So you live in the DC area and want to transfer your family business to your children. Do you know if that child wants to own a business? Not to be insensitive, but have you assessed whether that child has what it takes to run a business?
These are tough questions! We know, because we’ve stood by many clients as they considered both. They are also important questions, as the answers received might just save parent and child from a rocky road.
Truthfully though, those are just two of the questions we ask business owners who are thinking about family business transition planning in the DC area.
So What’s Typical With Family Business Transitions in DC?
Every family is different, but a question we hear a lot is: How do I transfer my business in a way that is good for my business and fair to all of my children? We have found that owners get to the point very quickly!
Then there is that key question about whether or not your child actually wants to run the business you built. Here’s an example of how that conversation went for one of our clients.
Joyce came to us for help with the transfer process. Her son Jeremy (both names are fictional) was her designated successor for her multi-location chain of furniture stores. At our first meeting with them both, we asked Jeremy if he wanted to own and run his family’s business. He turned to his mother and said, “Mom, I know the business has meant a lot to you, and I don’t want to let you down, but I really don’t want to run it. I saw how much time and effort you put into it and I just don’t want that. I’m sorry.”
Sorry? Jeremy and Joyce didn’t realize it but Jeremy had just given his mother the best gift possible: an honest admission that he didn’t want to step into her shoes.
In our experience, many, many children don’t speak up – perhaps from fear of disappointing their parents. Other children feel pressured into assuming the reins while others are willing to step up, but their parents do not give them the training and latitude to become successful owners.
Of course, in a perfect transfer, your child not only has the technical skill set to take over for you, but also has the necessary entrepreneurial drive and personality. That’s just the beginning of the road to successfully transferring your business to your child.
How It’s Done
At Obsidian, we divide the family business transition process into five tasks:
Task 1. Create a written transfer plan.
Task 2. Build a business that is transferable.
Task 3. Set merit-based performance standards to control the transfer of ownership to children.
Task 4. Address the issue of fairness to all children
Task 5. Draw up contingency plans for both parent(s) and child(ren).
Let’s look at each.
Task 1: Create A Written Transfer Plan
Like every other exit path, a successful transfer to children begins with a solid foundation and framework: an exit plan.
Regardless of the type of successor you chose, your exit plan should be guided by three principles:
1) Minimize Risk. You want your plan to minimize the risk that: a) the transfer will not produce financial independence and b) your businesses will not survive the transition.
2) Maintain Owner Control. You should remain in control until you receive as much of the value of your business as you want or need. This principle is especially critical in family transfers because family dynamics can cause parent-owners to put their trust in children who have not yet proven their ability to be owners.
3) Maximize Value. Exit Plans must maximize business value (or cash flow) if an owner is to attain post-exit financial independence.
Using your clearly stated goals as a foundation, we then assess your current resources, and calculate any gap between the resources you have today and those you need when you exit.
Putting your exit plan in writing is crucial when explaining your goals to all family members.
Task 2: Build A Business That Is Transferable
Can your business function–with no interruption to cash flow–with a child (or children) at the helm? Does it have all the value drivers in place and functioning at peak performance? Or, are you the center of all activities? If you are, your business is not transferable to any type of successor, including children.
Task 3: Set Merit-Based Performance Standards To Control The Transfer Of Ownership To Children
Family business transfers that succeed include objective performance standards rather than subjective or hopeful opinions. Objectivity is key to assessing your child’s ability, and to demonstrate to your other children (if you have them) that the child “you picked” to get the business has earned ownership.
Not too long ago, an owner asked us to interview his sons to assess whether they could run the business after he left. We politely declined, but explained that there is no interview or personality assessment that is as effective in predicting a child’s success as performance standards.
When we remove family from the equation, performance standards make perfect sense. If you were selling your business to key employees, what standards would you set to motivate (and reward) them over time to increase business value and cash flow? If employees met your standard, they’d receive (generally) a cash bonus. If your child meets that standard, he or she receives ownership in your business.
The performance standards we design—whether to reward children with ownership and/or allocate ownership among business-active children—are founded on your goals.
Put The Performance You Expect IN WRITING
Performance standards vary from business to business, but, at a minimum, they are linked to increasing business value. It is important to put, in writing, the performance you expect so we can communicate the standards clearly to all involved. We will work with you to make sure that standards are attainable, and when attained, result in financial security for you. Each time your child meets the standard, he or she earns and is awarded ownership via stock bonus, gift or purchase.
When children meet (or surpass!) a performance standard, they demonstrate their ability to operate your business successfully. When standards are linked to increases in business value, you may be able to leave your business sooner than you planned with more money in your pocket.
Task 4: Address The Issue of Fairness To All Children
Let’s define terms. First, “equal” is not the same as “fair.” Second, fair is in the eye of the beholder. In family business transfers in Washington DC, the beholders are: 1) you, the parent/owner, and 2) your children–both business-active and non-business-active. Third, you love all of your children and are naturally inclined to distribute your assets equally. Fourth, there are three challenges to manage: a) value, b) the efforts of the business-active child, and c) timing.
How can you leave the business to your business-active child and make an equitable distribution of the balance of family assets to your inactive children (and perhaps to the business-active child as well)? Here’s where coordination with your estate plan is key.
Second, as you make a judgment about “fair,” so too will your children. That’s why it is key for you to define fair before involving other family members.
One of our clients, “Donna,” told us that she shared ownership with her two siblings “Richard” and “Harry.” We asked how she had come into ownership and she told us that her father, “Stefan,” had successfully taken over the reins of the family business from his father. None of Stefan’s siblings had any involvement with the business. When Stefan designated Donna as his successor, he wanted to be “fair” to all his children. “So, he split the ownership of the company between my brothers and me.”
We asked, “What do your brothers do for the business?” Donna replied, “Nothing, really. Well, every few months they call to draw some money out of the business.” Wow. Donna was working owner hours to run a company and sharing the profits with her uninvolved brothers. How fair is that?
Like Stefan you probably offered all of your children an equal opportunity to become owners, yet only one child seized that opportunity. Why force your most ambitious, risk-oriented child—the one who chose to succeed you—to share the rewards with children who chose different careers? Would you have enjoyed sharing ownership with siblings who took on none of the load?
If dividing ownership among several children still seems like a good idea, know that giving your business-active child the controlling vote is not a solution. The child running the business will have a fiduciary duty of fairness to his or her sibling-owners.
Finally, value and risk are the reasons non-business-active children don’t want business ownership if you offer them other equivalent choices and let them know that they will receive their inheritance through your estate plan. As you well know, ownership interest in a closely held business is less liquid and more risky than most other assets. The only buyer for ownership will be their sibling who likely doesn’t have the money to purchase it. Second, without a controlling interest, a shareholder cannot make any business-related decisions. Third, if the value of your business rises, the inactive child’s heirs may face the not-insignificant estate tax consequences of owning a highly valued, but illiquid asset.
Task 5: Draw Up Contingency Plans For You And Your Children
Inevitably, circumstances can and do change. That’s why we include in your exit plan two Plan Bs that anticipate as many events as possible: one for you and one for your successor.
Your Contingency Plan
If you die or become incapacitated before you can complete the transfer of your business, your estate plan (wills and trusts) must direct the transfer to the child(ren) of your choice. If, however, your business is so valuable that your child cannot buy your company, and gifting it would trigger high taxes, we have other solutions.
What will happen if your designated successor loses the drive or the willingness to make the sacrifices necessary to run a successful business? What happens if you and your successor find that you cannot settle difference in management style? That’s where a comprehensive succession plan comes into play.
Contingency Plans For Your Children
If your transfer plan involves several children sharing ownership, what happens if it the children can’t get along? Once they receive ownership, children should have their own backup plans in case one leaves for whatever reason. Once again, here’s where succession planning is important. We have experience in creating succession plans for new owners that protect the business and minimize estate taxes for your children and their heirs.
Your Family Business Transition Planning Process Will Be…?
Being at the helm of your family business transition planning – in Washington DC or anywhere – can be one of the most rewarding things you’ll ever do. Making that transfer successful starts with a thoughtful conversation about you, your children and your business. Don’t skip that conversation! Obsidian is standing by, ready to guide you and your family to a strong future, together.
Obsidian Business Planning Solutions 301-990-4395