I have saved the most common transition for businesses is to sell or transfer to family. The State of Owner Readiness Survey conducted by the Exit Planning Institute in 2013 indicated a whopping 32% of private businesses intended to transition the business to family members.
Did you know only 30% of family businesses make it to the second generation, and only 12% make it to the third generation?
What is good about a family transition?
Business legacy preservation – what was built can continue to be a livelihood for the next generation.
Planned – Conversations can, and should begin, long before it is time
to transition so the finances and leadership changes can be controlled and expected by customers, management, and employees.
Lower transaction costs – In theory, the “deal” can be made and then
committed to paper by an attorney, and the tax planning done by a CPA. This cuts out the need for brokers or investment bankers, which can usurp up to 15% of the sale price.
More control of sale and price – The agreement will be decided based on many factors, and not as likely to be based on a true valuation
of the business. While you may be able to save the significant cost of hiring a professional to formally value the business, you need
to be aware of special IRS considerations around a sale to family. Your CPA and attorney should be able to help you navigate these considerations
to ensure you are in compliance. Remember: the terms of the deal are even more important than the sale price because earn-outs and financing take valuable time.
Less disruption to the business – Typically, the style of the business continues so the transition is not a culture shock to customers and employees.
Higher buyer/seller motivation – It is not likely either side is walking away from this deal, nor are they shopping around for any other alternatives.
Negative factors to consider when selling to family:
Family dynamics – There are entire books about this subject, as well as an entire profession of “family advisers” who help smooth the
emotional and political side of negotiating business within a family setting. It is quite typical to be dealing with deep-seeded and ancient
histories of a myriad of issues:
• children deemed or actual favorites
• attempts to balance wealth distribution to children not
involved in the business
• sibling rivalry and bullying,
• birth order issues
• gender biases, and
• strong differences of opinion regarding business potential
and direction.
• addiction or mental health issues
• conflicts around spouses or significant others
I have seen many tears over Mom’s opinion versus Dad’s regarding which child should have majority ownership or a superior position, how to compensate the one child not involved in the business, how the children’s skill and effort compares to their compensation, and real doubts about the children’s preparedness to run a business of this caliber
should something happen to the parents overnight. This is a situation most likely to create issues and the more children, the more issues.
Lack of funds/illiquid buyers – This is the situation I run into most often. The next generation has no funds to buy the business, and they
do not wish to incur debt nor take a lifestyle decrease through payroll in order to buy out their parents so they rely on future, uncertain, profits to repay the debt. Many families fail to consider what may happen if the business does not do well and the impact that may have on parents reliant on that cash flow or children trapped by debt.
Complications around being indebted to family – The lender/borrower dynamic influences those in that relationship even when everything has gone according to plan. However, even after a deal is arranged, many second generation buyers fall short on the payments. If there was a plan made to pay out the parents through salaries and
benefits (see Way #26), it doesn’t take long for the buyer-children to start complaining that the parents “aren’t really doing much” and
wondering when they can take them off the payroll, or treating scheduled debt payments as “optional” and abuse the family relationship
Next generation not prepared for ownership responsibility – In most cases I see, the children feel entitled to the business because they
helped to build it. There appears to be a lack of appreciation for what sacrifices the older generation made in order to build the business to the comfortable and secure state it has attained. The grit and keen sense of entrepreneurship that has developed the strong infrastructure and processes into a well-oiled machine could be skills the next generation
has unfortunately not had a chance to develop. Much like a baby bird that has been helped out of its own shell, being spared the
struggle can sometimes fail to equip the children with the necessary skills to be successful. I am describing many, but not all situations
where the parents know the true sacrifice to build the business that cannot be conveyed to the next generation.
Lower sale price – If you are selling to your family, you are not likely to negotiate for the highest sale price because of emotional ties to the buyers.
Key employee flight risk – why would employees stick around if family members are the only senior executives or potential owners?
Tradition may outstrip good strategy – Sometimes new buyers bring new blood and new ideas, and there’s not always such a change when the business goes to the next generation.
Path of least resistance – but not always a path to growth or success. In many family businesses, the entire family has gotten used to working
together and avoided learning from the outside world in terms of personal interaction, management styles, working under a schedule
or other restraints, and living on a salary without the benefit of draw or additional bonuses.
Uncertainty around financing
As Thomas William Deans describes in the book Every Family’s Business, the best thing you can do if there’s any question at all about
financing is to sell the family business to someone else, give the children a nice bonus, and everyone move on with the fruits of your labor to
retire or start the next chapter. I know, this sounds harsh because so many parents want to continue the family legacy, but it can cause much
more dissension than good if (a) Mom and Dad cannot retire with any dignity because of lack of funds, (b) the payments aren’t being made
as agreed, or (c) the company is suffering because of making the payments. This doesn’t make for a fun Thanksgiving dinner table.
Consider that selling the family business4 can be the greatest success, rather than the failure it is usually considered to be. Imagine pooling
the generational effort to build the business to its greatest value, sell it at a premium, and have everyone ride off into the sunset with a great deal of cash in their pockets to begin their next adventures. How could that be considered failure? At the very least, have some critically honest conversations on a regular basis. I suggest you read “Every Family’s Business” by Thomas William Deans for greater insight into this topic.
{Excerpted from 50 Ways to Leave Your Business by Sandra Finch, on Amazon soon in print and e-book format}
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