Surveys and experience tell us that transferring a business to the next generation has a well-deserved reputation for being problematic.
There are dozens of family business centers, hundreds of books, and likely thousands of advisors who specialize in the dynamics of family business succession planning. Why?
The answer is simple: family. Successfully transferring a family business is more difficult than any other Exit Path because it involves family. But owners wish to transfer their companies to their children precisely because they are family. It can create quite the conundrum. However, owners who persevere—with help from advisors experienced in these transfers—find that a transfer to children can be enormously rewarding.
This article and the next several describe the effective process BEI uses to help owners and their families with these transfers. We will describe and illustrate the techniques we use to overcome challenges and secure the benefits business owners deserve. But first, let’s revisit the fundamental principles of every Exit Plan.
A Planning Recap
Like every other Exit Path, a successful transfer to children begins with a solid planning and implementation foundation: an Exit Plan. It shares the same guiding principles as those of all Exit Plans:
- Control. Keeps owners in control until they receive as much of the value of their businesses as they deem suitable. This is perhaps more important in family transfers than in any other ownership transfer. Family dynamics can cause a parent-owner to place unwarranted trust in a child unproven for ownership.
- Risk. Minimizes the risk that (a) the owner will not achieve financial independence and (b) the business will not succeed.
- Value. Maximizes value (or cash flow) of the business to assure the owner’s financial independence post-exit.
The Five-Part Plan Design
There are as many variations of family-transfer plans as there are families, but BEI Exit Planning Advisors use a five-part process to design their plans:
- Create a written road map.
- Construct a business that is transferable.
- Set merit-based standards for the transfer of ownership to children.
- Tackle the delicate issue of fairness head on.
- Incorporate a backup plan.
The Written Road Map
The Exit Plan advisors create must clearly describe the owner's resources, goals, and any gap between the resources they have today and those they need when they exit. It minimizes the income tax liability of both the parent and child. This written plan is crucial in explaining the transition process to all family members and their advisors. In this context, advisors must remember that their clients are the owner and their spouse—not the entire family. This distinction needs to be clear, in writing, and communicated to all interested parties. To do otherwise risks creating actual or perceived conflicts of interest and sinking the entire Exit Plan.
A Transferable Business
Advisors work with their clients to create a business that can function with no interruption to cash flow through the successor child (or children) in charge—not the owner-parent. As part of that process, advisors (a) counsel their clients on how their role within the business may need to change and (b) direct the owner, the owner’s Advisor Team, and management team in using and strengthening the tools and processes that the business depends on to grow transferable value.
Successful transfer plans rely on objective performance standards rather than subjective opinions of what is “fair” for the successor. Advisors use these standards to assess a child’s ability to demonstrate to a successor’s siblings (if there are any) that the child “getting” the business has worked to earn ownership.
As experienced advisors know, “equal” does not necessarily mean “fair,” and the plans they create must pass the fairness tests of three constituencies: parent/owners, business-active child, and non-business-active child. The primary challenges to treating all children (both those receiving the business and those not) are (a) value, (b) the efforts of the business-active child, and (c) timing.
A Backup Plan
Circumstances can and do change, so including a backup plan is an integral part of an owner's transfer plan. BEI advisors design backup plans for both the owner and the successor owners that anticipate as many events as possible.
Keep Your Eye on the Prize
Part of the advisor's role, especially in the case of their client’s financial independence goal, is to prevent a family’s wishes from overriding the owner's wishes. As stated earlier, the wishes of other family members may conflict with an owner's goals.
In addition to keeping the owner’s financial goal as a North Star, advisors must help owners determine the importance, priority, and timing of their other goals as they relate to transferring a business to children. For example, an owner’s desire to exit quickly may clash with the reality that it will take several years before children are sufficiently experienced to be capable successors. Or, a parent’s desire to transfer the business equally to all children may collide with the reality that one or more business-active children might vehemently object to that idea.
An advisor's starting point and safe harbor when managing likely family disagreements is the owner's financial security, other goals, and aspirations. In short, the best way for advisors to address the challenges inherent in family business transfers is to begin with their client’s end in mind. It’s much easier to stay the course through troubled waters if they’ve set a clear and unambiguous destination.