A family business can be tricky to plan for. Lots of times, family issues bleed over into the business, making planning for future success a matter of helping owners and their families. A family business creates unique dynamics for successful planning because owners and advisors often need to consider the wants and needs of people other than the owner. Although the business owner is the advisor’s only true client in these situations, owners and advisors should still prepare themselves to tackle issues that affect the family. Here are three things owners and advisors should consider when planning for the future success of the family business.
Keep Ownership Agreements Up to Date
Many owners create ownership agreements early in the business’ life. As the business evolves, many of those owners fail to update those ownership agreements. The most common type of ownership agreement that doesn’t evolve with the business is a Buy-Sell Agreement. Having an outdated Buy-Sell Agreement is especially dangerous for family businesses, and it’s up to advisors to identify and fix the issue. Consider two examples about how outdated ownership agreements can destroy a family business.
Jake Simpson was the sole owner of a custom fabrication company. Each year, he brought in a salary of $350,000 for his family, on top of the health benefits and other perks his family enjoyed. One day, Jake had a sudden heart attack and died.
Jake had created a Buy-Sell Agreement 25 years ago that named his wife, Mary, as the owner should something happen to him. He never updated it, always telling his advisors that he’d do it later. Mary had no experience running a business. So, she immediately called Jake’s advisors and asked them to help her sell it for as much as they could. She informed the company’s key employees in an effort to be transparent.
When Mary told the key employees that she was selling the business, many of them began looking for new jobs and left. Revenue crashed, and Jake’s bank began to call in the company’s debts. Mary couldn’t find a buyer for the business, so she liquidated it for $500,000. After repaying the company’s bank debts, Mary was left with just $200,000, no health coverage, and no income.
In this example, a sole owner put his wife in an impossible situation. By failing to update his Buy-Sell Agreement, he left her stranded without direction. Had Jake’s advisors pushed him to update his ownership agreement yearly, the family business might have survived—or Mary could have at least sold it rather than liquidating it—despite his untimely death.
Now, consider a co-owned business with outdated ownership agreements.
Janelle Black and Sierra White were co-owners of Black & White Distribution. Their business was appraised at $5 million. Each brought home $375,000 in salary. According to their Buy-Sell Agreement, which they created just five years earlier, if one of them were to die, the surviving owner would purchase the remainder of ownership.
While driving home from work one night, Sierra was killed in a car crash. As 50/50 owners, Janelle and Sierra had each taken out a life insurance policy on each other. After Sierra’s untimely death, Janelle used the insurance funds to pay for Sierra’s half of the business. The $2.5 million lump sum wasn’t enough for Sierra’s family to continue living their current lifestyle. Rather than the $375,000 annual salary, Sierra’s family income fell to just $100,000 a year, based on a 4% withdrawal rate.
In this case, the Buy-Sell Agreement worked as planned, yet Sierra’s family still suffered. When an owner’s family relies on the business to maintain a lifestyle, advisors must be sure that owners understand the consequences of their untimely departure from the business. Constantly reviewing the owner’s goals, asking the right questions, and updating any ownership agreements is a good way to protect family businesses.
Separate Fairness and Equality
When owners of family businesses have children, planning for future success becomes more complex. In many family businesses, some children decide to work in the family business while other decide not to. This can cause owners to confuse fairness and equality when planning for their post-business lives.
Consider a business owner, Joe, who has three children: Doug, Glen, and Jania. Jania has worked in the business for 20 years, growing it from a $1 million enterprise to $15 million. As Joe approached retirement, he planned to transfer ownership to Jania and leave $1 million apiece to Doug and Glen after he died. When the brothers learned how much the business was worth, they demanded an equal amount in cash from their father. They didn’t think it was fair for Jania to receive what they considered to be more money, even though the company’s value was largely illiquid and they had nothing to do with its success.
Advisors can mitigate situations like these by establishing the owner’s goals then creating plans to communicate those goals to the children involved. Advisors are independent and unbiased about fairness toward children, working to achieve the owner’s goals foremost. Advisors can also determine what’s fair in terms of how each child contributed to the business’ success and how any ownership or monetary transfers can reflect those contributions in the context of the owner’s overall planning goals.
Have a Backup Plan
Family business owners often want to keep the business in the family. While this is often possible with proper planning, advisors must encourage owners to have a backup plan.
Advisors can help business owners create a backup plan in tandem with planning for a successful future. The surest way to do so is to install Value Drivers in the owner’s business. Regardless of whom the owner wants their successor to be, all potential buyers/recipients of ownership will want Value Drivers to be present in the business.
Another way is to determine whether the owner’s chosen successor can continue to grow the business. Implementing strong incentive plans is a way for advisors to help owners determine this and reward high-performing potential successors.
- Family businesses typically face more challenges to planning for future success. Advisors and owners should identify these challenges and address them early in the planning process.
- Keeping ownership agreements up to date can prevent family businesses from facing surprising outcomes brought out by the owner’s unexpected departure from the business.
- In planning for the future success of a family business, advisors should know how to explain the difference between fairness and equality, and implement backup plans.