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Transferring the Family Jewel to Children: The Disadvantages

Submitted by John Brown on Fri, 01/15/2021 - 8:00am

In our previous article, we listed the numerous benefits to owners (and their families) who transfer their businesses to their children. In this article we ask, how can an exit path that has so many advantages crash so often and so spectacularly into the brick wall of reality? The following reasons come immediately to mind.

Financial Security

Basing a business transfer on family ties, especially ties to someone who can’t or won’t run the business properly can threaten not only the owner’s financial security but the very existence of the business. Family dynamics can cause owners to transfer voting control to children before they achieve financial independence and before their children are prepared to run the company successfully.

The Time Factor

Getting paid full value for a company generally takes more time in a transfer to children than it does through a sale to a third party or a sale to an Employee Stock Ownership Plan (ESOP). The longer the buyout period, the longer the parent-owner’s financial security is exposed to general business risk. Another recession, pandemic, or a new and stronger competitor entering the marketplace puts the owner’s (and their family’s) financial security at risk.

The Time Margin

If children can’t run the business without the parent-owner remaining at the helm or are squabbling with one another (or the owner) in the business, the owner’s time margin (the period of time owners have to prepare themselves, their businesses, and their children) may disappear.

Tax Consequences

Without careful tax planning, owners and children can pay far more in taxes than necessary.

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Value-Based Goals

  • Family harmony - If children don’t get along well with each other when they aren’t working together, how will they likely behave when they are? These children generally act like children—not owners—when making business decisions. 
  • Family discord - Transferring ownership of the family jewel—the family business—to children often exacerbates existing family friction, discord, and perception of unequal treatment among siblings, between parents and children, and between owner and spouse. Have we left anyone out? Oh yes: you need to consider friction among sons- and daughters-in-law who we refer to as “The Gatekeepers to Your Grandchildren.”
  • Blood is thicker than water, in so many ways - Communication among family members is emotionally loaded in a way that it is not between unrelated third parties. If not managed early, correctly, and continuously, it can create or add fuel to the family discord described above.

Successor

The designated successor (the child(ren)) may not share the owner/parent’s vision of the business’s future. In addition, the only people happy with the owner’s choice of successor may be the owner and the selected child. The rest of the family may not be happy at all. Don’t be surprised when owners in this situation attempt to shift the blame for their choice to their advisors. The successor (child/ren) does not have the owner’s desire, ambition, or aptitude for running the business. Parents too often overlook behavior from their children that they would find unacceptable in a non-family successor.

It’s important, when representing owners who are considering this exit path, to review these potential disadvantages. Even if properly designed and implemented, transfers to children cannot avoid all of these problems. When owners conclude that the disadvantages or risks of this exit path are too great, you may wish to recommend that they consider alternative paths.

The benefits to advisors in discussing with owners the possible disadvantages inherent to this and other exit paths is straightforward: you align your interests with the owner’s and demonstrate that our version of Exit Planning is truly owner-centric.

If you would like information about the variety of designs and tools that trained Exit Planners employ in successfully transferring businesses to children, please contact a BEI representative

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