All in the Family – Creating a Legacy Hot

 

Family dynamics require that a founding owner make a number of important decisions, after due consideration:  

 

a)     Are the family members in question capable of running the business?

b)     Are they qualified in the eyes of the clients?

c)     How will the business be structured?

d)     How will the successors be paid, and the payment obligations secured and collateralized?

e)     How does a retiring owner ensure fair treatment of all family members, even those who don’t participate in the business?

 

To be certain, the formula for disaster is to let the owner’s children inherit and own the business equally when one child is working in the business and the others are not.  In the event all of the children of a family business are not actively engaged in the business, which is probably the norm, only those who are actively engaged, day-to-day, should be permitted to retain an ongoing ownership interest and management role.  That having been said, the financial interests of the children not actively engaged in the family business should be required to be bought out at a reasonable value and over a reasonable timeframe.

 

Transitioning control to a family member, like transitioning to an employee, requires that the parties begin the process at least ten years early.  By way of perspective, third-party buyers and sellers “cut the deal” and then move on; it’s over and done with.  Family members continue to meet and talk and interact for generations to come, before, during and after the transition. To be sure, the failure or success of the family business transaction or succession plan, even the continuing business growth, will be revisited and will affect generations of family members, owners or not.  

 

The starting point for this strategy, assuming the talent and desire to perpetuate a family business exists, is to have the advisory business formally valued by an outside third-party, and have it re-valued every couple of years. This is a critical step, and learning/planning tool, for both sides of the transaction, especially for non-owner family members.

 

Most founding owners tend to believe their business is more valuable than it really is; next generation family members tend to significantly undervalue an intangible advisory business.  In either case, applying a “multiple of revenue” is a big, big mistake, in almost every case. Remember - the succeeding generation of owners can pick an arbitrary multiple of revenue just as easily and just as (in) accurately as the founding and exiting ownership can. Formal valuations are the best answer.  

 

Life insurance often is utilized in a transition plan, but don’t rely too heavily on its power to solve problems or to achieve the realization of value for your business. Plan instead on transferring the business during the founding owner’s/parent’s lifetime, in tranches, such as 20% to 25% at a time. Go slowly, and don’t sell the next tranche until the previous one is paid for. Apply minority discounts sparingly. Life insurance is always a back-up plan and often only applies to the last tranche of stock still in the founding owner’s hands, typically conveyed through a shareholders’ agreement or buy-sell agreement. 

 

Too often, founding owners spend their time working in the business rather than on the business; when it comes time to plan for transition, they’re often shocked at the amount of work and the emotions involved. But as with the other strategies, integrating the next generation into the business process often improves the business and helps it grow and prepare for the future – if the process begins early enough.  Set aside two days a year, maybe as part of a weekend retreat, and force this process into the business building cycle at least ten years before you think you might want to retire – the worst mistake you’ll make is to plan ahead.

 

Perpetuating a legacy may be hard work, but if done correctly, it may be the most important work an owner will ever do.