When handing over family assets to the next generation, each owner must be able to decide whether continuity or wealth generation should follow, says R. Adam Smith, an American financier, investor and expert in the financing of family businesses, in an interview with TREND.
In Slovakia, 30 years after transitioning to capitalism, many family businesses are grappling with succession or further transformation. The transformation for the next generation is crucial. How do you perceive it?
Having studied International Relations for many years, I find it fascinating to observe the evolution of the Slovak economy and other emerging European countries. It's heartening to witness the growth of larger businesses, family offices, and the rise of an entrepreneurial economy.
Over the years, serving on the boards of family-owned companies, I have frequently encountered the challenges of succession andtransformation, irrespective of the business's size or location. In terms of the transformation, governance, ownership and legacy are important soft and harders elements for these family businesses.
What should they not underestimate in this process?
Family businesses must recognize the softer elements in ownership, governance, and legacy. Legacy is an intrinsic part of any family business. I've explored this extensively in discussions, and with experts on the Family Business Audiocast.
Legacy can be deeply personal, driven by financial or emotional motivations. It's essential to consider each owner or partner's unique definition and purpose around legacy. They must ask themselves: Are they focused on continuity, or are they driven by the goal of wealth generation? The challenges between continuity and monetization are complex and distinct.
What is your advice if they want to focus on continuity?
For those emphasizing continuity, excellence in human capital, as well as board and governance resources, is crucial. The business must evolve as an operating asset, encompassing a range of factors. Conversely, for those leaning towards monetization, meticulous preparation is key, often requiring a year-long process.
What are the most common options for the transfer of family business assets in the USA, and why?
In the USA, transferring family business assets is a critical consideration. Owners often choose from several common options, each influenced by tax implications, control preferences, and succession goals. These include gifting, trusts, family limited partnerships, direct sales, and employee stock ownership plans.
Each option has its pros and cons, tailored to the family's circumstances, the business’s nature, and the desired outcomes of the transfer. Working closely with advisors ensures that the chosen method aligns with tax efficiency and the family's broader goals.
- Family business asset transfer options in the USA
• Gifting: The IRS allows a certain tax-free amount to be gifted annually. This gradual transfer method can be efficient, lowering tax liabilities
• Trusts: By placing assets in a trust, the original owner can maintain control over distribution while enjoying certain tax advantages and protecting assets from creditors
• Family Limited Partnerships (FLPs): FLPs allow family members to jointly own and manage property while benefiting from significant tax advantages. Ownership can be transferred gradually through partnership interests
• Direct (Family) Sale: A straightforward method of selling the business to the next generation, potentially structured with installment sales for tax benefits.
• Employee Stock Ownership Plans (ESOPs): ESOPs offer tax advantages and ensure employees have a stake in the company’s success, which is beneficial if family members are also employees
When transferring property, there is often a problem right at the beginning when owners cannot determine the value of the company. How to correctly determine it?
Determining the value of a family business is one of the most critical and challenging steps in the ownership transfer process. Accurate valuation is essential for fair transfers and meeting legal and tax obligations. There are three primary valuation methods: Income Approach: This method values the business based on its future income-generating ability. Common techniques include the Discounted Cash Flow (DCF) analysis and capitalization of earnings, which consider the present value of expected future cash flows, discounting them at a rate reflecting the business's risk.
Market Approach: This method compares the family business to similar businesses recently sold. By examining the sale prices of comparable companies, one can estimate a market value. This method is particularly useful in robust markets for similar businesses, though smaller companies may need to hire advisors to gather this data.
Asset-Based Approach: This method calculates the value based on the net asset value, which is the total value of the company’s assets minus its liabilities. It’s often used for businesses with significant tangible assets or in liquidation cases.
What are the factors affecting the value?
Several crucial determinants influence a business's value: financial performance (including revenue, growth, profit margins, and cash flow), market position, competitiveness, brand strength, and market share. Other factors include management and workforce quality, customer base, growth potential, physical assets (real estate, equipment, inventory), and intangible assets (intellectual property, patents, trademarks, brand reputation).
Growth potential is particularly important—what has been achieved organically without investors or changes, and what remains unaccomplished due to constraints? Engaging professional appraisers and financial advisors can provide more effective and objective valuation work, which is crucial when seeking meaningful investors or buyers.
In the Slovak Republic, family companies often choose a holding structure during transformation. If they opt for trust funds, they look for solutions in the Czech Republic. What are the advantages of trusts?
Trusts are invaluable for managing family wealth, especially as businesses grow larger and involve more family members across generations. Establishing formal trust structures is an effective strategy for wealth management and succession planning, offering robust asset protection against creditors and legal disputes. Trusts provide substantial tax efficiency, control, and flexibility, and facilitate a smooth transition of business ownership and management, thereby reducing disputes and ensuring continuity.
They ensure that family assets are preserved, managed efficiently, and distributed according to their wishes, securing the financial legacy for future generations. This is becoming increasingly relevant as families consider philanthropy, as seen from conversations with UBS, Camden, Ron Diamond and larger philanthropic advisors.
- Key steps for successful handover of a family business
1. Start Early: Begin succession planning well in advance. This allows ample time to prepare and address any potential issues that may arise
2. Clear Communication: Maintain transparent communication with all stakeholders, including family members, employees, and potential successors. This helps manage expectations and reduce conflicts
3. Formal Succession Plan: Develop a detailed succession plan outlining the process and criteria for selecting and transitioning to new leadership. Include timelines and specific responsibilities
4. Training and Development: Invest in the training and development of the next generation or chosen successors
5. Governance Structures: Establish robust governance structures, such as family councils or advisory boards, to oversee the transition and ensure continuity in decision-making
6. Engage External Advisors: Utilize external advisors for their expertise and objective perspectives
7. Gradual Transition: Implement a phased approach to transition responsibilities gradually. This allows the outgoing leadership to mentor and support the new leaders
8. Performance Metrics: Set clear performance metrics and goals for the new leadership. This ensures accountability and provides a benchmark for success
9. Preserve Legacy and Values: Ensure that the core values and legacy of the family business are preserved and communicated to the new leadership. This helps maintain the business’s identity and culture
10. Develop contingency plans to address unexpected events or challenges that may arise during the transition
Is something changing in the approach of family business owners? How have their decisions evolved in response to recent crises (COVID, energy crisis, inflation, etc.)?
We all in the world went through a super challenging time that affected the way we manage our lives and how we view the importance of work and the workplace, being more attentive to unknown outcomes.
Recent global crises have profoundly impacted how family businesses operate and make decisions. The COVID-19 pandemic, in particular, has changed organizational work setups, emphasizing the importance of flexibility and responsiveness.
These crises have accelerated the need for digital transformation and pushed family businesses to invest more in technology. They have also highlighted the significance of human capital—companies are only as strong as their people. As family businesses adapt to an increasingly volatile world, they are adopting more resilient, sustainable, and adaptive strategies to thrive.
At what point do you recommend family businesses call in an external advisor or manager for help and consultation?
As an advisor to many family enterprises and family offices over the years, I believe it’s essential to involve advisors during strategic transitions, such as entering new markets, acquisitions, leadership changes, operational shifts, mergers, or joint ventures. Advisors provide invaluable expertise, objective insights, and can assist in developing and implementing comprehensive succession plans. They can also mediate conflicts among family members affecting business operations.
Bringing in external advisors can offer fresh perspectives and strategies for revitalization when businesses face stagnation. Ultimately, family businesses must grow to survive, and external advisors can be critical in providing the necessary guidance and support to achieve that growth. Often, the answers to a family business's challenges are not found internally but through the objective lens of experienced advisors.
- R. Adam Smith
R. Adam Smith is a leading expert on the financing of private companies, family businesses and strategies. Since the mid-1990s, he has worked as an investor, advisor and financier in more than fifty companies backed by venture capital and private capital. During his professional career, Adam has been involved in transactions worth billions. In 2022, he played a key role in the relaunch Salomon Brothers, one of the most respected firms on Wall Street, originally founded in 1910. He is a founder of RAS Capital Partners, which serves as a major merchant banking platform dedicated to providing sustainable capital solutions and strategic insight primarily to family businesses and entrepreneurial businesses. Adam is married, the father of three children, actively engaged in international relations, passionate art collector and philanthropist. He founded Family Business Audiocast, a global media platform that features interviews with industry leaders around the world. R. Adam Smith will speak at the International Congress of Family Businesses at the Château Belá Hotel in Slovakia in September 2024.
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