It’s something that business owners don’t like to think about: What’s going to happen to your company when you’re no longer able to run it due to death or disability?
And while the business may survive if a family member simply takes over when you’re gone, the odds of success are much higher if you’ve created a plan to transfer ownership, says Keven Prather, a financial adviser specializing in exit and transition planning at Skylight Financial Group.
“The biggest consequence of not planning is simply waiting too long and having life dictate your exit from the business,” says Prather. “Suddenly you have cancer and you have to sell because you can’t work anymore, but you have no one to sell to. That’s a tragic situation to be in.”
Smart Business spoke with Prather about how to facilitate a smooth transition of your business to a family member.
How can a business owner determine if transferring ownership to a family member is the right move?
First, look at whether the family member is qualified to take over the business. Having the business continued by a family member is very satisfying for a business owner, but oftentimes, the founder had key attributes that allowed that business to succeed. You need to determine whether a family member has those key attributes to continue the business. Do some personality profiling and digging to find out what motivates people to carry on that business.
The second question to consider is what that owner needs from the business. Often, family transfers do not involve cash up front, so when the business is sold, what are the income needs of the transferring parties? How much money do they need to live, and does the buyer have the financial resources to facilitate that? Do the sellers need a larger sum up front, or can they live with installment payments? If you’re doing installment payments, make sure the business is lendable and get the seller some cash up front so you’re not creating a huge cash outlay that can drain the financial resources of the business.
Once the owner decides to sell, what are the first steps?
Begin with the end in mind. Dig deep into everyone’s goals for the transaction. The family seller and the buyer might have opposite goals, so you have to have very clear communication and set very clear goals of what both parties want to accomplish with the transfer. The second step is to figure out the financial resources of the business. What are its unique characteristics that make it lendable? Also look at who pays taxes. If the buyers are children of the owners, they may be on salary, and the company gets a deduction for that. But installment payments coming out of that business to pay for the sale are treated as part interest income, capital gain and non-taxable return of basis, and portions of these payments are not deductible. It takes a lot of financial planning to pull off a sale.
What is the next step?
The next step is protecting the business value. A key piece of a business’s value is its people. If some key people are not family members or shareholders, making sure they stay is a big part of the pre-transaction work. This is where a lot of family transactions fail: The parents might have a great relationship with key employees, but now the child is in charge, and the dynamic has changed dramatically.
Owners also need to make sure that all processes and systems are well documented and in place. An outside organizational development coach can help make sure all the processes are in place for the business.
You also have to protect the business from the ‘what ifs.’ What if someone becomes disabled? What if someone dies? What if there’s a cash flow crisis? How do you make sure the business can continue after a catastrophe? Those things can negate a sale and force the sellers to take the business back.
What is the final step?
The last step is tying together the financial planning and estate planning of the seller and buyer. Make sure that everyone has a financial plan and that estate plans are in line with the sale. The sellers may want to take advantage of gifting or other techniques to transfer that business, so it is critical to look at the overall planning picture to ensure all bases are covered.
How can parents make sure their children are treated equally?
Parents need to figure out what they want to do in terms of equalization, but keep in mind that equal does not equate to fairness. An outside adviser can help you sort through the potential mine fields, ask questions, hold family meetings and help you create a family governance plan that outlines, ‘Here’s what it takes to become part of the business, here’s what it takes to govern this business and here’s what’s going to happen. Here’s our corporate succession plan, here’s how its going to work and here’s how we’re all going to act when the succession plan comes into play.’ It takes a good adviser to get to the bottom of what’s important to the parents and to all family members. That adviser will act as a quarterback, helping to set egos aside, working with the CPA, estate planner, attorney and other advisers to create a collaborative approach.
Planning should begin two to seven years before the owners plan to exit the business. If you’re building a salable asset and have value in the business, it doesn’t work to just walk away. Too many factors, such as estate taxes, capital gains taxes, banks and family dynamics come into play, and to maximize the value of your business and keep it on track after you leave it, you have to plan accordingly.
Keven Prather is a financial adviser specializing in exit and transition planning at Skylight Financial Group. Reach him at (216) 592-7314 or email@example.com. Keven Prather is a registered representative of and offers securities, investment advisory and financial planning services through MML Investors Services, LLC. Member SIPC. OSJ: 1660 W. 2nd St., Suite 850, Cleveland, OH 44113, (216) 621-5680. The views expressed are those of Keven Prather and not those of MML Investors Services, LLC or its affiliated companies. CRN201304-147470