Family Business Succession or Entrapment?

MSI - Family business1By Andrew Mattner, Hattam McCarthy Reeves, Accountants, Adelaide.

It is a well-known statistic in Australia that the Baby Boomer Generation (someone born between 1946 and 1964) makes up approximately 25% of the total population – while controlling 55% of the nation’s private wealth.  A vast majority of this wealth, estimated at $4.3 trillion, is tied up in Australia’s small medium (SME) business sector.

Research commissioned by Family Business Australia (FBA) also indicates that as the baby boomer business owners approach retirement (81% indicate that this will happen within 10 years) one of the major concerns is facilitating a successful generational change.  This is a significant issue in that 65% of all family businesses have two or more generations working in the business.  The percentages in farming businesses are even higher.

While these statistics are interesting they do little to tell us about the practical issues that this generational change poses.  Let me explain.  In any generational transfer there are numerous factors that create barriers to success, and conflict between individuals.  These include:

  1. The need to balance family concerns and business interests
  2. Adequate compensation of family members working in the business
  3. The ability of the business to generate adequate financial returns to support the family
  4. The level of trust in the ability of potential successors to run the business

These are all very real concerns.  In my work as a family business advisor I have first-hand experience in managing all of these issues but the one that causes the greatest level of conflict and is perhaps the greatest barrier to success is the third issue.  When this occurs one of the common results is a symptom that we define in our office as “entrapment”.

Entrapment in a family business occurs when the older generation employs family members in the business at lower than market rates on a promise that one day the family business will be theirs. Normally this occurs in underperforming businesses that are unable to financially support multiple generations or have not generated sufficient return to enable the older generation to step away in the comfort that they have sufficient “off-business” assets to retire.

Unfortunately, in a lot of circumstances, entrapment not only leads to the destruction of the business but to the destruction of the family also as it has the potential to:

  1. Create significant conflict between generations working in the business
  2. Create conflict between siblings (between those working in the business versus those that are not when an untimely death occurs)
  3. Create a “lazy” business that ultimately becomes financially unsustainable
  4. Create a knowledge black hole where the entrapped children are unable to financially support the educational needs of their children
  5. Lead to further generations walking away from the family business because they don’t want to do what their parents did (there is significant evidence of this in the rural sector as evidenced by the diminishing number of children electing to stay on the farm)

There are countless examples of families that have managed this situation well, and just as many that have not. Unfortunately for those that have not managed it well so much damage is often done that it is difficult to repair.

If your family business supports multiple family members or you are contemplating a generational change it’s important you to seek assistance to ensure that you have every chance of success.

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