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A Backup Plan for Family Business Owners & Their Successors

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Owners preparing for any type of exit find that circumstances can—and often do—change. Intergenerational business transfers are no exception. The twist in family business transfers is that owners should have a backup plan not only for themselves, but for their successor as well.

A Backup Plan For You.

Let’s look at the most common causes for employing a “Plan B.”

  • If an owner dies or become incapacitated before the transition is complete, his or her estate plan (wills and trusts) must effect the transfer of the business to the child(ren) they designated as successor owner(s).
  • If the business is so valuable that a child cannot financially manage a buyout and gifting it would result in unacceptably high taxes, consider a sale of some or all of the business to a third party, and/or transfer a considerable portion to a charitable trust or organization.
  • If a business active child (BAC) is able to acquire ownership of a valuable business, can the owner provide assets of appropriate value to non-active children (NBAC)? Fairness, as the parent defines it, is a determining factor here.
  • Similarly, some businesses become too complex or too sophisticated for any one person to run and control. No child can be expected to shoulder that burden successfully. If the business has not been successful in creating a professional management team to operate the company for the benefit of the owner’s family, the best alternative may be to sell part, or all, of the company to a third party.
  • As time passes, owners may realize that their business-active child does not possess the drive or interest necessary to run the business successfully. The child’s desire to please may have blinded the parent to the child’s lack of ability or willingness to assume risk. Or, the child may not have fully understood the personal and financial sacrifices necessary to maintain the success of the business. Again, a sale to a third party, or to management, may be a better option.
  • Finally, as parents and child move through the transfer process, substantial differences in management style and practices can emerge. Sometimes these differences can be overcome but often they are so great that the transfer cannot be completed. If the transfer falters, the company must have the ability to reacquire the BAC’s ownership interest at the lowest defensible price. This is best accomplished through binding buy-back agreements between the company and business active children.

A Backup Plan for Successor Owners. 

When more than one child owns the business poorly designed Exit Plans can create ticking time bombs that can explode after the parent leaves. Have you addressed what happens if:

  • The kids can’t share the business after all? New owners (children) should have their own backup plans should one child leave (on good or bad terms) after ownership is transferred. This means creating an agreement when ownership is first transferred to a NBAC allowing the NBAC to cash out at a price and terms both the BAC and NBAC deem fair.
  • One child wishes to transfer ownership to his or her children, but the other BACs object to any transfer that doesn’t first give them the right to acquire ownership?
  • A majority of the new owners wants to sell, but one child-owner objects?
  • A business-owning child divorces a spouse?
  • The business-owning children disagree on the future path of the company?
  • The new owners decide to sell the company for a windfall (compared to the price they paid for it) within a few years of assuming ownership?

Good plans address these questions, and many more, before the children receive substantial ownership. The answers are incorporated into agreements (such as buy-sell agreements among the incoming owners) between children and parents. For example the owner (or his/her estate) might want to retain a first-right-of-refusal should one or more of the above situations occur.

It is also important to recruit a best-in-class business attorney with substantial experience working with family businesses for your planning team.

Divorce

The event most likely to occur is the divorce of a child who has received, by gift or otherwise, ownership of the company or ownership of family assets. The tools you may wish to use to protect the business and other assets from an involuntary transfer of ownership include trusts and other entities that protect these assets from creditor (including ex-spouses) attack. Many of these tools also serve to avoid or minimize estate taxes for the owner’s children and their heirs. At the risk of sounding like a broken record, recruit the best possible estate planning attorney (one with substantial experience working with family businesses) for your planning team.

If you wish to recruit an experienced family business consultant, contact me at lboss@mercadien.com or 609-689-9700. We can help you formulate and facilitate the decision-making and execution process, because as you know, transfers to family members require owners to be more inclusive and communicative in decision-making than any other exit path.

The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial advisor. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial advisor. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Exit Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice that you need.

Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.

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