Archive for the ‘Family Businesses’ Category

As gruesome as the topic seems, it is a contingency for which a succession/estate plan must be made.  The death of a proprietor means that the proprietorship is over. The T2125 return must be prepared up to the date of death and this is filed in accordance with the rules for filing a deceased person’s return:

  • 6 months after the date of death or April 30th (of the following year) whichever is sooner.

This return is called a “terminal return” and a copy of the last will and testament of the testator (the deceased) must accompany the T1 return along with a copy of the death certificate (provided by the funeral home).

It is important that an experienced estate representative be appointed as the business may be closed as at the date of death, there may be contracts to complete, trade receivables to collect and payables and statutory filings to make.

The assets and liabilities of the proprietor would become estate liabilities and estate assets and must be properly accounted for.

 

This seems like a very strange post on a small business site.  It isn’t! ‘Death’ is an unplanned exit strategy for a small business owner – gruesome as it might sound. The death of a proprietor or shareholder should be part of contingency planning.

The death of a proprietor signals the legal cessation of the proprietorship. The T2125 form has an end date on the date of death of the proprietor. The assets and liabilities are those of the deceased taxpayer anyway so disposing of those can be performed as part of the winding up of the estate of the deceased proprietor.

The death of a small business shareholder presents a few unique problems. The common shares of the deceased shareholder need to have a valuation placed on them. Any shareholder loans payable to the shareholder now are payable to “The estate of the (deceased) shareholder.” The corporation is a separate legal entity and can survive the death of a shareholder – but may not.  Is a succession plan in place? If 100% of a shareholder’s livelihood derives from a salary and the shareholder dies, there is no carry-on of a shareholder to an estate.

It could take 1-2 years to successfully windup a small business corporation and legally surrender the articles of incorporation. The assets must be disposed or and used to pay liabilities. If there is any cash left, the estate could declare and pay a liquidating dividend to the estate of the deceased shareholder. In reality, the cash collected from outstanding trade receivables might be insufficient to cover current liabilities, including CRA remittances. In that case, the estate representative (executor) might have to inject more money into the business to pay all bills.

I have seen many small businesses wind-up with large amounts owed to shareholders – in the form of a shareholder loan and issued common stock. There is some tax relief available in the form of an Allowable Business Investment Loss (ABIL).  This is a “too late” strategy for the estate.

It is imperative that the shareholder(s) of a small business have a succession plan in place. An executor should be appointed who understands business in general and who may be responsible for winding up the business.

Large publicly traded companies announce top executive changes months in advance.  A large bank may announce that their CEO is leaving in 9 months and a search committee has been formed already to find a successor.

Large companies have a roster of qualified candidates for top management positions but care is always taken.  This isn’t the case in a small business or a family business. In many cases the replacement is known. It’s a matter of when the change will occur.

What sort of business environment will the successor inherit? If the current shareholder will pass the torch to his/her successor, what is being inherited? In too many instances, the inherited problems could be as great or greater than before the transition.  The business environment today is much tougher than it was when your parent moved into the front office. A strategy of “more of the same” could spell the end of the family business.

It is incumbent on the family owner/managers to have a business planning process in place. What is the state of the business now and what challenges will the new owner face? The business should be dropping one (executive) salary but will the business really be better off.

A change in control without a succession plan is a recipe for disaster.

I will talk about a succession plan in the next couple of posts.

 

I’ve spent the last several posts commenting on flaws in the family business modus operendii. It isn’t all bad of course. There are tens of thousands of family businesses in this country that have successfully transitioned from generation to generation.

There is one novel approach used by Canada’s  Jim Pattison. He is one of the wealthiest men on Canada and, at last count, he owned close to 70 companies.  The Jim Pattison Group is ubiqitious. However, Pattison has no family members in his empire. He strongly believes that his kids need to make a life (and fortune) for themselves – on their own. Pattison started out in the car business. He looked at the output (of his sales staff). The lowest performers on the sales chart were always terminated.  This is a very tough business approach but, it worked for Pattison.

While that might be at the  extreme end of the spectrum, I have read articles in various business magazines in Canada and the US where, the best run family businesses were those that required the next generation to gain business/management experience at non-family businesses before they joined “the firm.”  It makes sense. A large business could never survive without a strategic plan, a complete understanding of their market, budgets, responsibilities and accountabilities.  This means “structure.”

Once the family member has 5-10 years business experience then they may be ready to think about joining the family business. They bring experience and insight if they decide to join the business. In hindsight it would have been a benefit to both me and the family business if I had opted for this approach. However, hindsight is 20-20.

The newcomer to the family business might ask some tough questions of his/her parent. Do we have a strategic plan? What market are we in and are there any market trends that could impact our business? Do we have an organization structure that will allow us to focus on strategic direction yet make sure the day-to-day tasks get done? Oh yes, one other thing: does will business make a profit after adding my salary?

Tough questions but fair. These would never be asked if the newbie hadn’t gained experience working somewhere else. This is called due diligence.

The new arrival into the family business brings youth, new ideas and a certain amount of irreverance that is positive as long as it is controlled. There are some problems that will arise and I will discuss a few here:

  1. Do I have authority to go along with your expectations?  This is a critical issue. The boss may get annoyed that his son or daughter made a bad decision or took initiative without consent but there should have been clear expectations about protocols for decision making when hired.
  2. None of my ideas are ever taken seriously. This is a routine complaint. Inter-generational arguments center around this. The owner usually retorts by saying that “you need to spend more time understanding how this business operates.” The new respondent replies: ” Your tried and true methods have been in place for years and they don’t work.”
  3. What is my role in the business? This is a fair question. I used to ask myself this when I went through stretches where I questioned if I was of any value at all.

The incumbent(s) need to carefully plan a management apprenticeship program. It seems counter-intuitive since the newbie is already in management.  The seeds of discontent can be set in with feelings of marginalization. I’ve heard many new family members say: “I am nothing more than a glorified gofer.” Well run family businesses may start the new family member in the shipping department and have them work their way up through the various departments before they ever see their name on an office door.

The acid test however is having a financial investment in the business. If a new member buys in to the family business (literally) then the rules are different. There may not be the due diligence undertaken similar to a sale of an interest to an outsider. If a second (or third) generation family member invests dollars in the business, before the ink dries there should be clear articulation of duties, remuneration and eventual acquisition of more shares.

The rule then becomes caveat emptor.

Sadly this isn’t the case…

Most, if not all, businesses benefit from new blood. The proponents agree that the benefits to the business are: new ideas, new processes, an awakened vitality and different ways to connect with customers. All of this should be good… right? There might be one dissenter. The current controlling shareholder of the business.

“It worked for my father and my father’s father so why should we change anything?” Here’s a nugget that I’ve heard on too many occasions while working in family businesses: ” I know what I’m doing.” This means that any ideas of exploring new ideas and processes are effectively curtailed.

This is not to suggest that the status quo isn’t a good thing. The status quo represents comfort and predictability. The second generation family business member has a lot to learn about business in general and their business in particular.

This certainly has merit since a new family member is usually parachuted directly into the ranks of management without any prior training. Yet, this is exactly the way that the incumbents came into management too.  This paradox is obvious to an outsider (like me) who worked in a family business and has been around family businesses for many years.

This works pretty well for businesses in secure markets who are not subject to extraneous forces that upset the applecart. Few businesses escape market changes or change brought about by technology.  A classic example is big box retailing.  The Walmart phenomenon started in the US midwest and is now worldwide.  Walmart used scale to deliver goods that customers wanted and at prices that were affordable. The other basic tenet of the Walmart philosophy was that mass retailing was not only delivered in large urban centres but in smaller locales. The automobile changed this. People  drive 50 miles to save a dollar on a specific item and buy a whole lot of other items at the same time. Walmart has stores that offer groceries as well. It is the complete customer buying experience.

So what does this have to do with the family business? Everything!  The family business that thought it was inure from the big box competitor gets a rude awakening when a small community announces that one of these big stores is opening soon in its area. Great for the customer but bad news for the family (dry goods) retailer that has operated in the community for 75 years.

Inter-generational change is a critical element and obstacle for family business.

 

A family business requires new blood. In most cases this occurs when a  younger family member joins the firm. I did this myself. I had just received my bachelor of commerce degree and joined my dad in the family retail business. He had many years of experience in the textile manufacturing business and had left his own family business in the early 1960s to start a retail fabric business. He had years of selling and buying experience but he was certain that I would be the person to drive the business to the next level. After all, I had a university degree.

Yes, I had 4 years of theory but absolutely no real life experience. I was immediately elevated to a managerial position with no experience in hiring, staff supervision or merchandising.  This seems unusual but it happens all the time in family owned businesses. One business analyst joked that family members get to where they are by dent of DNA not ability. It may sting a little hearing this but it is true.

There is absolutely nothing wrong with on-the-job training but what is the probationary period for the trainee and what are the qualifications of the trainer? I learned a lot in my nine years in our family business. The lessons learned I have applied to family businesses with whom I have been associated over the years as either an employee or a consultant.

Some issues that need to be considered:

  1. Is the new family member interested in this type of (intense) enterprise for the rest of their career? Most of us need money to survive but working for a salary is not the raison d’etre for a small business entrepreneur.  This may take 3 or more years to become obvious for both the scion of the family and the new arrival.
  2. In my experience, a new family member is an overhead position. Is there financial room to accommodate them? This, combined with #1 above could dig the business into a deep hole in the 3 year feeling-out period.
  3. It is harder doing business today than 40 years ago, when I started out. The trainee needs to get up to speed quicker and the trainer needs to provide on the job training that will achieve that goal.
  4. What true authority will be transferred as part of the training process? I considered making this #1 on my list but I have put it in #4 spot.

These are four key issues that haven’t changed during my tenure with family owned and operated enterprises. Many family businesses have survived from generation to generation. Many fail however and it wreaks havoc on immediate families as well as long term employers, customers and suppliers.

As I stated in my previous post, the first five years are the hardest in the chronology of a family business – any business for that matter! The new business is trying to create a name for itself ( develop goodwill) in its market. The proof will be – the bottom line. Is it profitable? When? Can the profits be duplicated and sustained?

The next 10 years may be the years where the most growth occurs and possibly the years where the scion of the small business feels most stressed. Growth is a good thing but ancillary issues arise:

  • Growth necessitates more office or production space.
  • Growth requires more staff.
  • More staff can result in more headaches if the right staff aren’t hired.
  • Growth necessitates better management. Specific skill sets (ie: marketing and selling, operations, finance, technical, IT etc.)
  • A serious review of the organization structure should be on the agenda.
  • Oh yes… lest I forget .. growth means having the resources (cash flow and financing sources) to handle the growth.

I am excluding the family business that remains relatively stable and whose size (or staff) doesn’t change. Maybe, in the long run, this types of family business wins the tortoise vs the hare marathon?

Growth is the desired outcome for family business owners. It builds a legacy and creates an opportunity for family members to join “the firm.” It can be improperly managed and can create a lot of problems later on. The six bullets above underscore a failing that many family business owners fall prey to” Micro-management.”

Micro-management is understandable given the genesis of the family business itself. Two spouses doing the lions share of the work and trying to do the lions share of the work even as the business expands beyond their capabilities or beyond a typical small business work week – closer to 60 hours per week vs 35-40 everywhere else.

There should be a segregation between strategic and operational management.  In a family business there isn’t. Marketing and business development are put on the back burner because the business has more work than it can handle.  Supervising staff becomes the game plan.  It is not surprising to me but most small business owners don’t have written job descriptions for key staff. It’s simply a matter of: .. do what I say.

This type of management is not strategic. The focus is short term. I have been involved in many family businesses with this management style. It is called crisis management.

Into this inner management sanctum comes the next generation.

 

I will attempt to break down the chronology of the family business into easily understood chunks. A family business that either starts out as a corporation or a proprietorship, needs to be able to survive the first five years financially. The Canadian Federation of Independent Business (CFIB) posted a chilling statistic that (as of 2009): over 50% of all businesses fail within the first 5 years of start-up. So, the first order of business is – to stay in business!

The family business usually starts out small, and overheads are not out of line. A lot of administrative tasks are performed by a spouse, usually without compensation. This isn’t a bad things as there is the realization that unnecessary overheads must be controlled.

The goal is to not only show a profit within the first five years but to make the profitability recur on a year-over-year basis. Usually staff that are hired are hired as direct revenue generators. This is okay as well.

It has been my experience that financial reporting is not on a monthly or even a quarterly basis. It is usually on an annual basis as part of the year end income tax reporting calendar. Some family businesses play “catch-up” by getting all of their financial records ready for the external accountant and fail to take corrective action on a monthly basis. This is a serious oversight.

The well being of the business is determined by its bank position. The business has piles of vendor bills and a list of customers to collect receivables from but, a financial accounting software package is looked upon as an unnecessary expense or something that is too difficult to understand.

Cash flow management can be difficult. Statutory remittances for payroll and sales tax can be missed and then – the problems begin.

Yet, it has been my experience that a lot of family businesses survive longer than they should using this approach.

Then what?

Incorporation can take place at any time.  The fiscal year end can be any month of the calendar year. Incorporation usually occurs for tax reasons. The marginal tax rate of the individual (proprietor) is north of 45% so incorporation makes sense.

One of the drawbacks I see with small business corporations is their share structure. They are usually structured as “mom ‘n pop” corporations. The authorized capital is “an unlimited number of common shares” and the issued capital varies between 1 share and maybe up to 500 shares.

The problem with this type of share structure is that it assumes there will be no new shares issued to (family) investors.  There isn’t much thought given to estate or succession planning so, no preferred share capital is authorized, let alone issued.

A well thought out share structure should include:

  • Unlimited number of retractable non-cumulative preferred shares @ $25 each.
  • Unlimited number of Class A common voting shares
  • Unlimited number of Class B common voting shares

The parents get Class A shares. The kids who might one day assume control of the business get the Class B shares. This share structure will become more important as the parents reach the stage where they want to pass control of the business to their kids and want to monetize their equity.

More on this later.