Podcast!
This week on The Financially Simple Podcast:
- The Three-Generation Rule (1:10)
- “Most of it is nonsense!” (1:50)
- Entitlement (4:09)
- Is your dream your child’s dream? (10:22)
- Planning for future generations (12:20)
- Sibling rivalry and the family business (15:10)
- Mitigating the pitfalls of your kids taking over the family business (16:27)
Family Businesses and the Three-Generation Rule
If you’ve been in or around family businesses long enough, you’ve probably heard of the “Three Generation Rule.” Basically, it states that, by the third generation, they cannot manage the business so, it ultimately fails, taking the family’s wealth with it. According to Score.org, 30% of family businesses survive the transition from the first to the second generation. But only 12% make it from the second to the third generation. But does this truly indicate what the Three Generation Rule suggests?
Josh Baron, one of the world’s leading family business consultants doesn’t think so. “I get frustrated with the Three Generation Rule and the failure rate of family businesses; most of it is nonsense,” says Baron. “The reality is that making a business last 90 years, or three generations, is a huge challenge.”
The Trouble with the Three-Generation Rule
The truth about this commonly cited rule is that it came from a single study back in the 1980s. Additionally, the study followed very narrow guidelines. Only looking at manufacturing companies in Illinois, the findings are often described incorrectly. Many claim the study found that only 30% of family-owned businesses make it to the second generation.
However, it actually says that 30% of these companies last to the end of the second generation. That’s 60 years, folks! Additionally, the researchers found that 74% of family businesses made it for at least 30 years, 46% lasted for 60 years or more, and 33% survived for 90 years or longer. Meanwhile, Josh Baron and Rob Lachenauer cite a separate study of 25,000 publicly traded companies from 1950 to 2009 found on average, they lasted around 15 years, or not even through one generation.
So, the numbers aren’t as bleak as the Three Generation Rule suggests. But there are still problems associated with family business transitions.
4 Pitfalls of Your Kids Taking Over the Family Business
As much as I would love to tell you everything will just fall perfectly into place, that’s rarely the reality. There are many potential problems when planning to leave the family-owned business to the next generation. However, I’ve keyed in on four of the most common problems in a family business transition.
Typically, when we think of entitlement, we think of younger generations. However, entitlement often exists in the founder’s generation as well. In many family businesses, there’s this idea that you can continue running the business until you die, and everyone else will just have to wait their turn. Entitlement, from either generation, is often a root cause of family business failure.
Entitlement from the younger generation can cause non-family team members to become frustrated or even seek other opportunities when prospects for advancement are removed because they don’t share your last name. Similarly, your children may not be willing to continue waiting well into their 40s or 50s, for you to pass the business over to them. Entitlement causes resentment and diminished morale in the business and can lead to problems within the family unit. But what can be done about it?
Younger generations must take an active role in their education and preparation for an eventual transition. This can be done by working their way up through the ranks of the business while participating in a formal management development & training program. Meanwhile, the older generation must prioritize business continuity over personal control. You can achieve this by developing and strictly adhering to a succession plan.
“Your Dream, Not Mine!”
Another common pitfall of leaving the business to your children is a difference in personal passions. Think about it. Do your kids even want to take over your business? Maybe they don’t feel the way you do about your particular business. After all, it was your dream, not theirs.
If this is left unaddressed, or if you stubbornly refuse to accept it, it can create major problems when it’s time to transition. Therefore, you should have conversations about this with your kids, early and often. Although it might not be what you envisioned, you may find that selling to an outside buyer is the better path for business continuity.
Failing to Plan for Future Generations
If you really want to prepare for the future success of your family business, you must plan beyond the transition between you and the next generation. Your family will continue to grow and you’ll need a formal plan for how to handle what David Herritt, head of GenSpring Family Office Services, calls the “Cousin Consortium.”
Herritt describes the Cousin Consortium as a multigenerational family business that now has 12 passive shareholders through cousins who neither work in the business nor serve on the board. He suggests that family business owners should take a little extra time to plan for issues like these that come from having a more developed family tree.
Continued engagement, even from the extended family is vital to the long-term success of a family business. Family Business Magazine suggests:
- Holding meetings in fun locations.
- Having the entire family participate in a volunteer activity.
- Inviting them to tour your facilities and meet key employees.
The primary goal here is to foster continuous engagement from the family.
Perhaps one of the biggest obstacles family businesses must overcome is sibling rivalry. As you work through succession planning, you would be wise to look for examples of sibling rivalry among your children. If you find that it’s a problem, you’ll need to determine if it’s emotionally or strategically driven.
Emotionally driven sibling rivalry often stems from the need for family approval or recognition. You could remedy this by implementing a formal achievement recognition and award program within the company. Additionally, you could require your children to work for other businesses before being employed in your own. This enables them to develop confidence based on their own achievements and mitigates the need for parental recognition.
Strategically driven sibling rivalry, on the other hand, comes from siblings developing or holding different values, risk tolerances, and management styles. This can be managed by incorporating a rigid set of corporate values and a well-structured method of corporate governance.
Owning a business is one of the hardest jobs a person can have. When adding family into the mix, although rewarding, it can really amplify that difficulty. If you’re planning to pass down the business to your children, you may need to take a little extra time on your succession plan to account for some of these unique challenges.
Friends, life is hard. So, is owning a family business. But hey, life is good! Leaving the business to your kids can be frustrating but it doesn’t have to be. Take some time to work on your succession plan and please, seek the help of a competent and trusted advisor. You’ll be glad you did and it could help make your family business transition at least financially simple. Let’s go out and make it a great day!
Are you planning to pass your business on to your children? We could help. Reach out to our team to learn more about how we can help you prepare for a successful transition.