October 2024
Here are some key takeaways from their discussion:
- Small businesses are the cornerstone of the American economy, and 90% of American small businesses are family owned.
- About 70% of family businesses do not get passed down to the second generation successfully. Succession is difficult because there are so many complicated dynamics to navigate. Not only are there familial relationships to consider, but employees who are not related to the family that have a sense of ownership and passion for the company who need to be treated fairly.
- Implementing leadership training for the next generation and having more structures in place to ensure everyone is well-equipped and understands the shared vision is crucial.
- Assembling the right team with financial experts, estate attorneys, and exit planning advisors can increase the likelihood of a successful transition. Professionals can also help guide your children should they inherit a lot of wealth in how to best handle their new assets.
- It is important to have regular conversations with your family/team as a business owner and clearly communicate your intentions.
- If you or someone you know is thinking about a business succession, visit our Strategist offering page to learn more about how we can help.
Watch previous episodes here:
Ep. 104 What the Next Generation Should Know About Financial Literacy
Ep. 103 How to Prioritize Tax-Advantaged Accounts for High Earners
Hello, everyone, and thank you for joining us for another episode of THE FINANICAL COMMUTE. I'm your host, Chris Galeski, joined by wealth advisor and partner Joe Seetoo, thank you for joining us.
Absolutely, Chris, great to be here.
You know, one of the topics that comes up often with people that are, you know, growing in their life and looking to create some sort of financial legacy is building generational wealth. And as you think about it, like there's a few different ways that people can do it, right. You can inherit the money. That's the second stage of sort of building generational wealth.
You can work for a company as a W-2 employee and save and benefit through the form of restricted stock units, stock options or equity within a company. Sure. But you know, the keys to saving towards generational wealth is being very prudent with your money and living below your means and saving a lot. But then we've also seen a lot of people be very successful in terms of building generational wealth through the form of owning a business or real estate, and owning and operating that as a business as well. And you had some very interesting statistics about how large of a role businesses play in our economy that I wasn't really aware of.
Yeah, I mean, they are tremendous. Obviously, the baby boomer generation is one of the most entrepreneurial generations, ever. And then that has gone down to the Gen Xers, millennials, Gen Zs, etcetera, but something like 29 to 30 million small businesses, in America, depending on statistics. Right? I count for about 90%, of the small businesses in the United States and they are family owned or family controlled, I should say they employ roughly 60% of our workforce in the United States, and they actually create about 80% of the new jobs that we see on an annual basis.
But in terms of the magnitude of our GDP, right, our annual output as a country, it's roughly two thirds. Right. So it's it is an incredibly important component of the backbone of our economy of how folks put, you know, bread on the table for their families, how they find meaning and purpose.
I was just blown away by that stat. So if there's 29 million to 30 million businesses in the United States, roughly 90% of them are American businesses that are family owned and controlled. And the amount that drives to our, you know, economy being representing about 64% of our GDP. I mean, that plays a huge role in our economy and in the growth and the success of the United States.
And so that's why the politicians talk a lot about, you know, taxes that relate to businesses and the importance of putting incentives out there. So that way people can continue to be entrepreneurial. I was just blown away by that.
Yeah. And I think, you know, one of the challenges, though, is historically succession rates from the first generation to the second have been notoriously low. Something in the neighborhood of about 30% actually successfully survive into the second generation, and then something like 12%, I believe, is the statistic actually make it to the third generation.
And while it it is a great way to build wealth if you can do it. It is incredibly challenging. We'll talk obviously about some of the dynamics related to that. We should note, though, those who are doing it right, I think something like 35% of the fortune 500 companies are family controlled and family out.
So you can do it, but you have to put it in the right sort of structure in governance to, get to that elite level.
And, and you noted in some of the studies that you do that, that 85% of the issues that face family businesses are related to succession planning. Yeah. So it's not having the conversation or not having the framework in order to be able to, you know, have the right conversations to figure out what succession looks like because, you know, 12% of businesses making it to the third generation, that's a huge disconnect from maybe some of the conversations that we have with clients around building generational wealth and their intention.
You know, I'll give you a real life sort of, case study here. And that is exactly this point, Chris. You know, we did a Los Angeles, we partnered with the L.A. Business Journal, the exit planning chapters here in Southern California. And I actually did a state of owner readiness survey, about a year ago. And interestingly, the number one transition option, this is about 320 owners that we surveyed in the Southern California area, L.A. area.
Their number one transition option was actually a family transfer for the owner to, you know, whether it's to sell to the son and daughter to, some, some, family member. Again, that was by far the single biggest transfer option that was elected to. I would have thought third party sale would have been much higher. But when we delve, we dive into the, details a little further...
What we saw was that 80% of them were reliant on the income from the business, and actually only one in three of those owners had actually sought advice from their attorney. So let me kind of you could imagine the, the, family dinners that are going around. Hey, kids, I'm going to transfer this business to you. By the way. I need the income from it to support me while I when I travel, when I get ready to retire, what I want to do those things. And we haven't really, sought our estate attorney's advice on how we're going to do this the right way. Do you think that's going to go over well?
I mean, you also have a statistic about the percentage of small and medium sized businesses that are actually able to be sold.
Yes. So that's something like and again, various studies show different things, but upwards of only about 20% of companies that actually go to market, sell. Right. And so this is one of the things that we want to help improve, that we want to work with our partners, transaction attorneys, M&A advisors, CPAs to rally the team of advisors to support the owners so that they can have a much more successful exit so they can build that family, that family wealth that we're talking about.
I mean building wealth, it's always been an interesting sort of topic, because one way to create a lot of wealth is be concentrated and be right. One way to to lose a lot of wealth is be overly concentrated and be wrong.
Yeah. But if, if there's, you know, 29 million small businesses, you know, across the United States and 90% of them are family owned, but only 20% of them are actually able to be, you know, sold. And 80% of those owners are reliant upon the income in order to be successful. I mean, there's a lack of diversification within probably their own assets of their own, their own set up in order to be able to properly live without that business if it can or cannot be sold.
Yeah. That and I think what oftentimes part of the challenge that it comes down to, right, is the fact that they get so busy working in the business, it's hard to set up the right structure, the right framework on how to sort of get their heads up and look out 50,000, get that 50,000 ft view.
I think it comes down to the, the family business, the dynamics there that you're dealing with are much more complicated in the sense that you've got the parent to child relationship. And these can be adult children. You have the sibling relationships across the board. But then you also have to think about the key employees who are maybe in management roles that maybe even have some sense of ownership, oversight, responsibility.
Now you have all of those dynamics that have to be navigated. Are those key employees if family members are being brought into the business, into supervisory roles, are they being treated fairly? Right. And so is the governance in place not only for the family, but for the business and is it being communicated properly to, to all parties fairly and equally? The other big thing that that I see here is that financially, generally speaking, right, the idea of actually transferring the business to the second generation historically is not as financially rewarding for the first generation, coupled with the financing options for the second generation. It can be very challenging.
And that's just because if you're going to go get debt today to go buy a business, it's at a much higher interest rate than where it was 4 or 5 years ago. Yeah. And those numbers might not pan out, especially if you have to pay out that previous owner. Yeah.
I mean you've got the actual financing options. I mean you have the down payment options coming from the second generation or you gifting the shares. Right. Or you're actually are you doing a formal valuation? Are you setting a fair, you know, share price and actually having, having that second generation buy in over time. In some cases, maybe they feel like they should just be gifted it.
But this comes back down to the original thing that we talked about, which is, I think early on, having conversations and setting expectations across the board. On how, you know, how the vision of what the owner wants to have happen.
I mean, that TV show Succession is so fascinating because it sort of... it over does it with the complications of family. But I mean, that's fairly normal in terms of, you know, there are certain individuals that maybe work in the business that want to be part of it and would like to grow with it or take over.
There are some, you know, children or family members that maybe don't want to work in the business, but maybe want to benefit from that value. Yeah. But then there's all these other statistics that say, hey, if you're running a business and taking it from $1 million of revenue for it through $10 million of revenue, you need a certain skill set in order to be able to do that.
And then be able to take it from 10 million of revenue to 100 million. You need a completely different skill set. And the question there is like, do you have the right team in place? And so that's something that you help work with business owners on to better understand the business that they have in place, the different levers that they can, that they can pull in order to create a salable business that's not reliant on just one person or just one particular industry.
Yeah, absolutely. You know, Mike Rudow, one of our partners, and myself, we have the Strategust offering which is this flat fee offering, working with owners where we're helping them craft a master plan that aligns the business, their personal financial plan and then their personal life goals. And I'll give you an example. Right. We have a client that, elevated one of their key employees, not a family member, to the position of CEO.
\
And after helping them, go out to the, to the market, actually talking to some HR consultants, getting the data on what's an appropriate level of pay, they ultimately want to leave the door open for their son to come in at some point in the future. And so rather than actually having the son take over a CEO right now who candidly, it just isn't the right time.
But this individual who is now taking over the CEO role is going to a likely mentor, the son as he comes into the business. And so one of the things we see that is, usually, that that is a stepping stone for, success for the second generation, one of the best practices we see is that they actually go out oftentimes work, maybe, work separately.
Right. They've gone off. Maybe they've gone to business school, they've worked in other roles. They've had other leadership responsibilities. They've gained perspective and experience, actually able to come in and add value and essentially they're interviewing, right in the same way another employee would, so that nothing is just sort of being gifted to them to the detriment, of, some of the other, managers who maybe are non-family members, but that have been there for ten, 20, 30 years building the business with, with the founder.
Yeah. It's such an interesting sort of dynamic to follow because I've seen it in a couple of different cases with clients where some have chosen to sell the business, to then create a nest egg that can transition throughout their future generations, their kids and their grandkids and they might even have kids or family members that work in the business.
They chose to do that just because it was easier to handle a pot of money that you can put in different trusts and different entities to be able to transition to a hundred generations without the complications of having to run and operate a business. And then I've seen it the other side. Or, you know, people have transitioned the business to their other family members that have then taken it over from there.
But the key is making sure that you've got the right structure, the right team in place, being able to have the key employees and everybody sort of buy into the future long term vision of the company.
I absolutely agree with you one hundred percent, and I think you said a couple things there. I want to dive a little deeper on it. Number one is the communication of the vision has got to start with the founders. So when I think of a strong framework for a family succession, right, it obviously starts with the founder, their ability to communicate the vision not only for the family but also the business.
Then we take a step down and look at the bucket of the business itself. And in many cases it's separating ownership from management. And I think far too often those two items get conflated. And kind of back to the example I was sharing about the client we're working with, where they've elevated somebody who's a non-family member into a management role, having clear delineations of how the business is going to be managed, whether it is appropriate to have a family member that's at the first of the second generation non-family members really teasing that out, having job descriptions, having metrics that everyone buys into that's being properly communicated.
Then you can then I think more easily think through ownership, right. That who actually owns this LLC or S Corp or C Corp. And then that will filter into how you actually draft your estate documents, the need for a coordinated plan with not only the CPA or the wealth advisor, but particularly the estate attorney, and then lastly, the family.
Right. And so within the family. And I think this is where many owners, struggle is like, what does good governance look like? And whether that's family retreats, an actual family council, a family constitution, leadership training for the second generation, putting those structures in place because, as you know, when to go from generation one to 2 to 3 and the family grows and now we're dealing with siblings, with cousins, it gets infinitely more complicated.
But to have that structure in place are going to have a much like greater likelihood of being one of those 35%, families that actually make it to the fortune 500, right?
Without a doubt. I mean, structure is so important within this piece there. I mean, I've seen people pass along real estate through the form of trusts. But what happens by the time that third generation gets it is now all of a sudden they inherit these assets. And then there's a revaluation of the property taxes and everything. And now all of a sudden you go from paying $25,000 a year in property tax on a building to $250,000 a year in property tax, just from that change of ownership.
And now all of a sudden, the rents versus the expenses, it just doesn't make sense to keep that property. And so where a family might have said this is a legacy property that I want to be around for future generations because they chose the wrong structure, it just became economically ridiculous to continue to hold that up. And then you couple that into like, if you go the LLC route.
Yeah. And you've got a few kids and those kids have a few kids each. By the time you get to that third generation, you go from one person having sort of ownership and control to then three to then potentially 12. And that's where it gets really, really confusing. Very complicated.
Yeah. No, I agree with you. So whether it's real estate or imaginary, you know, an operating business. Right. It's even I would say even infinitely more complicated, there as well.
So making sure that we've got the right governance and structures in place, even for family retreats to talk about philanthropy, making sure they've got committees, leadership training. You talk about having a family council or family constitutional constitution, but there's a need for special resources, like having a family business consultant or a team to be able to put the right structures in place.
Yeah. I mean, you know, in addition to sort of the traditional group of advisors, right? Again, the CPAs, the estate attorneys, the wealth advisors, you know, there are other consultants have real deep expertise. And I would say, you know, groups, like the Family Business Consulting group out of Chicago, they have consultants who work specifically only with families on these intergenerational dynamics.
They have the ability to help set up some of these, the family constitution, the family council bring special resources able to deal with those, interpersonal dynamics. Right. I'll give you an example. The second generation working in the business, for example, is a little bit out of the natural rhythm of the way most of us grew up.
Right? We get our driver's license, we go to college, we go off. We find careers that are typically different than what our parents are in. For those that are the second generation, where the owner/founder is still very involved, they are still sort of underneath and dependent on that first generation until such time as they have enough stock in the business and control, and it's really turned over to them.
And so it's I've heard it likened to almost like living in their parents' basement still when they're working in the family. And so how do you navigate that? Right, in a way that is not detrimental to the business, not detrimental to the relationship of the parents, that the second generation feels like they are contributing. Right. And so having those special resources helps us, I think navigate in a positive direction.
I agree with that. I mean, having the right resources and conversations, it's also fascinating to me where I've seen families come here to the United States, build a business or, you know, a group of people have properties of real estate properties, and they're adamant that their kids, do something else.
It's like, no, I want you to be a doctor. I want you to be a lawyer. It's just so fascinating. But but it all comes back to being able to have the right conversations with your family, what your intentions are, being transparent, which is one of the downfalls of our society, is we don't talk often enough about money or educate around finances.
Joe, you brought up a lot of really good points and one of the best paths to building generational wealth besides real estate and investing in stocks and bonds, which is a form of owning a business. It's just you don't have to be the one day to day in it. Is through building a business and creating generational wealth.
But if you're going to create a business that you can then eventually sell, you want to make sure that you're working on the right governance, the right controls, the right processes. So that way it's not solely reliant upon you.
Yeah. Do you have any other resources that might be helpful for people to sort of navigate these conversations?
Yeah, I think there's you know, I just finished reading, a great book for the second time. It's called Every Family's Business. Thomas Dean wrote it, and it tells the story of two owners who actually just recently sold. And they're on a they happened to be on a plane together. They sit down in first class and they're sharing their experiences.
And the big takeaway from it is what they call the family blueprint. And it's essentially 10 to 12 questions that each owner, in the family should be on a regular basis, bringing up like, you know, are you interested in buying more stock? You're interested in selling more stock? Are we both in agreement that we understand that unsolicited offers from time to time will naturally come in, and that we need to evaluate these in the course of our fiduciary duty?
In the course of maximizing shareholder value. We won't go through all of them. But those are the kinds of conversations that, again, Mr. Dean suggests that on a regular basis, every year, you're doing a family blueprint so that those thoughts are naturally going through people's heads anyways, that they're getting out on the table all the parties feel like they understand where each other are coming from.
And so when that unsolicited offer happens, or I need maybe to sell or to promote, you know, whether it's a family member or somebody else that everyone's on the same page. And I just love that. I think it's a great structure to, help somebody start to move in the right direction.
No, I think that that's great, Joe. And, you know, one of the challenges that I see a lot of clients have is, you know, hey, I've had to work my whole life to create this wealth. Well, yeah, I don't want it to just go to the next generation and then to just, you know, spend it, give it away or throw it away.
And so making sure that they've got enough knowledge and understanding around the structure, the different estate planning attorney, how the taxes work, how to properly invest. So that way when the time comes, they can properly manage this wealth.
Joe, thank you so much for joining us.
Disclosure: The information presented herein is for educational purposesonly and is not intended to constitute financial advice. The views and opinionsexpressed by the speakers are as of the date of the recording and are subjectto change. It should not be assumed that Morton will make financialrecommendations in the future that are consistent with the views expressedherein. Past performance is no guarantee of future results. You are encouragedto seek tax and/or financial advice from your financial advisor and/or taxprofessional to thoroughly review all information before implementing anytransactions and/or strategies concerning your finances.
