From Family Business to Family Office

This transition happens only once in a lifetime, so it pays to plan well in advance

What’s a family to do with a business worth $100 million or more?

Today, there are over 1,500 of such businesses in the U.S. alone, and the owners of 40% of them are expected to retire by 2017.

The largest family-owned American companies include Wal-Mart (the largest by far), Ford, Cargill, Koch Industries, Comcast, News Corp., Bechtel and Mars.  In fact, more than a third of the companies in the S&P 500 are family-controlled1.

When family members who own these substantial businesses decide to sell them, they can either outsource the management of their newly-liquid wealth or, as is becoming increasingly common, create their own single family offices to watch over their nest eggs.  SFOs are gaining in appeal because they offer the total financial privacy and control that is prized by the ultra-affluent but is not otherwise available at private banks, trust companies or investment advisory firms.

As many of these families are discovering, however, SFOs need to be carefully tailored to reflect family priorities and idiosyncrasies and, in order to avoid internecine warfare, SFOs also need to be embedded in formal legal structures with clear, practical and even-handed shareholder rights.

Two to three years

“Done properly, the process of turning a successful family business into an effective family office takes as long as two to three years,” according to Robin Coady Smith, co-founder of Privatus CI3O Services which counsels families through their passage from business ownership to wealth management.  “There are a lot of special skills involved in readying a family business for sale and simultaneously erecting an entirely new investment structure that meets the family members’ diverse expectations and harmonizes their complex interpersonal relationships.”

golden nest egg isolated on white

As you can imagine with families controlling so much wealth, the hurdles in this process —  structural and circumstantial — can be daunting.

For example, a family I know with a $100+ million business now owned by ten members of its third-generation was bitterly split over the issue of bloodline ownership.  In the original shareholders agreement, the family patriarch restricted control of the company to his lineal descendants, their spouses and offspring, and any amendment to the agreement had to be unanimously approved.  While most of the ten cousins were married and had children, one was gay and another was a committed bachelor.  The family was thus faced with finding a legal solution that respected the patriarch’s wishes as much as possible while accommodating the lifestyle choices of all the family members.  The compromise outcome was to issue new non-voting shares to the equity stakeholders which would be transferable to outsiders.

In another case handled by Privatus, a family with a $3.5 billion business whose ownership was spread across four generations suddenly lost its 54 year-old CEO in a skiing accident.  The company had no succession plan and family members had to scurry home from all over the world to determine who was best suited to run the business.  None of them was actually available to play that role, and so the family had to go through the contentious process of hiring an outsider.  Getting all the family members to agree on a single candidate proved to be a Herculean task.

‘Seller’s remorse’

Historically, only about 30% of family-owned businesses in the U.S. have even survived the transition from the first generation to the second, only 12% have survived the transition to the third and only 3% to the fourth.

In contemplating the sale of their companies, even the wealthiest families often don’t adequately prepare for the transition because they’re too emotionally involved in their businesses.  According to Carl Sheeler, Privatus’ other co-founder, “most family business owners, for example, don’t really understand how their 50 year-old governance structures fail to meet modern standards or how their business operations create unnecessary risks or undermine profitability.”

 “A family business of any real size needs outside advisers to guide the transition since wealthy families just don’t have the objectivity to diagnose the weaknesses in their businesses and make the necessary adjustments to appreciate those businesses for future generations.”

Not even ultra-affluent families have the skills and experience necessary to cover all the bases.  “A family business of any real size needs outside advisers to guide the transition,” says Coady Smith, “since wealthy families just don’t have the objectivity to diagnose the weaknesses in their businesses and make the necessary adjustments to appreciate those businesses for future generations.” She also warns that the interests of family advisers are not always perfectly aligned with those of family members, and so their agendas may need to be closely monitored and coordinated.

One of the wrenching issues that bedevils almost all family business transitions is how to replace the income on which family members have been relying.  According to Coady Smith, this is where ‘seller’s remorse’ can set in if the transition is handled without comprehensive planning.  “As we all know, wealthy American families are famous for frittering away their fortunes within three generations.”

1 Altogether, there are 17 million family-owned businesses in the U.S. today and they constitute 90% of all U.S. businesses.

  • David Gorman

    I hope to be able to fritter one day!

  • Caroline

    Really enjoyed this article!