Not Strategizing for Business Transition Now? A Precursor to a Tale of Woe?

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Abstract

I published the book 50 Hurdles: Business Transition Simplified in 2014. In that book I wrote a section I titled The Growing Importance of Addressing Family Business Transition NOW. Transition in family controlled businesses can, of course, mean either an arm’s length sale of all or part of company ownership or a generational/multi-generational transition. In the latter scenario ownership is transitioned, and management may be transitioned, to succeeding family generations.

Three short years later, I believe the reasons for NOW strategizing and planning for business transition – not only for family owned businesses but for all privately-owned businesses – are far more compelling than they were in 2014.

This article discusses the roadblocks to business transition – and why business owners need to address transition now if they are not already doing that. If they fail to begin now to continuously plan for business transition I believe business owners run a serious risk of ultimately failing to achieve the transition success they dream of.

Recent Survey Results

Recently we asked business owners and advisors whether they think business owners should focus on business transition “now” in the face of ongoing globalization, central bank policies, government intervention and technological advances. As shown in the following chart the overwhelming response (90%) was “yes” they should.

A discussion of why business owners procrastinate over business transition, and why it is important to continuously plan for business transition now.

We also asked those same respondents whether in the future they thought fewer business owners would succeed in generational business transition than has been the case in the past. As shown in the following chart the majority response (69%) was that fewer business families would succeed in generational business transition going forward than has been the case in the past. This where other surveys suggest that historically only 30% of family businesses transition into the 2nd generation, only 12% transition to a 3rd generation, and only 3% transition beyond the 3rd generation – and that less than 10% of Canadian business owners have a formal business transition plan in place. I am unaware of any documented reasons to believe that when it comes to transition that business owners in other countries act in a materially different manner than do Canadian business owners.

Prospective Generational Transition Success

Roadblocks to business transition strategizing and execution

I believe the following is a reasonably inclusive list of the reasons business owners either postpone business transition planning and execution, or do not focus on it to the degree I believe they should.

  1. Mistaking business transition as a point in time event rather than a process whose relative success is coincident with planning and execution over time. This where business transition is a process that will see best results through dedicated effort over time.
  1. Failure to acknowledge the importance of business transition planning and execution in our new normal economic and business environment in the context of long-term business viability. Of course, without long-term business viability at some point business transition becomes moot.
  1. Prevailing current and near-term business issues takes business owner time-commitment precedence over business transition strategizing and execution. While understandable, unfortunately for many businesses I believe near-term business issues are likely to exacerbate, not diminish. This inevitably will put further “opportunity cost of time” pressures on business transition planning and execution.
  2. Bowing to emotional intelligence over intellectual intelligence. There is always tension between emotional intelligence and intellectual intelligence. In family owned businesses in particular this tension inevitably leads to compromise which theoretically – and usually practically – leads to less than maximized solutions and poorer corporate governance than otherwise would be the case.
  1. Business owners believing they better understand the risks that attach to their business than they understand the risks that attach to financial and other investment markets. And generally they probably do. This often makes deciding to sell their businesses more difficult than it otherwise would be in circumstances where the best transition option for the business is an arm’s length sale.
  1. Unwillingness to consider selling the business and hence the possibility of creating a family business legacy. Hence an unwillingness to consider business transition options.
  1. Being paralyzed by uncertainty over business, retirement options and “end of life” issues.
  1. Concerns over family and family member disruption that might arise out of business transition strategizing and execution.
  1. Bowing to family pressure against systematic business transition planning and execution.
  1. Failure to recognize – or acknowledge – risk to their business of possible health issues that might alter management strength.
  2. Failure to recognize – or acknowledge – one’s aging process and mortality.
  1. Failure to recognize – or acknowledge – the potential of shareholder disputes over business ownership, business management, business income distributions, business value, and liquidity of ownership interests. Among other things, particularly in family businesses, these things arise from differences in business owner risk profiles and liquidity needs. In my experience it is broadly predictable for such differences to arise in privately-owned businesses over time.
  1. Failure to recognize – or acknowledge – the potential of matrimonial disputes involving business owners that could impact their business ownership interests, compensation if employed in the business, and attitudes toward business income distributions and shareholders liquidity.
  1. Failure to recognize – or acknowledge – the possibility of shareholder oppression claims in jurisdictions where such remedies exist.
  1. An unwillingness to spend the time and out-of-pocket expense to properly strategize and execute a systematic business transition plan.
  1. Failure to seek out and engage objective business transition advice, but rather rely on professional advisors with conflicted or vested interest positions in supporting owner perceptions and beliefs.
  1. Failure to acknowledge the importance of putting the business ahead of individual family member interests in our new normal economic and business environment.
  1. Failure to focus sufficiently on ongoing internal and external changes that continuously impact business viability. Hence in many cases holding to an unrealistic view of long-term business viability.
  1. An unrealistic view of current and prospective business value, and in the case of family businesses failure to focus on the important relationship between the number of family member participants and the size of the business measured by annual free cash flow and business value.
  1. Business owner perception that the annual return on net after-tax proceeds if their business is sold will be less – and perhaps significantly less – than the annual income and capital growth potential their business generates.

The proverbial “frog set to boil”

11187845 - edible frog, rana esculenta, in water in front of white background

The frog set to boil is an anecdote describing a frog slowly being boiled alive. The premise is that if a frog is put into boiling water, it will jump out – but if that same frog is put in cold water that then is brought slowly to a boil it will not perceive the danger until it is too late, and won’t survive the experience.

An important question in our current changing economic and business normal is: How many business owners are blithely akin – or not willing or prepared to deal with – what increasingly appears for the businesses of many of them to be an economic and business pond of water that is becoming ever warmer before their very eyes?

Why is it critical business owners and their advisors focus on business transition NOW

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There are three important reasons it is critically important that business owners and their advisors focus on business transition NOW. These reasons are, in order of importance:

  1. Successful business transition – be it pursuant to arm’s length sale or generational transition – is a process whose relative success is coincident with planning and execution over time. It specifically is not a point in time event.
  2. In our new normal economic and business environment the water is continuously heating up for business owners. Not all business owners and advisors seem to be focused on this to the degree they should be.
  3. The current age demographic of family business owners and senior management suggests that a large number of them are getting very close to the point where they will have to make business transition and retirement decisions. Far better to do that where they are robust and in good health rather than the alternative.

Successful business transition as a process, not a point in time event

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From 20,000 feet successful business transition typically is rooted in continuous:

  1. implementation and improvement in corporate governance principles and execution.
  2. growth in annual free cash flow and business value.

Neither of these things are “snap of the finger” events. Both are achieved only over comparatively long periods of time. Both require belief in their importance and commitment to them. Both need to be carefully strategized and planned, and are often best achieved with the help of:

  1. arm’s length directors and advisors with industry specific contacts and operating experience.
  2. professional advisors who have high-level business transition advisory experience, and professional advisors who have “specific discipline” – e.g. business valuation, corporate governance, corporate law, communication, income tax, etc. – advisory experience.

What is causing “the water to continuously heat up” for business owners?

Business owners need to avoid being akin to frogs sitting in water that is getting ever hotter and that might end up boiling them alive – i.e. harming or destroying their business. That may well be the result for business owners who don’t pay close attention to the ongoing changes occurring outside their control that almost certainly – for better or worse – are likely to impact their businesses going forward. Their professional advisors can play an important role in keeping business owners focused on these ongoing changes and their possible business specific consequences.

Factors and changing conditions that will or may impact business viability

Recall the saying “when a butterfly flaps its wings on one side of the world a tornado might result on the other side”. One can easily argue that today there are a myriad of butterflies concurrently flapping their wings in various parts of our world.

Transition Now Chart

The 2008 financial crisis arguably was – and continues to be – a watershed event for business owners in all countries. This is because the following things became less opaque and have become subject to significantly increased and increasing focus.

  1. The broad realization that the investment banks – in the United States, Europe and pretty much everywhere else in the developed economies – not only had by September 2008:
  • taken advantage of financial opportunities that significantly favored them at the expense of wide swathes of the population (e.g. the sub-prime mortgage market in the U.S.).
  • become “too big to fail”. This in the aftermath of the Bear Sterns rescue in March 2008, and the Lehman Bros. bankruptcy in September 2008.
  1. Globalization – including increased focus on the off-shoring of developed country jobs. Ongoing globalization impacts businesses in the contexts of economic growth, country-specific economic growth, trade relations – including issues around free trade and trade protectionism. All of which in turn will impact developed country inflation rates and consumer spending in a contagious manner.
  1. Central bank monetary policies that saw virtually non-existent (and in some cases more recently negative) interest rates and related so-called quantitative easing measures. These things in response to the major economic stability concerns and concern over country-specific unemployment and gross domestic product growth. And this where in the case of economic growth it is becoming ever more evident that central bank quantitative easing has not generated, and currently isn’t generating, the levels of sustainable economic growth that central banks (and everyone else) has hoped for.
  1. Country-specific government monetary, trade and related economic policies that has seen budget deficits and debt escalate significantly after 2008 – and currently continuing to escalate – in many municipalities, provinces/states, and federal government levels. It is easy to argue this means it is virtually certain the free cash flow of many businesses will be negatively impacted in future years if for no reason other that governments at all levels will have to find incremental funding to eliminate ongoing operating deficits and pay for ever increasing social programs.
  1. Ongoing technology advances that:
  • in many cases improve outputs and increase productivity.
  • are not conducive to on-shoring jobs that previously have been lost to globalization.
  • increasingly seem likely to favor large business enterprises over smaller ones, and persons of greater intellect, drive and emotional stability over those less blest – and that many believe will for the first time result in greater net unemployment than net employment.
  • advance the timing of sustaining and growth capital spending – and in turn for free cash flow – for businesses, and in particular for capital-intensive businesses.
  • may mean consumer spending and gross domestic product growth in any given country-specific economy is likely to be impacted negatively. See Technological Advances: What Business Owners and Advisors Need to Know.
  1. Ongoing business combinations in many industry and service sectors which contribute to economies of scale for the consolidators – with, depending on fact-specific circumstances, resultant possible pricing and cost pressures for non-consolidated smaller competitors that may make many of them less competitive going forward.
  1. Increasing wealth disparity, which may result in enhanced and further societal issues – which in turn may exacerbate economic and business uncertainty.
  1. Add “lowest hanging fruit” commodity issues and prices, climate change, ongoing environmental debates, continued world population growth – you name it – and both business owners and their advisors ought to readily “get the picture”.

Conclusion

Following from the foregoing I believe the following five suggestions focus on important business transition success metrics.

  1. Don’t postpone business transition strategizing and planning. Begin now if you are not already systematically doing that.
  2. Generate a Board of Directors approved written business transition strategy and execution document. Continually address and adapt it as economic and business conditions change, and as technological advances are introduced.
  3. In the case of a family business, always consider the interests of the family business (the “goose that lays the golden eggs”) ahead of the personal interests of individual family members.
  4. Continually work toward ever better corporate governance in your business.
  5. Continually work toward ever increasing annual free cash flows and capital value in your business.
  6. Continually consider business diversification within your business as a risk hedge.

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50 Hurdles: Business Transition Simplified

50 Hurdles Cover

The book 50 Hurdles: Business Transition Simplified, is available here at a price of Cdn$37 (including sales tax where applicable and free shipping). Read book testimonials here.

If you are an owner of a family business you might consider purchasing a copy for every member of your business family. If you are an advisor to business owners you might consider purchasing a copy for one or more of your clients. Discounts are available for multiple book purchases.

Ian R. Campbell FCPA FCBV

Ian R. Campbell is a Canadian business valuation and business transition expert. He is the author of several Business Valuation texts and of 50 Hurdles: Business Transition Simplified. The Canadian Institute of Chartered Business Valuators recognizes his contribution to the Canadian Business Valuation Profession through the annual The Ian R. Campbell Research Initiative.

He curates economic and business news relevant to business transition and valuation filtered from world media sources. He writes, with other contributors, The Business Transition and Valuation Review newsletter for business owners and their advisors.

You can reach him by email at icampbell@ircpost.com, or by telephone at 905 274 0610.

Comments
  • Eric Germain

    Thanks for your ongoing valuable insight. I have your 50 hurdles book, but this is a good medium to refresh the ideas and keep it front of mind.
    Kindest regards,