Save family businesses, save the community
Historically community banks haven’t embraced their role in addressing the opportunities and challenges in ownership and management transition for family-owned and closely-held businesses. Rather than continuing to stand at arm’s length, there are several issues that community bankers need to take into consideration that would benefit their business clients and could mean new business opportunities for the bank itself:
- With the legendary lessons learned from the real estate and tech bubbles in mind, we know that poorly planned and executed transition strategies may be the next great threat to the quality of their loan portfolios.
- Proactive support for transition planning in family and closely-held businesses may provide community banks with a unique way of differentiating themselves from the more transaction oriented megabanks.
- By factoring ownership and management transitions into discussions with centers of influence community banks can position themselves as offering a unique value proposition to clients, lawyers, accountants, financial advisors and insurance agents.
- Lastly, family-owned and closely-held businesses comprise the backbone of many of the communities that community banks serve. Successfully planned and managed transitions may be as important to sustainable economic development as luring the next big factory with tax incentives and low cost land.
A Demographic Tsunami is Threatening Family Businesses
Small businesses face an unstoppable demographic tsunami.
The calculus is pretty simple. Family-owned and closely-held businesses comprise something more than 80% of all North American businesses and 80% of those employ 20 employees or less. Family businesses account for not less than 58% of GDP, more than 60% of the US workforce and at least 78% of all new job creation. The community bank’s stake in having a robust and vibrant small business sector is obvious. Yet small businesses face an unstoppable demographic tsunami. Around 60% of these family- owned and closely-held businesses expect a change in leadership or ownership in the next 10 years as Baby Boomers retire.
There is ample evidence to suggest that many family-owned and closely-held business owners have spent precious little time preparing the next generation for management or ownership or committing to build long term value in the business should the exit strategy ultimately be the sale of the business. According to one survey, over 80% of current business owners think the business will still be in family hands in five years. Other statistics may support a sadder outcome. Twenty percent of business owners have no estate plan; forty percent have no transition plan at all. Ninety-seven percent of all family businesses don’t make it past the fourth generation. And this is the same market segment where community banks are “all in” at their own peril.
Family Business Lending Risks
Having spent the better part of my banking career as a lender, and also working in succession planning and community banking, I have seen family-owned and closely-held companies come and go. Until recently, I put that change in the context of classic Darwinian capitalism. Changes in markets help some and hurt others. Some companies survive changes in the economy; others die from them. Some families are capable of keeping the family business successful and others are hell-bent on destroying them. The bank would try to manage the risk with collateral, covenants and controls.
I have reevaluated my personal perspective now that some very real examples continue to haunt me:
- I think of the small machine shop run proudly by two brothers. One became ill and was committed to a nursing home. The other brother continued the business but died of cancer a couple of years later. The brother in the nursing home died shortly thereafter. The business collapsed without leadership or management while the estate of one brother was in a standoff with the estate of the other. There was no buy-sell and no life or disability insurance. We ended up liquidating the business, sending a number of folks to the unemployment line, and putting another empty building on the market in a community that doesn’t need more empty buildings. Shame on us.
- I think also of the owner of another machine shop who announced that he had cleverly taken advantage of the impact of the Great Recession on his balance sheet by gifting half of his company to his son who was working in the business. When asked what would happen to the remaining 50%, he said he would split it between his two daughters, neither of whom was active in the business. One was a stay at home mom and one was a drug addict. I asked him why he would choose to cause a dog fight in the parking lot of the funeral home, he said he didn’t understand. When I explained the sisters’ inevitable desire to get out of their interest at a time when the brother needed to focus on running a business that didn’t have the resources to buy them out, he began to get it. Without a valuation, buy-sell or funding mechanism, he now knew his biggest bequest was going to be a mess. And the covenants in our loans to the company needed to incorporate protections against that eventuality while the owner scurried to alter his estate plan.
- The last of many examples I will share is the successful plastics processing and machining company who was a prospect of my bank. When asked about his exit strategy, the owner said he hoped that the $2 million life insurance policy benefitting his wife would be augmented by the auction proceeds from the sale of his building and equipment. He thought his only option was to abandon the legacy of a 15 year old business, send 41 employees packing and have the fate of the rest of his business assets be subject to the whim of the auctioneer’s gavel. His current bank was sitting comfortably on a well collateralized seven figure building and equipment loan without a clue as to his planned exit strategy. He should have a better plan and a better bank.
It has become clear to me that banks must take a much more granular look at client transition strategies and mechanisms. Businesses without contingency plans, well-defined exit strategies and supporting strategic plans may pose a significant credit risk for banks. Ten-year-old estate plans, five-year-old insurance coverage and complex family or ownership dynamics may not complement each other at the exact time but they all should be harmonious. Lack of clarity on succession and the resolution of ownership issues may lead to conflicts with minority owners or between family members, distract management from the important task at hand and negatively undermine business results. But it doesn’t need to be so.
It has become clear to me that banks must take a much more granular look at client transition strategies and mechanisms.
Out of Crisis, Opportunity
The growth and profitability of a successful family-owned or closely-held business have often been grounded in technical excellence, efficient production and unique craftsmanship. The owners excel in their chosen field, but too often just manage day-to-day. They may have honed their skills at firefighting more so than fire prevention. In practice, the long term success and survival of the business through an ownership transition depends on retaining this tactical excellence while coupling it with a matching strategic excellence that prepares the business, the ownership or the family for the future.
A successful transition requires a new paradigm. Traditionally, an owner’s relationship with his or her lawyer, accountant, investment advisor, banker and insurance agent are usually kept separate and can often involve conflicting advice suggesting different goals over conflicting time frames. These relationships are usually always competent, but in a transactional way rather than as components of a larger structure or strategy. The complex issues of ownership and family dynamics, and questions about the business direction and future of the company go unasked and unanswered. The business owner just doesn’t feel competent about raising these issues, so they often aren’t addressed even though, deep down, he or she knows they need to be.
I am always looking for ways to differentiate my community bank from others. There is no more powerful new business development tool than to give the owner of a business permission to talk about important issues, those they have been afraid to talk about and keep them up at night, despite their ability to disturb family and ownership relationships and disrupt the business. When I ask prospects what their current bank is doing to support them in their management or ownership transition or help in the development of a long term exit strategy, I typically get a stare of disbelief that screams, “Banks don’t do that.”
Well, I would suggest that we can and we should. The long term success of a family or closely-held business requires that the efforts of these professionals be coordinated in a much more organic and holistic way. Our bank has elected to provide education, support and planning resources to show our commitment to the future of the business. It solidifies the bank’s position with current family-owned and closely-held business clients and advisors and gives us distinct new opportunities with others.
Getting Centers of Influence on Your Team
Every bank tries to develop referral networks with other professionals, but I am looking for a different kind of professional advisor on my team.
I am looking for great corporate and estate planning lawyers. I want them to be something more than expensive order takers looking for billable hours. I don’t ever want to see again a client buy-sell agreement without a funding method identified or a tie breaking mechanism included. I don’t want ever again to see a perfectly drawn estate plan reflecting the wishes of the owners but containing outcomes that will cause conflict, confusion or threats to the very existence of the business, all of which were avoidable if the right questions were asked at the beginning.
I am looking for great accountants, but they have to be strategic thinkers as well good bookkeepers. I want accountants who understand that diversification is important to the value of a business and don’t wait until their client is ready to sell before suggesting that large customer concentrations may hurt the selling price. I want accountants who understand the importance of valuations and the structure and tax consequences of buy-outs and ownership restructurings.
I am looking for insurance agents that don’t settle for an insurance sale and then live off of the renewal commissions. I want insurance agents committed to problem solving that comes from a deep understanding of the client’s needs.
Where appropriate, I love to see the local Manufacturing Extension Partnership engaged to support the long term growth and profitability of the business with strategic planning assistance and the implementation of continuous improvement methods such as LEAN and QRM. There is a very clear connection between the adoption of process improvements and credentials such as ISO and AS9100 certifications with company performance and value creation.
I want advisors that aren’t afraid to coordinate their efforts with other professionals on the team. I want advisors who take the mystery and mumbo-jumbo out of their profession.
But, most of all, I am looking for a great quarterback for the company owners to rely on through this “once in a lifetime” event of transitioning management or ownership of the company. In our bank, we have invested in becoming a Family Business Advisor and Certified Exit Planning Advisor to assist clients in this area. This may not be for every bank, particularly those concerned about lender liability issues. An independent consultant with appropriate training and experience is critical to helping the business owner through the maze of issues that need to be addressed and providing the structure and discipline to keep all of the professional advisors on the same page.
Because we are taking a very forward thinking, looking and feeling approach to ownership and management succession and pushing advisors to look at the challenge more holistically, we are getting professional advisors who want to be on the team. They see our approach as being a differentiator for the bank and they want to have some of that differentiation rub off on them, even though they may not quite understand the approach. We may also appear to them as a bank that will provide better solutions to their clients when it comes time for referrals to go the other way.
Save Family and Closely-held Businesses, Save the Community
So many family businesses are “stumbling into the future” with no idea how they are going to exit the business or harvest a return on a lifetime’s worth of investment. The more they wait, the fewer the options that are available to them. Sale or liquidation becomes the last resort. Many of our community bank cities stare at the scars of giant hulks that were once plants and headquarters of global giants that long ago reduced or eliminated their operations. Family and closely-held businesses now comprise the backbone of the local economy for many of our banking communities. Unfortunately, there just aren’t a lot of economic development efforts or resources focused on management and ownership succession in these enterprises. If we don’t figure out how to manage these transitions more proactively, our communities could be stuck with the next generation of empty buildings and the perpetuation of the chronic unemployment that plagues so many of our cities. Community banks can play the defining leadership role on this issue.
Getting it Right
So what does it take to do an ownership transition right?
- Owners should develop a strategic plan with the engagement of family and other owners to get collective agreement and focus on the future success and long term value of the business.
- There should be a clear definition of roles, responsibilities, and expectations for those owners and family members inside and outside of the business.
- They should invest the time, energy and money to prepare the next generation of leaders.
- Owners should put conflict resolution measures in place including buy-sell agreements, shareholder agreements that require mandatory arbitration, family councils and advisory boards.
- They should also put mechanisms in place for a funding option for the purchase of shares of deceased or incapacitated owners.
- Lastly, they should define a long-term exit plan that is something more than dying at their desk and make sure their estate plans are aligned with their exit plan and succession strategies.
Whether the transition plan is succession or sale, if the owner has done it right, there are a number of very tangible benefits:
- There is a good chance, because of thoughtful and proactive planning, that the value of the business has increased.
- Family and ownership harmony is maintained or, at least, family and owner conflict has been minimized.
- Management is in place to lead the company to long-term success either under continued family, current ownership or new outside ownership.
- An orderly transfer of ownership to the next generation of family or new ownership may minimize the disruption of the business and maximize the benefit to the selling owner.
- The owner leaves a permanent legacy. The position of the company as an employer, providing leadership and philanthropy to the community, has the best chance of being preserved.
- Lastly and most importantly, your community bank has solidified its relationship with a valuable client and its new ownership or management by helping them navigate through an important transition.
For the sake of all of us, our banks and our communities, this is the reality we must create.