By Maurie Cashman
The parentâ€™s financial security and independence precedes any transfer of ownership and control to the business-active child
In the first four parts of this series on family business transfers, we described:
- The obstacles that must be overcome if a family ownership transitions is to succeed;
- The steps to take to achieve a successful family business transition;
- The advantages of Limiting Ownership to One Child, and;
- Designing a transition that is fair to all children.
The key issue that must be managed correctly for any successful family business transition is to insure that that parentâ€™s financial security needs are met. The business is the primary source of wealth and income for most owners. If you are a parent transferring ownership to a child, you should have all of the cash you will need secured before you transfer control and ownership.
There are three basic categories of financial security: those who have it; those who know how to secure it; and those who have the means to obtain it.
- Those who have financial security can afford to receive less than full fair market value for their businesses. They have reached financial security by investing earnings outside the business during while they owned it.
- You can secure financial security by transferring or purchasing assets outside of the business, and lease those assets back to the business. These my include office equipment, warehouse/manufacturing facilities, and production equipment. Keeping these types of assets outside the business lowers the value of the business, making it easier to transfer to the active child by incurring less gift or estate taxes and limiting the transfer value to only the operating business. This can also preserve a long-term income flow to the parents in the form of lease payments. Keeping assets outside of the business also makes those assets available for transfer to the inactive children. Finally, keeping assets outside the business protects them from future creditors of the business after the parent has left.
- You may be able to achieve financial security by selling your businesses for cash to the business-active child. However, you should not transfer control, either operational or ownership, before financial security has been achieved. If you want to leave the business before accumulating enough wealth to insure financial independence, then the business-active child must obtain financing in order to pay sufficient cash for the ownership interest.
As a business owner, you must determine which type of financial security you want to achieve. Even if your financial security does not depend on receiving full market value for your business, you must either insist upon it or realize that by taking less you are giving away a part of the business. You will open the fairness can of worms between your children if you start giving things away. If you donâ€™t handle these fairness issues through your estate planning documents, you may have a very difficult situation with your children.
Finally, if you want to sell the business for cash to the business-active child, you must begin the transition process before you sell. A child must receive significant ownership before buying the rest of the company for cash. It is critical that you retain control and implement a buy-back agreement should the child leave for any reason. You should also have the right to repurchase any interest from a business-active child so that, if he or she chooses not to complete the buy-in process, you can execute your back-up plan.
Next week weâ€™ll discuss the need for the child to demonstrate readiness to take over the business and the need to have a Plan B.
Â© 2016 Aspen Grove Investments, Inc.