Why and when to divest in family business

Succession planning in the context of family businesses is not merely about passing on businesses to subsequent generations. It involves more of a holistic preservation of wealth for future beneficiaries.

However, based on multiple studies, more than 60 percent of family businesses do not have a succession plan in place and over 50 percent of business owners over the age of 60 years do not have a documented plan to facilitate the transition anticipated upon their exit.

Unfortunately, the beginning of such a transition period is more often triggered by ill health or even by sudden death; both of which render the original owners incapable of any further executive involvement.

Even where the founders are actively working on a succession plan, a decision on whether to retain ownership of the business within the family or to sell it to third parties is an agonising financial and emotional challenge.

Further, the decision on the appropriate timing of a family business divestiture is convoluted because of the many social considerations that have to be factored into the process.

What are the factors that may tilt the scale in favour of a decision to either hold or divest the business?

1. Risk of losing bequeathed wealth

Economist Adam Smith observed that great fortunes are seldom extended and are often lost by children and grandchildren.

His observation is validated by recent research indicating that only 30 percent of family businesses make it past the second generation of leadership, while 10 to 15 percent make it past the third generation with a mere 3 percent making it to the fourth generation.

A decision on whether to hold onto or sell a family business may therefore be better informed through careful assessment of the beneficiaries including their perspectives and interests in life, their areas of passion and their overall ability to carry on the business.

A founder whose heir has an unfettered pursuit of grossly divergent goals may find it better to divest from the business and invest the funds for future wealth preservation.

This ensures the beneficiaries benefit from the wealth created by founders and use it in a way that benefits subsequent generations.

2. Lack of a successor

Succession planning within the family is also affected by the lack of a family member to take over the business. In such a case, the decision to divest is inevitable.

It is also becoming increasingly common to find situations where heirs do not wish to undertake the business because they either lack the intellectual flexibility required to steer the business through turbulent economic times and ultimately catapult it to greater heights or simply lack the founder’s zeal, passion and skill for the specific line of business.

In such situations, an exit strategy in the form of divesting is necessary so that the funds realised can be applied in an area aligned to the heir’s competencies and interests, thus retaining wealth within the family.

3. Effects of the internet revolution

New forms of technology-driven businesses have been a threat to traditional ‘brick and mortar’ enterprises in terms of direct competition.

Further, the existence of fast-growing technology-related entities increases the opportunity cost of being in a traditional business because the latter has slower financial returns and lower general appeal to the younger generation.

This is compounded by the fact that there is a generational divide between founders and beneficiaries; a divide that was accelerated by the internet revolution.

In such cases, it may be important for the founders and their beneficiaries to jointly decide on the future of the business, part of which may include the hiring of external professionals to run the business on behalf of the family or changing business models to adapt to current trends that beneficiaries can identify with.

4. Economic considerations

In some cases, offers to divest are irresistible due to the potential cash value.

Although emotional and social factors may transcend economic considerations, it is important for the family business to carefully evaluate such opportunities because this could mean higher wealth growth and preservation for the family in the longer term.

5. Impact of debt

Some family businesses are gravitating towards increasing debt, where they have to continually borrow to survive.

The owners may have a blurred vision of the future regarding how exactly this debt situation will pan out thus providing a compelling reason to divest to safeguard family wealth.

5. Life after-sale

Founders have to factor in the effects of the divestiture on their post-sale preoccupation. For people who have been fully engaged in building their business daily for decades, life outside the demands of the business may be daunting.

There would be a need to determine what they will be engaged in since this may inform the need to leave themselves a few roles in the business as they ease themselves out, as opposed to an outright sale.

Whatever the circumstances, family businesses should carefully review their succession plans and revisit them regularly to ensure the wealth maximization and preservation objective is met.

Often such businesses and families would benefit from the involvement of an independent outsider who can help analyse and map out the family dynamics, intentions and objectives and the state of the family business in providing clarity to the benefits of various options.

Mr Shah is a Partner in PKF Kenya LLP and Head of Assurance for PKF in Eastern Africa. He is an expert in Succession Planning and heads PKF’s service offering in this area.