PITTSFORD: Don’t skip succession planning in family businesses

This weekend, if you bypass the big-box store to buy a new snow blower at the locally owned hardware store, you’re helping to feed an economic machine that employs more than half of the nation’s workers and pays out 44 percent of all U.S. payroll. The same can be said if you grab your morning coffee at a franchise restaurant owned by one of your neighbors, or purchase a new sofa at a furniture store with deep local roots.

By making those transactions, you’re engaging with some of the 28 million operations described as closely held businesses, the sector that includes 99 percent of all employers in the United States—and that constantly runs the risk of falling short of its potential. Generally, the “mom and pop” in these mom-and-pop businesses are growing older (in Indiana, we know that the average age of business owners is 60), and the next generation may not be trained to keep things going at the current level.

Each year, I travel around the country to attend more than 15 industry conventions to talk with business owners. Typically, as I speak to these groups I’m looking out at an audience of people between the ages of 60 and 80. Sometimes these are married couples who have invested their lives in building their businesses. They might have one of their children sitting alongside them, or perhaps a trusted manager. In other words, they brought along the person who represents the future.

Through our research, we have learned that, typically, about 25 percent to 30 percent of the owners will transition their company to family members; about 15 percent to 20 percent will sell to key employees; and about 30 percent to 40 percent will sell to another company within their industry.

Here’s the problem: Many of those age-60-and-over owners at those meetings are just now beginning the process of planning to sell. Based on research, we can expect that half of these folks plan to retire in five years or less, but they have not made concrete plans for how that would work. For example, if Mom and Dad intend to sell the business to a son or daughter, they might not have thought through how that child will finance the purchase. Or they don’t really know what the business is worth, so they don’t know what the next-gen owner should pay to acquire it.

Compounding this problem is the fact that nearly all of these folks expect the proceeds from the sale of their business to fund their retirement, but they haven’t fully considered if the proceeds after tax will support their needs, or how payments on financing the purchase would affect cash flow. Maybe the owners think they can simply step away and draw paychecks as owners, but they don’t know how that would fit into the long-term salary structure.

Add to these challenges the fact that they’ve spent years not putting away much money for retirement because they invested virtually everything back into the business, underpaying themselves and saying they’d make it up “someday.” Meanwhile, they’ve been so hands-on and in charge that they haven’t “coached” the next generation or given the heir apparents the responsibilities that would prepare them to take over.

The result of this situation is sobering: Only 30 percent of family businesses make it to the second generation, and only 15 percent make it to the third generation. Often the result is that the business eventually reverts back to the kind of hands-on owner-operator scenario that started it. We refer to this as “shirtsleeves to shirtsleeves in three generations.”

Please note: I do not mean to suggest that “mom and pop” are poor operators. The truth is, they’ve been so dedicated to being great operators that they put off thinking about the future.

Unfortunately, we all depend on their futures. One small business stumbling won’t hurt our economy, but this is a national issue with far-reaching implications. As this generation of business owners prepare to retire, we need them to prepare for the future, not just so we can continue to get that rake, that coffee, that sofa or the many other purchases we rely on them for. No, we need them to prepare for the future so that the massive economic engine they represent continues to hum smoothly. •

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Pittsford is president and CEO of Castle Wealth Advisors.