When private businesses become very profitable, what is the first thing that they do? They start to look to buy a business. Once they find one and digest it, they look for another and another and so on. How much is enough? How good is the owner of the business? He may be excellent at running a small business but once it gets too large, can he handle the operations? Will he hire people with more expertise than himself to run the business?
Now the owners kids are growing up and they go to university to study a field which dad feels may help the business. In family businesses, the first generation makes the business, the second generation may keep the business and sometimes improves it but the third generation typically loses the business and if the third generation has not, the fourth will make sure that the company fails. These are statistics and there will always be exception to these statistics.
If the child has taken a course, does that mean that they are the best person to be put in charge of the company or a certain aspect of the company? You can take a horse to water but you cannot make the horse drink. What is the difference here. Did the child get the position for who he is or for whose child he is. If he got it for who his father is, is this a recipe for disaster and the ultimate demise of the company? Family members often want to see their children run the business and keep the parents legacy going. They may do that in the short term but can they deal with catastrophic changes which can affect the business? Can they make the right decision in tough times?
Many second generations go on a buying spree and keep adding businesses to their entity. Do they know how to run these? They may take on too much leverage. When times improve, they have the opportunity to sell one of their subsidiaries at a large profit or refinance the business so that they can improve their balance sheet. How often do entrepreneurs believe that they are invincible? Why dilute their profits today and share with others in good times? They never look to the bad times. How many times have companies failed because of greed – instead of safeguarding the company, they look for what is best for themselves and not the long term survival of the company. There are several examples of public companies run by second generations which are now experiencing this problem. Some companies which have failed financed long term assets with short term debt. If the short term debt market collapses, the company can no longer finance the business and the lenders all demand the repayment of their loans. This series of events has brought down very large companies because the entrepreneurs made large bets, so large that if they were wrong, the entire corporation would crash and collapse.
Did the business lose sight of its goals? As one generation retires and the next takes over, do the goals change? If they change, are they logical and reasonable or risky? Did the second generation take a conservative company and make it risky by taking the company on a new direction – growth. Why do you need the growth – is the original company deteriorating and it needs to be changed? Does it make the original company better or are you going into new territories that you are become large for the sake of being large. If you have a business in Canada, buying a business in a similar business in Australia which caters to a different market and has no ability to use the same resources as in Canada – what is the benefit of this investment? There are no synergies, you can now say that you have built a company which stretches across the world but how did that benefit the existing business?
Too often, growth of a business is done because it sounds good or an advisor is going to make lots of money from the fees associated with this acquisition but is the acquisition relevant to the business, will it help the business and do you have the capacity to digest the business, both by man power and by management.