If you’re considering transferring your business ownership to another family member or members, you might be tempted to put your family’s wants over your own goals. While altruism is an admirable trait, in this kind of situation it can also cause more problems than it solves. You, your family members, and your business won’t be better off if during your family transfer you make decisions based on emotions and not on what is best for everyone in the long term.
Consider a family transfer situation where there are multiple family members dependent on the continuing profitability of a family business. The current owner needs to fund his retirement from the sale. His sons and daughters need a smooth transfer of ownership and leadership in order for the business to thrive and generate enough income to support them. Here’s an example:
“Darnell Orie was unsure how to approach his business exit. His son, Hannibal, was the main reason why his company had tripled its revenues and profits over the last 15 years. And even though he wanted to begin winding down his own involvement in the business, he knew that he had to keep Hannibal motivated to grow the company: His retirement depended on Hannibal’s continued success growing the company.
Darnell had always wanted to transfer ownership to Hannibal, but he knew Hannibal didn’t have the money to pay him full value. He wanted to begin transferring ownership now, but he also felt it would be unfair to expect Hannibal to pay full value, because Hannibal was primarily responsible for the business’ success through his work.
While Hannibal agreed that his sweat equity should lower what he would pay for ownership, Darnell knew that Hannibal’s stepmother and half-sister would probably disagree, even though they were not involved in the business. Darnell is agonizing over three goals: his own financial security, making sure Hannibal’s sweat equity is rewarded, and treating his wife and daughter fairly.”
Here the owner, Darnell, is torn about how to be fair and have everyone’s needs and goals met through the family transfer of the business. It can be a real challenge to make this work and make it work without ruining family relationships. What steps should he take?
1. Focus the Exit Planning Process on Financial Security
Darnell’s initial goal was to transfer his business to his son Hannibal. He didn’t evaluate his own needs, like how much money he would need to fund his retirement, or set a firm exit date. These are both very important considerations, and the process cannot begin without Darnell getting serious and evaluating his own financial needs. Once he has done that math, it will be easier to set other goals, like determining an exit date and deciding on his successor (or successors). It’s impossible for him to defend his decisions to himself or his wife and daughter if he hasn’t made them.
2. Create an Incentive Plan for Key Employees
In this example, Hannibal is a key employee. Without him the company would suffer and potentially fail. As the owner, Darnell must acknowledge this and factor it into his exit planning. Hannibal’s value to the company and his sweat equity should be factored into any offer. It’s wise to create and implement an incentive plan that depends on key employees’ performance. An owner who is transferring ownership to a business-active child, might offer that child shares of ownership for meeting certain performance goals. Those performance goals, when met, would allow the owner to exit with the necessary financial security and would recognize his child’s contributions.
3. Make an Equitable Estate Plan
Darnell’s wife and daughter didn’t want to own or work in the family business, but he still had to consider their needs and be mindful of what they would consider fair. Estate planning is a good solution to this problem. Estate planning allows for flexibility approaching family considerations throughout the business exit. By adjusting his will and trusts appropriately and keeping his Buy-Sell Agreements current, Darnell could more easily do what he considered right by his wife and daughter without short changing family members who take on the risk of running an otherwise illiquid business (in this case, Hannibal).
Planning is key to ensuring financial security during and after a business exit. It can also save family relationships and maintain family harmony. This is why we at Prometis Partners always advise leaving plenty of time for planning, mentoring, communicating, and making necessary adjustments especially when a business is being transferred from a family member to another family member (or members). If you would like help in your family transfer process, please contact us today.
The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial advisor. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial advisor. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Exit Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice that you need.
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Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.