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Exit Planning

The Five Pros and Cons of Family Business Transfers

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There are hundreds, probably thousands, of advisors who specialize in family business representation (perhaps you are one?), hundreds of books about the dynamics of family businesses, and dozens of family business centers dedicated to the success of family-run businesses.  The purpose of this series of articles on family business transfers, however, is to:

  • Highlight the challenges and benefits of family business transfers,
  • Describe the three essential elements in a successful transfer,
  • Reveal the ingredients of the road maps BEI Members create for owners to follow in these transfers,
  • Tackle the thorny issues of merit and fairness, and
  • Explain the back-up plan necessary for both owner and successor.
     

Let’s start with the benefits and challenges that these transfers present to the brave owners who wish to pass a business to the next generation.

Benefits

Financial Security:  If you properly structure the transfer for your business-owner clients, they can receive the amount of income they need or want during and after their exit–even if the business value does not justify that sum of money.  Further, you can design the transfer so that owners retain control of their businesses during the buyout period and until they receive all of the money they want and need.

Time:  If an owner does not want to leave the business today, you can structure the transfer to children to take five to ten years depending on the owner’s goals, the abilities of the successor owners and the readiness of the business.

The length of this exit path gives owners time to slow down, develop other interests and prepare themselves, and their business, for life after the sale.  It also gives owners time to collect income from salary, perks, and distributions while maintaining control.

Taxes:  Using a strategy unique to family transfers, you can minimize (and often avoid) the income taxes on transfers of ownership to family members.

Values-Based Goals:  Owners often choose to transfer their businesses to children because, if done correctly, it achieves so many of their values-based goals.  These include:

  • Continuing the joy and satisfaction they gain from working with their children during and after the ownership transfer.
  • Offering children greater employment and financial opportunities than available elsewhere.
  • Maintaining the business as the “glue” that holds the family together.
  • Fulfilling the expectations of children who have grown up in the business, know, want to stay in, and one day, run it.
  • Reaping considerable (and justifiable) satisfaction from family tradition and values that benefit family, employees, customers and community.
     

Known Successor:  When the successor owner is one’s child(ren) rather than a third party, owners know all about their honesty, work ethic, leadership and management skills.

Challenges

How can an exit path that has so many advantages crash so often and so spectacularly into the brick wall of reality?  The following reasons come immediately to mind.

Financial Security:  Basing a business transfer on family ties, especially ties to someone who can’t or won’t run the business properly is a huge threat to the parent’s financial security and the very existence of the business.  Owners put their financial security at risk when they transfer voting control to children before the owners achieve financial independence and children are prepared to run the company successfully.

Time:  If an owner wants to leave the business within a year, remind them that getting paid full value for the company from children generally takes several more years than it does from third parties or Employee Stock Ownership Plans.  The longer buyout period of a family transfer (like that of any inside transfer) also extends the period of time that the owner (and thus his or her exit goals) is exposed to general business risk.

Taxes:  Without careful tax planning owners can pay far more in taxes than necessary when transferring ownership to children.  With planning, owners often pay no capital gains, gift or estate taxes when transferring ownership to family members.

Values-Based Goals:  As you have likely experienced, when family transfers run amok, they can destroy businesses and families.

  • If children don’t get along with each other when they aren’t working together, can owners expect them to behave well when they are forced to work together?
  • Transferring the ownership of the family jewel–the business–to children often exacerbates existing family friction, and a perception of unequal treatment among siblings, between parents and children, and between owner and spouse.  Let’s not forget the often-hidden discontent of sons- and daughter-in-laws who I refer to as “The Gatekeepers to the Grandchildren.”
  • Communication among family members is emotional in a way it is not between unrelated third parties.  If advisors do not manage communication early, correctly and continuously, it can create or add fuel to family discord.
     

Questionable Successor:  If an owner’s goal is to transfer a business to children, you must ask that owner:

  • Does your designated successor share your vision of the business’s future?
  • Will the choice of your successor please the other members of your family?  If not, then what?
  • Can your successor match your desire, ambition, and aptitude for running the business?
     

If children can’t run the business without the parent or squabble with one another in the business, the owner will return both to the business and to the parenting business.

Not one of these challenges is insurmountable unless you fail to help owners to recognize the existence and significance of each and create a written and comprehensive road map to address them.  That map should take owners from where they are today (running a successful business) to where they want to be (living a financially secure life, watching their offspring run the family business and enjoying family harmony).

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