For many family businesses, ownership transfers to children can be tricky. There are the questions that need to be asked regardless of the buyer—business value, purchase price, etc.—as well as others unique to this particular situation. For example, how do other siblings feel about it? Let’s explore these questions through a recent example.
Stan Briggs was perplexed when he told his advisor, “My son, Patrick, has worked in the business for the last twelve years. In that time, the business has tripled its revenues and its profits. I’ve started to think about scaling back my activity and I realize how important it is (for my own retirement income) that Patrick be motivated to continue to grow the company profitably. Since I’d like to have him own the business someday, is there a way to start transferring it to him now? It seems unfair to make him pay for all of the business value since he created so much of it and since he is so important to my financial security. My son, of course, agrees wholeheartedly with this analysis but I’m not so sure that his mother and sister are on the same page. What issues do I need to consider?”
This isn’t an unusual scenario, and by examining transfers to children through the Briggs Family lens, we can examine some of the most pressing challenges it presents.
Equal vs. Fair
How do you create a “formula” for the transfer of ownership to a child? First, Stan must determine if his son is already paying for the business through “sweat equity” (more working hours, greater risk and lower compensation than he could have earned elsewhere). If so, any reduction in the established purchase price is not a gift, but rather recognition of Patrick’s contribution.
Second, are Patrick’s efforts adding value to the business? If so, should Patrick have to pay for his efforts by receiving a reduced share of his father’s ultimate estate? What about the other children in the family? Does Stan have enough non-business assets to equalize the estate between active and inactive children?
Third, if Patrick’s involvement in the business is critical to Stan’s retirement, Stan should consider tying his son to the business using “golden handcuffs,” such as awarding ownership if Patrick stays to run the business—and the business stays profitable. An employment agreement is also advisable for any key employee.
Fourth, in many business-owning families, every child is offered the opportunity for involvement in—and ultimately ownership of—the family business. Many times, however, only one child forgoes the allure of the “outside world” to commit to working in the sometimes uncertain and illiquid world of a closely held business. How does this factor into the ownership formula?
Where to Start
As always, we recommend starting with a series of facilitated family meetings. It is important to analyze the transfer issue in light of your own personal goals, but you also have to consider your children’s goals and life aspirations as well as the potential impact of your choices on the family. Be certain that any transfer to children will satisfy your exit objectives. Explore with your advisors other issues and concerns that may arise as you begin to transfer ownership to a child. For example, how much money will you need after you leave your business? What, if anything, needs to be done for your key employees or for your other children? Temper and qualify all transfers to children in light of your over-arching exit objectives. In short, make certain the transfer of ownership to a child is also a good business and retirement decision, but with an eye on the long term impact your decisions will ultimately have on family harmony.
Use Your Advisors
When considering a transfer of your business to a child, don’t underestimate the value of using experienced family business consultants and advisors. Their counsel, experience and input are perhaps never more important than when dealing with your own family. The need for independent, non-emotionally-charged advice can be critical. A good family business advisor will also know how to walk the entire family through what can be a series of difficult conversations.
First, determine the level of contribution your business-active child has made to the value of the business.
Second, determine the contribution that child must continue to make to ensure the achievement of your exit objectives. Those determinations can form the basis of what is “fair” with respect to both the business-active child and the other children.
Third, use your advisors to help explain, guide and implement the transfer of the business, and to engage your family in a constructive and meaningful way in a decision that will have a profound impact on them. For more information, please feel free to reach out to Consulting Principal Kathleen Hoye, CExP, ACFBA, CFWA via e-mail or phone (502.882.4411).