Is Your Family Business Ready For Your Retirement?
By: Adrian C. Spitters, FCSI®, CFP®, FMA Senior Wealth Advisor• May 18, 2016
I came across this article by Adrian, it is so well written I couldn’t have said better myself and decided to share it with you in its entirety.
Let’s face it, one day your business is going to change hands, whether you plan for it or not.. When you have a formal plan in place, you are making a voluntary choice to take control of who will take over your business, when and how you want the transition to take place and ultimately the price you get for your business.
When you are in control, you are in charge of securing your retirement nest egg and ultimately your family wealth and legacy. So how do you make it a voluntary transition instead of an involuntary transition? Fortunately, I have good news to announce! Before I do so, let’s go over the issues and your choices.
You may have children, extended family, key management or employees who have expressed interest in taking over your business when you’re ready to hand over the reins. On the other hand, you may not have anyone interested in taking over your business and therefore you will either sell to an outsider or simply wind up your business and close it down. Transferring your business to family, selling to key management, or a third party, or just winding it down, are all collectively known as exit strategies and every business owner should have a formal one to avoid an involuntary exit.
When it comes to exiting your business, you have a choice; you can either do it voluntarily by having a formal exit plan in place, or you can do it involuntarily by doing nothing. When you have no plan in place, you have made a choice to let someone else take control of your exit strategy. You have given up control of who ultimately takes over your business, the terms of the transition or sale, and the ultimate price you get for your business. Not the outcome, most business owners would want to see happen to their business. Whether your business changes hands voluntarily or involuntarily, there are basically three types of exit strategies that most business owners will experience. They are:
Many business owners have a desire to have one or more of their children take over their business, after all, the business is their baby and legacy, and who wouldn’t want a son or daughter to carry on the family tradition. Clear communication is very important, business owners often make the mistake of assuming that one or more of their children would eventually want to take over the business, but fail to communicate with them to find out their interest.
Making the assumption that your children will either take over your business, or that they have no interest at all is a mistake. Many business owners who decide to sell their business do so because years ago their children expressed no desire of ever wanting to own the family business. However, over the years their children have grown to appreciate the business and may even be thinking about owning it one day. Unfortunately for them, since no formal discussion had taken place over the years, when the time comes for the business owner to retire, their children will not have the formal training necessary in key management and financial matters to effectively take over the business to ensure its continued success.
It is too late to start the training process once the business owner decides they want to sell or are forced to sell for health reasons. So advanced planning is necessary to ensure the children are ready and capable of taking over the business. Even if the children had expressed interest in taking over the business and are currently working in the business, if the owner maintains management and financial control of the business, their children will not be prepared to take over the business when the time comes.
I know all too well the result of not having a transition plan in place, having gone through a poorly executed transition experience with my father’s estate. I grew up on a dairy farm and remembered my dad telling my brothers and me that he wanted the farm to stay in the family and that he had arranged to make sure that happened.
As co-executor (with two brothers) of my father’s estate, I discovered he had a poorly executed, unworkable Will and a non-existent farm succession plan. This led to family discord. Despite receiving the majority of the assets, the brother who inherited the farm suffered financial distress and became insolvent. He was not prepared to take over the farm because my father maintained management and financial control of the farm until his death.
This is very common among business owners even though they assume that their children will take over the business, they do not want to let go of the day-to-day management and financial control of their businesses, and therefore do not effectively prepare their children to take over the business, when the time comes. So clear and ongoing communications and training is necessary among family members to determine who’s in or out. Regular discussions should be held with all family members on how responsibility will be transferred to those who will eventually take over the business and how to fairly treat those who are not going to be part of the business and what their role will be if any.
Management or Employees Buyout
If you do not have any family members currently involved or interested in your family business. You may want to consider selling to key management or employees. While not as desirable as keeping the business in the family and securing your legacy, it may be the best way to ensure your business continues without interruption for the management of employees and customers. This is only viable if you already have trained your management and employees to run your business without your day to day involvement, so that your business is not dependent on you. If you are still making all the management and financial decisions for your company and your key clients still call you, the value of your business will suffer. Instead of a smooth transition, your business may lose some customers and experience a loss in revenue as your management and employees learn to take over key management and financial decisions. Therefore, it’s important to have a transition plan in place long before you consider retirement so that you can prepare your employees to take over the management and financial decisions of your business.
Sell to a Third Party
Many business owners prefer to sell their businesses to a third party because it gives them more certainty in the price they receive for their business, and can be far less complicated than a family transition. In order to maximize the value of your business when it’s time to sell, your business needs to be ready to be sold and your employees need to be ready for the sale. While many business owners over estimate the value of their business, a surprising number of them under estimate the true value when transitioning to family or selling to key management or employees. So when selling to a third party, when done properly, the market sets the price for your business and the price set by the market is usually a fair price. If you do not have a plan in place, the market will dictate the price of your business on their terms. However, if you have a formal transition plan in place and have trained your management employees to run your business without your day-to-day input and get their buy-in that you will sell one day, your business will be worth a lot more money to the buyer.
Another reason to have a formal business transition plan in place is so you can identify potential buyers who have similar clients to your business. By buying your business and adding your product or service, the buyer can enhance what they can offer to their clients. This in turn can enhance their profits, making your company an attractive purchase for them and as a result, they are willing to pay more for your business then a stand-alone buyer.
Whether you are transitioning your business to family, selling to key management or employees or selling to a third party, you need to know what your business is worth and that requires a business valuation. Determining the value of your business takes time and expertise. You need an expert who understands your business, who can look at your assets and liabilities and goodwill with an objective viewpoint. Business valuators are better positioned to see the bigger picture of what your business is truly worth than you as the business owner, since you would be too close to the business and emotionally attached to get an objective view.
Buyers are becoming more sophisticated and will look for shortcomings or potential problems in your business, so they can discount the final price they are willing to pay for your business. A business valuator takes the time to analyze your business to find these shortcomings and potential problems, so you can correct them before you decide to sell your business and to do this correctly requires time.
Regardless of whether you’re selling your business to a third-party, management or employees, or transferring to family members, there are a number of tax consequences that need to be taken into consideration. If you are selling the shares of your business you, your spouse and any family member that owns shares in your company may be able to take advantage of the $800,000 lifetime capital gains exemption. For that to happen your company must be a qualified small business corporation (QSBC) and for your company to qualify, your company must meet a number of tests. If your company does not qualify you must purify it first. This process requires advance tax planning and can take up to two years to accomplish. With proper advanced planning, you can ensure that your business qualifies, entitling you, your spouse and any family member owning shares in your company to claim the $800,000 lifetime capital gains exemption.
In addition to doing proper tax planning to ensure you minimize the tax from either the sale or transfer of your business, there may be some estate planning opportunities you may want to take advantage of before selling or transitioning your business. This may involve restructuring your business, setting up a separate holding company to transfer the shares of your operating business into, to avoid double taxation; this requires advanced tax and estate planning and time to prepare.
So that’s the problem, but is there a solution?
A voluntary transition plan that gives you greater choice over key decisions related to the transition or outright sale of your family business. A successful transfer or sale on your terms begins with the recognition that you want to have control over how and when to start the transition process, your retirement nest egg and ultimately your family’s wealth and legacy. More specifically you will have control over the following:
How best to protect your family business assets?
Who will be able to take over daily operations?
Do you have plans for growth or to maintain status quo?
Will the transfer be affordable?
What are the tax implications of a transfer?
How best to protect and preserve wealth and investments?
Have successors/buyers been identified?
What are your future income needs?
How will you define your legacy?
How best to ensure that all concerns have been identified and addressed?
Of course, this type of family business transition planning isn’t right for everyone… but if you want to have control of the transition process than it may be right for you. When you’re in control of the transition process, you are in a better position to secure your retirement nest egg and ultimately your family wealth and legacy.
When it comes to an objective independent business valuation as part of your "voluntary transition plan" we can help. Please give us a call or email us email@example.com Your initial consultation is always free.