Family-owned businesses play a major role in the economy and founders face difficult decisions when it comes time to consider passing it down to the next generation, experts said in a new podcast.
The latest episode of Goldman Sachs Exchanges discussed how family-owned businesses should approach planning for generational transitions given their importance to the economy, according to a transcript reviewed exclusively by FOX Business.
FX de Mallmann, chairman of investment banking at Goldman Sachs, noted that in the U.S. “there are over 32 million family-owned businesses, which represent over 80% of all businesses.”
“Those account for over 60% of GDP and over 60% of the overall workforce. If you move from the private company world to the public company world, around 35% of the Fortune 500 companies are family-controlled or have a significant family owner, which has a substantial base,” de Mallmann added.
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They also play a significant role in the global economy, with family-owned businesses accounting for about 70% of the world’s economic output and 60% of its jobs.
“In the history of civilization, it used to be a much higher percentage than that. It’s only in the last couple of centuries where we have more of a corporate structure and the scale that comes from that more permanent capital that comes around that, that’s led to this,” Tucker York, chief of global wealth management at Goldman Sachs, said.
While family-owned businesses account for a large share of economic output and jobs both in the U.S. and globally, it’s relatively rare that they get handed down through one or more generations. Goldman Sachs noted that only three in 10 family-owned businesses reach a second generation, and only about one in 10 reaches a third generation.
“What I find with investors is the moment that you start thinking about [the] next generation, how do you invest, how do you think about those things? As distinct from what do I need to do this week, this month, this quarter? It all turns on a long-term orientation,” York said.
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Generational transitions are a critical moment because the founder of the business is faced with two decisions, in de Mallman’s view.
The first centers on whether the family should stay involved in the management of the business and in what capacity; while the second is how the founder is going to pass on the stock and ownership of the company from one generation to the next and how it’s organized.
“In my experience, this process and this mechanism needs to be thought through early on before the number of family members gets too large,” de Mallmann said. “And typically having some exit right of some form and having some conflict resolution mechanism in case there is one or disagreement on any point goes a long way.”
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The capital needs of the business for expansion, who the potential investors would be, and how an investment would impact the family’s equity are other considerations in succession planning for family-owned businesses.
Third-party investors, either at an individual or group level or the public market, can bring discipline and serve as a forcing mechanism for the family to discuss complicated aspects of the business, potentially leading to a decision to sell, de Mallmann added.
“What I have witnessed many times in the context of the sale is there could be great economic outcomes and great solutions for businesses to be consolidated, merged or sold, but that often the family has part of its identity in the business and a sale has a significant impact on the family’s emotions and on their sense of identity that’s tied to the business,” he said.
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York explained that succession planning and long-term capital structure planning can also change over time, and as a result, “this concept of we’re going to make a plan and then we’re good, it doesn’t apply. It needs to be reviewed and stress-tested regularly.”
