Turning Your Employees Into Owners
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Preparing yourself for a transition is just as important as preparing your firm.

I have the privilege of knowing the leaders of many successful family businesses; I have also been one myself.  Passing down the leadership of a successful company can be a great opportunity for the next generation, and I’m glad I got a chance to work with and get to know my father in that way. But family businesses do not always work out well. Lines can get blurred, and sometimes people go to extremes, pushing children into or out of the business. A lot of people are understandably reluctant to mix family with work. I simply suggest that you take the time to discuss and consider all the issues before making your decision.

My father initially discouraged me from joining his company. He saw that I was finding success on my own and knew I could continue doing so. Many parents take the position that a family business is not an option—they feel that each generation should start from scratch and find its own way. Even those who want to give it a try find that family complicates business leadership.  How do you instill a strong work ethic, pride of accomplishment, and self-sufficiency in future generations?  How do you negotiate the boundaries between the professional and personal relationships? What do you do if the offspring you want to join the family business do not want to? What happens if the eager family member can’t or won’t do a good job? Is the business really a family asset to financially support current and future generations or is it simply your job?

Those who are ready to seriously address all these questions and more will be able to help their offspring avoid substantial startup risk. Joining a family business may allow the next generation to have more influence on their work schedules, location, and the team that they work with.  But it isn’t an easy path. Based on my experience, it often means working harder and longer that you would in any other company–for me, working with my father meant a lot of time spent in airplanes and hotel rooms. For a family business to be successful, the next generation must have the determination and sheer willpower to forge ahead—and the current generation will have to figure out how to pass on their institutional knowledge and business savvy. Together the family must find ways to maintain those characteristics that make the business a success while managing the changes that new leadership and new challenges will require going into the future.

Transitioning the family business to the next generation is a gift.  The family business can create opportunities and carve out destinies.  It can result in pride of authorship through creating and selling a product or service that makes a difference.  It allows you to stand up for what you believe in and lead through example.  It allows you to have a positive impact on yourself, your family, your team, your community and those around you.  91% of all American work for someone else—but the family business can provide your children a fast lane into the 9% that lead others.  This gift is not about joining a country club or getting things handed to you. It is about hard work, integrity, responsibility, and about making decisions that can impact hundreds of lives.

I would submit that building on the success of the current generation’s business and using it as a spring board may be the harder option, but can result in greater opportunity and accomplishment.  Neither generation should dismiss this opportunity. It is a viable option that can positively impact all involved.

 

So, you’ve put time and energy—maybe years of your life—into growing your business and making it a success. Congratulations. But if you think retiring or moving on to your next project is as simple as hanging out a “For Sale” sign, you might want to think again. Many of these sales simply do not go through. Since 74% of those failed deals involve businesses worth less than half a million dollars, if yours is a small business you face especially long odds.

You can improve your chances of success by treating the ownership transition as a process, a process that begins with careful planning, sometimes years before you actually plan to move on.

One of the reasons that selling is particularly difficult for smaller companies is that the buyer is typically another individual looking for an employment opportunity, not a private equity firm trying to make an investment. And as the Baby Boom moves into retirement age, there aren’t very many younger entrepreneurs coming up to take their places. Generation X just isn’t as big. You’re facing a classic buyer’s market, and that weakens your negotiating power and reduces your options.

One way to shift the advantage your way is to grow your own successor by training your employees to take over the business.

As a small business owner, you probably have little experience, if any, with ownership transitions. That is the other reason why the owners of smaller companies often can’t close the deal. But you do know how to grow your business and how to work with your people. You can draw on the experience you already have by treating the transition as just another phase of developing your business and training your team. Focus on preparing your company to change hands and preparing your people to take over. This is a great opportunity to reflect on exactly what it is you do that works so well, where you want to make sure your successors stick to your vision and where you need to let go and allow their innovations to take your company in a new direction.

Training new, prospective leaders does not necessarily obligate you to sell to insiders (unless you start making promises). If an outside buyer comes along with a more appealing offer, you can take it. The point is that you will have more options and you will be able to oversee the leadership transition from a position of power, not a place of desperation.

Turning employees into owners is one of those situations where everyone wins. You win, because you know you’ll have at least one qualified, interested buyer and so you can negotiate from a stronger position. Your employees win, because one or more of them gets to own a successful business. Your business wins because a smooth transfer to a fully trained team increases the chance that your winning strategy will keep on winning. And since most people do better work when they have a sense of ownership of a project, training to your employees to take over not only protects the future of your business but also enriches its present.

 

You have established your company through unwavering determination and sheer will power.  You have moved beyond the startup mode into a thriving successful business.  As your company matures and grows, so does your family.  At some point, it is likely you will be confronted with the decision to hire a family member.  Candidates may include spouses, children, siblings, in-laws, and family friends.  In the interest of full disclosure, I was a boss’s son in the family business.  And now for the “Good” the “Bad” and the “Ugly”.Smal

The “good” being that the family business gave me a ten year head start on learning the business.  I got to do more quickly and learn at the elbow of my father.  This greatly accelerated my learning curve and provided me opportunities that were not available to my co-workers.

The “bad”.  It changed but expanded my relationship with my father.  No longer were we just father and son.  We now saw each other both through the eyes of the family and business.  While we tried not to talk business in a family setting, it was almost impossible.  It not only changes the father/son dynamic, but also influenced my relationship with my siblings.

The “ugly”.  For me it worked out.  I give most of the credit to my father.  He gave me enough rope to learn but not enough to hang myself.  Over time as my role increased he gave me the room to make my own decisions even if he would have chosen differently.

However, others have not been so lucky.  In my banking days, I saw several family businesses suffer from a domineering family patriarch that was not able to share or teach and ruled with an iron fist.  In other instances, I saw a son or daughter that was in over their head and did not know how to transition to their passion outside the family business gracefully.

Based on my observations and experience here are some of the lessons I have learned.

 

1.  The Thanksgiving Test

One of our definitions of success was always being able to sit down at the family table for Thanksgiving.  We were able to combine a family and business life that allowed this to happen.  However, some families have not and it is a very big price to pay.

2.  Learn on Someone Else’s Nickel

As a new employee fresh out of school, we often make mistakes.  Everything from getting to work on time, to defining your own work ethic.  In addition, the intangibles and the business lessons learned from other organizations will have tremendous value.  For me, a four year stint in the banking industry gave me a great skill set to contribute to the family business.

3.  Being The Boss’ Kid Makes You Different

Your work ethic, personality and capabilities will impact how you are viewed, but you will never be one of the gang.  As a family member you have tremendous opportunities, but it can also be lonely.

4.  Start At The Bottom

Even if you move through the ranks quickly, it is important for family members to know the organization well.  Lead by example and no job is too big or too small.  The relationships you build with the team will be critical to your future success.

 

Why Do It?

As the patriarch and business leader it is important to recognize that you will give more than you get for some time.  Be patient.  As the leader it is our responsibility to anticipate and plan for the future.  When you initiate a planned succession or a tragic event creates change in leadership, having several good options is a blessing.  Some options may include the following:

 

1.  Close The Doors: While this may seem simple and straight forward, there are many loose ends to consider. How and who will take care of the current customers, employees, accounts receivable, suppliers, and tax obligations? If you are still in the leadership role the likelihood of a smooth closing is possible. If not, a crash landing with significant carnage may result.

2.  Sell To A Financial Buyer: Often this may be a competitor or financial investor. This solution could significantly impact your customers, employees, suppliers and business’ legacy. How do these relationships and outcomes impact your definition of success?

3.  Family Asset: Your Company is generating a quality of life that allows you and your family to live very nicely. Cashing out may seem short sighted and wasting an opportunity for future generations to benefit from this family asset. If the family talent is not available today, a professional manager may provide the needed expertise while leaving options for younger family members.

4.  Selling To The Family Or Employees: Creating and nurturing the next leadership team involves passing on the institutional knowledge and business savvy you have developed throughout your career. With your hand picked team and having evaluated each member’s ability and will to lead, you can feel comfortable leaving your customers, suppliers, employees, and legacy in good hands.

 

When planning for the future it is important to create a number of options that you can test and pick from at the appointed time.  Change is constant and what looks like the best path today may not be the desired outcome tomorrow.

 

 

In today’s WSJ there was an article titled “Amid Crackdown, Some Firms Rethink ESOP Sales Practices” which relates to owners rethinking how to sell to employee-stock-ownership-plans (ESOP) following a crackdown by the Labor Department.  It seems to me we are missing a piece of important information in the ESOP relationship that allows the new owners to make an informed decision.

The Basics:  When a founder or majority shareholder wants to liquidate their closely controlled shares to their employees, one option is an ESOP.  In this scenario, a trust is created that will hold the company shares.  The value of these shares is determined by an outside appraiser.  The purchase of these shares may be funded by the employees’ retirement savings account.  In my view, the premise of this structure is that the employee is not capable of making an informed decision.  A trustee is hired (often an outsider and, with the recent crackdown, a likely choice to protect the business owner) to protect the workers’ interests and a third party valuation firm is hired to determine a value.  It seems to me that if employees have a working knowledge of the organization that includes the institutional knowledge and business savvy, they are qualified to make their own decisions.  If they don’t, are they really qualified to be an owner?

What If:  I would submit that an employee team that has the information necessary to make an informed decision regarding the purchase of their company results in a better outcome for both the current owner and the future owners.  An ownership group that is informed will be equipped to capitalize on the historical successes and lead the firm well into the future.  This means today’s owners need to invest time and resources in the future owners by passing on the institutional knowledge and business savvy to the next generation of leaders.  By institutionalizing this knowledge and getting it out of the leader or founder’s head, it will make the company more valuable not only in the owner’s eyes but in those around them.

The WSJ suggests that the Labor Department has observed that the value of a firm may be set to meet some predetermined expectation on the part of existing owners.  This could be viewed as a one-sided negotiation that a willing participant would never accept when buying a car or home.  Why should we consider it when buying a business?

The ESOP is to be used as a financial and legal tool to facilitate the completion of a business relationship between competent, knowledgeable parties.  It should not be used as a tool to manipulate terms and conditions based on a lack of knowledge or transparency.  As business leaders it is our duty to pay it forward by developing a team of leaders and owners that have a sustainable financial foundation to lead the company into the future.  It should not be our priority to squeeze every cent out of the transaction by taking advantage of our position.

One of the questions that gets asked during almost every business review in our Vistage meetings is “What Happens If You Stop The Bus”?  As leaders, our job is to live in the future to prepare our organization and family.  Unfortunately, we have little to no control when we will “exit stage right”.

One of our members was fifty and his kids were in college. He had a successful company with a respectable net worth that required tax planning.  After our line of questioning, it became evident that he had very little planning in place.  There were no wills, trusts, or discussions about what should happen.  There was insurance in place for a buy/sell agreement with his partner, but very little structure.

One of the tenents of a group like Vistage is to hold each other accountable.  The outcome of this business review was to have the member bring back a completed estate plan in one year.  When he came back he had a funded family trust, revocable trusts, irrevocable insurance trusts, and wills.  At fifty-two years old  he suddenly passed away from a heart attack.

On March 11, 2012, my father passed away and I was his executor and successor trustee for multiple trusts.  What I learned from these experiences is even with the best formal plans (trusts, wills, etc.), it is very helpful to share the intent and thought process regarding decisions that were incorporated into your estate documents.  Shortly after my father’s passing I wrote two letters.  One to my best friend who was my successor trustee and executor and the other to my business partners.  The following was the outline for my family letter:

Professional Team (name, address, phone number)

  • Lawyer, Accountant, Family Chief Financial Officer, Insurance Agent, Bankers

Balance Sheet

  • Asset, Titling, Location, Account Number, Contact Name, Phone #, Balance, Purpose

Family Responsibilities

  • Our estates would receive at some point funds from our parent’s estates.  Explaining any future impact or transaction will allow better planning.  For planning purposes I roughly provided an idea of what funds or responsibilities might be coming our way.

Family Estate Plan

  • List of every family member, SSN, DOB
  • List every trust, title, tax ID #, and author
  • Provide a narrative of every trust, purpose, trustees, successor trustees, beneficiaries, disposition of trust, termination
  • List of corporations, type (LLC, S-Corp, etc), role, contact, % ownership, estimated value
  • Insurance Coverage, insured, company name, policy date, policy number, owner, beneficiary, death benefit, cash value, annual premium, premium due date, agent name and phone number

Family Operational Plan

Since the intended audience of this letter was not a family member, I described how we lived, where the money came from, what was the cash burn rate, etc.

Directives and Background

In my case, my best friend would be my executor and successor trustee after my wife in some cases.  I will explain more in a future post.

Children:  I shared the strengths and challenges of my children.  Suggestions on what type of mentoring they would need and general discussion of financial support.  I also discussed who should and could be a guardian.  I discussed several scenarios on how he could use trust and personal resources to respond to specific children challenges we anticipated.

Money:  I provided a summary of the resources that would be available and our intent on how to provide for our children.  Our first goal was to do no harm.  We discussed the intent of allowing when and how for them to control their trusts and how we intended to protect them if they were to get divorced.

Resources:  I also provided the names of my Vistage group members.  These individuals know more about me, than me.  They would be a good resource if he needed to bounce an idea off a knowledgeable group.

I update this letter every year and it gives my friend and I an excuse to get together and discuss life.  When my wife and I are traveling the world together, it gives me peace of mind that my family will be in good hands if something should happen.  It gives us the freedom to live life.