By Maurie Cashman
There are several steps that must be completed to achieve a successful family business transaction. In Can Family Ownership Transitions Succeed?, we discussed the reasons that families desire to undertake a family transfer. We also discussed some of the obstacle that must be overcome. Despite those obstacles, some transfers do succeed.
In a recent survey by The Boston Consulting Group, family business leaders ranked succession as the second-most-important subject on the their minds, topped only by the closely related issue of achieving alignment among family members on critical topics.
Letâ€™s begin to discuss how to successfully manage these critical topics.
There is a general formula for creating a successful intergenerational transfer. It isnâ€™t the only formula that works, but because it lays out a specific process, it increases the chances for success.
We must achieve certain objectives to implement a successful ownership transition. If we don’t address these, the result will change.
- Parents must undertake their own ownership transition process that establishes their objectives;
- The child(ren) active in the business becomes the sole successor owner(s);
- The ownership transition plan is fair to all children;
- Parents have achieved financial security (independent of the future cash flow of the business) before business ownership and control is transferred to the business-active child;
- The business-active child has demonstrated the capacity, ability, and willingness to run the business for a significant time period before the parents transfer control and ownership;
- A back-up plan is in place, communicated and ready to implement.
This process does not apply equally in each situation. You individual family and business will have unique issues and the plan may need to be adjusted to your specific circumstances. It is critical that you have an experienced team of trusted advisors to guide you through the process.
All business sales or transfers are challenging but owners wishing to transfer their businesses to children often find themselves in the middle of their own battlefield. Your spouse, children (and their spouses), other family members and friends all have opinions about how you should transition ownershipâ€”and they are often quite vocal (and uninformed) about those opinions!
In these situations, savvy owners use a process to successfully transition ownership. The process will enable you to put together a plan that takes into account the concerns of all family members. The process should integrate all points of view into a unified strategy, organize your priorities and be flexible enough to reflect additional considerations unique to your family business transition.
Letâ€™s look at each step in more detail.
Step One: Establish Parentsâ€™ Objectives
You may have a number of transition objectives but you should establish, at the outset, at least these three:
- How you (and your spouse) define financial independence;
- How you and your spouse define fairness regarding distribution of family wealth (including the business) among children;
- When you (and your spouse if active in the business) want to leave the business and transfer control according to a time-frame you set.
Step Two: Determine Companyâ€™s Value and Cash Flow. Evaluate Business-Active Childâ€™s Contribution to Both
In addition to knowing what you want, you must know what you have (the value of your company) before you can plan your transition. In the transfer of a family business, not only must business value be determined but the business active childâ€™s (â€œBACâ€) contributions must be considered. Often parents reduce business value by the amount of the BACâ€™s past contributions so that the child does not pay for his or her contributions to value. The current value can be used as a base so that any future growth in value (if not due to the active parentâ€™s efforts) is attributed to the BAC. The purpose of this is to keep the BAC from paying for his or her own sweat equity.
Step Three: Increase Companyâ€™s Value
Once you know what you want and what you have you must think about how you can motivate key employees. Incentive to increase the value of the company and remain with the company through the transition are critical.
Step Four: Sale to Third Party
This step does not typically apply to family business transitions, but it should be considered for two reasons:
- It insures that the parties to the transition have explored all of the options and understand them fully;
- It is a learning process in case an alternative plan must be put in play in the future.
Step Five: Transfer to Insider: Design Sale/Gift of Business Interest to Business Active Child
Design the transfer ownership to your business active child (and possibly some key employees). We can accomplished through a combination of gifting and sale, depending on your financial needs and other wishes.
Step Six: Business Continuity Planning (in case either parents or Business Active Child dies)
Make contingency plans for what will happen if you, as the business active parent, die before the transfer can be completed. For example, should the business active child receive the business via a buy-sell agreement or bequest at death? Should ownership first transfer to the surviving spouse before an ultimate transfer to the BAC?
Step Seven: Wealth Preservation Planning (Estate and Gift Planning to level the playing field for all children)
This is a critical step in the transfer of family companies. Through estate and gift planning you can provide for your non-business active children. You should also balance the fairness issues that arise in every family transfer.
Next week weâ€™ll discuss one child succession in business ownership.
Â© 2016 Aspen Grove Investments, Inc.