This article continues our series describing the advantages and disadvantages of the five primary Exit Paths that business owners might choose. In our last article, we showed you what business owners find appealing about an ownership transfer to children. Today, we’ll examine some the common problems owners face when transferring ownership to children. As always, our goal is to introduce important issues so that business owners, Exit Planning Advisors, and Advisor Teams can communicate and strategize on the same terms.
Many business owners instinctively gravitate toward transferring ownership to their children. However, they must be mindful of the common, sometimes devastating, problems that go along with a transfer to children. While disagreements in third-party sales and sales to management can affect owners’ business lives, those same disagreements can have wide-ranging effects on the personal lives of business owners, their children, and their families in transfers to children.
How can an Exit Path that has so many advantages crash so often and so spectacularly into the brick wall of reality? Let’s look at some of the common problems business owners face when transferring ownership to children in the context of the three fundamental goals of all BEI Exit Plan designs:
- Maximize the amount of money the owner receives.
- Keep the owner in control until he or she receives all monies.
- Minimize the owner’s risk.
Problems in Transfers to Children
Challenge 1: Financial Security
The biggest risk business owners face in a transfer to children relates to financial security. Basing a business transfer on family ties—especially ties to someone who can’t or won’t run the business properly—is the biggest risk. It threatens the owner’s financial security and the very existence of the business. Additionally, family dynamics can cause owners to transfer voting control to their children before they achieve financial independence, and before their children are ready to run the company successfully.
Challenge 2: The Time Factor
Because transfers to children tend to take longer than most other Exit Paths, getting paid full value for the company generally takes more time. The longer the buyout period, the longer an owner’s finances are exposed to general business risk. Another Great Recession, or new and stronger competition entering the marketplace puts the financial security of the owner and the family at risk.
Challenge 3: The Time Margin
Without proper planning, business owners may find themselves refereeing squabbles among their children, or worse, retaking the reins because their children simply could not run the business well.
Challenge 4: Tax Consequences
Without careful tax planning, owners can pay far more in taxes than necessary.
Challenge 5: Values-Based Goals
When transferring to children, values-based goals act as a double-edged sword. While many business owners consider transferring to their children a values-based goal itself, transferring to children can bring about unforeseen problems in the following areas if owners don’t have a plan in place.
- Family harmony. If children don’t get along well with each other when they aren’t working together, it’s unlikely that working together will solve that issue. An inability to work together can have devastating effects on an owner’s Exit Plan and personal life.
- Family discord. Transferring ownership of the family jewel—the business—to children often exacerbates existing family friction. It can accelerate discord and create the perception of unequal treatment among siblings, between parents and children, and between owner and spouse. It can lead owners to constantly ask themselves, “Have I left anyone out?” And of course, owners need to be mindful of friction among sons- and daughters-in-law, who we refer to as “The Gatekeepers to the Grandchildren.”
- Blood is thicker than water, in so many ways. Communication among family members is emotionally loaded in ways that don’t occur between unrelated third parties. If not managed early, correctly, and continuously, it can create or add fuel to the family discord described above.
Challenge 6: Successor
In terms of successor, business owners face three clear challenges:
- In transfers to children, owners face the risk that their children may not share the same vision of the business’ future. Additionally, other family members may not agree with the child or children that the owner chooses as the successor.
- The successor may not have the owner’s desire, ambition, or aptitude for running the business.
- Parents too often overlook behavior deemed unacceptable in a non-family successor. Things that would disqualify other candidates can be brushed aside simply because the successor is the owner’s child.
Addressing These Challenges
Many of the problems in transfers to children revolve around poor communication or ungrounded assumptions. BEI has developed a variety of bespoke designs and tools to minimize or eliminate these challenges in ownership transfers to children. These designs and tools are part of the pre-sale planning and execution process that focuses on achieving all of an owner’s goals and aspirations.
Keep in mind that the actions required to mitigate the challenges described here may take years. If business owners wait until they are ready to begin planning to transfer ownership of their companies to children, there is far less advisors can do for them. Because most owners would like to exit within five years, advisors must alert owners about the advantages and disadvantages of this Exit Path immediately.
In our next article, we’ll look at the advantages to owners of selling to an Employee Stock Ownership Plan (ESOP).