What to do with the family business
My columns in SP&T News up to now have mostly focused on issues regarding the sale of a family business to a third party in an arm’s length transaction.
By Victor Harding
But there is another choice for owners of a family business and that is to transition the business to another family member. I don’t see these transitions that often because the people who hire me have mostly decided to sell their business to a third party. The problem is, transitioning family businesses to other family members can be more difficult and risky.
At this point I want acknowledge a critical source from which I have drawn a lot of ideas on the transition of family businesses. Ian R. Campbell is a foremost Canadian authority on business valuations and has written a book called “50 Hurdles: Business Transition Simplified.” Any family business owner who really wants to protect their family business should buy this book.
According to Campbell, only one third of all family businesses in Canada transition to the next generation successfully. And only one third of that third manage to transition to the next generation after that. I know this first hand because my family business, Harding Carpets Ltd., which was a leading Canadian carpet manufacturer and distributor in the 1960s, 70s and 80s, did not handle the transition to the next generation — that being my generation — very well and it was only in reading Campbell’s book that I came to see some of the reasons why.
So what do owners of family businesses need to do to minimize the risk of transitioning their business to the next generation? Firstly, owners need to be constantly planning for the transition of their business — whether to a family member or third party — and review the plan every year or so.
Most owners do not do enough planning. For example, what happens if an owner gets sick or dies and the family has not talked about what should happen to the business? The next generation family member may not be ready to take over, may not want to, or have the skill set to do so. I was working at Harding Carpets when my father was gearing down and although we talked in general terms about what might happen to the company, in hindsight we should have far more detailed conversations.
The second issue for owners of family businesses is being sure to distinguish between ownership and management interests. Many business owners do not make this distinction. The next generation may simply not have the right skills to manage the business going forward. This does not necessarily mean that business has to be sold; an outside manager can be hired.
Another issue that’s pertinent to transitioning a family business is the whole question of the ongoing viability of the business. This applies to security businesses as well. Only a minority of business owners that I have met objectively assess their business in terms of its strengths and weaknesses against what is happening in the market. We made this mistake with Harding Carpets. The facts are that broadloom carpet would become infinitely less popular as a floor-covering product in 1990s. Secondly, none of us saw how much cheaper U.S. broadloom would be relative to Canadian carpet.
Applying this same thinking to the security industry, I would argue that if your business model is prefaced on selling and installing lots of new residential alarm systems, you need to take a close look at the competitive landscape. The telcos and authorized dealers of the big companies are taking an increasing share of this market. Secondly, I think business for the smaller security alarm player is just getting more complex what with cell back up, Alarm.com, cameras, verified response, and constantly changing technology. There are very few simple installs anymore and I worry about the popularity of monitoring over the next five to 10 years. My concern here is not that consumers will want to install the system themselves but whether they will be willing to pay $30 or $50 a month for monitoring.
Another very important concept to consider whether planning the transition of your family business is the difference in value you can expect to get from selling to a third-party, strategic buyer versus selling to a family member.
When you sell to a family member the business and its cost structure usually stays much the same. That gives off a certain value. However, when you sell to a third party there often are synergies to be had by the buyer, some of which can and should be passed onto the seller in terms of a better price. Selling to a third party can often result in a better price for the owner than transitioning to a family member.
There is much more than can be said about transitioning a family business but I particularly liked one of Campbell’s catchy phrases in “50 Hurdles.” As he says, there is a degree of “Darwinism” and “Draconianism” in transitioning family businesses. “Darwinism” in that you have to transition your business to the person in the family best suited for the task; “Draconianism” in that at times, you have to be Draconian with your family members.
Victor Harding is the principal of Harding Security Services (firstname.lastname@example.org)
This story appeared in the March 2019 edition of SP&T News Magazine.