Keeping it in the Family

Family Transfer Scenario

What is a Family Transfer?

Family Transfers, also known as “Intergenerational Transfers”, are internal transfers of ownership from one family member or generation to another. Usually, this involves parents transferring their ownership to one or more business-active children, or BAC(s). Different amounts and types of ownership interests can be transferred over various periods of time by way of gifting or sale strategies. The primary goals for any Family Transfer are:

  • Financial Independence for the current owners (usually mom and dad)
  • Achieving “fairness” among all children and family members (note: fairness doesn’t mean equality)
  • Transfer of interests to the ideal BAC successor
  • Business Independence for mom and dad

How Do Most Family Transfers Work?

Most Family Transfers occur when the matriarch or patriarch (mom or dad) decides to transfer their ownership to one or more BAC(s). This generally occurs when the owner decides to retire, wants to pursue other challenges or is ready to transition the business to the BAC(s).

Most parents want to gift or sell their interests when THEY are ready, not when the BAC(s) or the organization is ready. This can create a number of issues and potential conflicts within the family or business. Also, more times than not, the owner tries to transfer all of their interests over a short period of time without planning to meet defined performance standards, achieving their financial goals, or having a process in place to retrieve their interests in the event things don’t work out.

As a result, most Family Transfers (approximately 66%) fail from causes such as alienation of the key employees, loss of current customers and suppliers, or a decline in the value of the business. In fact, research shows that only 33% of family businesses successfully change hands from the first to second generation and only 12% from second to third. Some experts believe that these numbers are even higher in reality.

What Ensures a Successful Family Transfer?

To achieve mom and dad’s primary goals (financial independence, fairness and harmony among the children, completed transfer to the intended BAC(s), and their retirement) it’s critical they design a transition plan which includes the following considerations.

STEP ONE: The starting point is defining the owner’s primary goals (as stated above.) This includes determining the owner’s vision and desire for their business after their transition. The vision typically includes:

  • Selecting the ideal successor(s)
  • Determining the owner’s timeline for departure
  • Determining how the business will evolve and change over time
  • Creating the new management and governance structure, and the roles of the successor BAC(s)
  • Identifying the key employees and how they will contribute and become vested
  • Agreeing on all other important aspects of the future business

Ideally, the vision also incorporates the values and goals of the successor BAC(s) and other key employees.

STEP TWO: Once the vision is defined and clearly understood by the successor BAC(s) and key employees, the owner needs to quantify and value their existing financial resources (both business and non-business) and determine the business’s level of free cash flow. This is used for funding the owner’s retirement, vesting the key employees, growing the business and carrying out all other required tasks before the owner “rides off into the sunset”. This important step also tells us what the business is worth today and what type of Transfer Scenario it can afford.

STEP THREE: The owners must then establish the guidelines, protocols and standards for bringing their children into the business or for developing and promoting the current BAC(s). This process is much easier said than done. It is the main reason why most Family Transfers fail within the first year.

The objective guidelines for how family members come into the business should address where they start, who they’ll be accountable to (hint: It should always be non-family key employees), what their compensation will be and their track for promotion and future equity. These guidelines and protocols are written and clearly understood by all family members and non-family key employees. Preferably, the guidelines are adopted into the company’s by-laws or operating agreement and are part of the company’s growth plan after the owner retires.

STEP FOUR: It is also critical for the owner to identify, properly motivate and vest the essential key employees who will be needed to nurture and develop the successor BAC(s). This means they will actively participate in the growth of the business, and this process begins by defining what a key employee consists of and how they are different from other employees. It also includes determining their roles and responsibilities and performance standards and may include mentoring and training the BAC(s). It’s critical that key employees are part of the transition process and that they are “on board” with how the BAC(s) are developed and groomed for ownership. It’s typical for the key employees to be offered some form of limited ownership or non-equity stake in the business.

STEP FIVE: Once the above infrastructure is in place, it’s time to begin the family transfer process. The process includes finalizing the transition plan to accomplish the owner’s Universal Goals and Objectives (UGOs), motivate and retain the key employees, develop the successor BAC(s), and increase the profitability and value of the business. The ideal transfer likely includes various gifting and or sale strategies with non-voting equity being transferred to the BAC(s) over a specific period, assuming certain performance objectives are met. Once the owner has achieved their financial goals and the BAC(s) has proven to be willing and capable to continue the business, the BAC will become eligible to receive or purchase the voting equity and take full control of the business. On average, the Family Transfer process takes 2-7 years depending on the needs of the parties, family dynamics and specific facts & circumstances.

STEP SIX: After the transition plan takes effect and the owner has transitioned completely out of the business, the owner and successor BAC(s) will then create a Business Continuity Plan (BCP). The BCP protects everyone’s interest in the business in the event the previous or new owner(s) becomes deceased, permanently disabled, financially insolvent, violates any restrictive covenants, intentionally causes harm to the business or experiences divorce. The BCP also addresses what happens in the event the company loses a substantial part of its business, or if one or more of the owners unexpectedly decides to retire or leave the business. Acquiring the requisite life and disability insurances and creating estate plans for each owner is critical to ensure the owner’s UGOs are still achievable.

STEP SEVEN: Every good family business transition plan needs to include a strategy for taking care of the non-business active children (non-BACs) or family members not in the business. The plan needs to detail how to allocate and transfer non-business assets to non-BACs, either during their lifetime or upon the death of the owner. It’s important to remember that “fairness” does not mean “equal” in terms of the monetary value or the timing as to when a child receives they’re benefit. The plan needs to employ a “wealth management strategy” to maintain and build the owner’s nest egg and to ensure they can live the life they deserve once they are Business Independent.

“I don’t like the word ‘dynasty,’ but that’s what it is. It’s not just a business. There’s a lot going on in the background.”
― Jake Dyson

Moving Forward- Key Issues to Consider

Given the level of complexity in every family and family business, transferring mom and dad’s ownership to a BAC is trickier than most people anticipate. The transition process generally takes 3-5 years to implement and requires the assistance of everyone in the organization and skilled advisors experienced in transition planning and family business dynamics.

It’s important to begin the planning process well before the owner is ready to leave (at least 3 years before retirement) and to consider a “Plan B” in the event the BAC(s) are unable to successfully continue the business. Unfortunately, it’s likely that the BAC(s) will encounter challenges and difficulties not experienced by the owner and there’s a strong probability they will not succeed unless there is a well-defined transition plan in place.

In the event Plan B is necessary, the owner could look to sell the business to the non-family key employees (see Key Employee Transfers) or look to sell to an outside third party (See Third Party Transfer). Regardless of whether Plan A or B materializes, it’s critical that a well thought out transition plan is in place which builds enough Transferable Value in the business and allows the owner the flexibility to change course as needed.

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