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| Planning to Pass Down
the Family
Business Transferring a family-run
business to a second generation, whether it is a hardware store, a
restaurant or a business-to-business organization, is intricate and
one should not underestimate the complexity of transferring ownership
from one generation to the next. A proper business transition requires significant
thought, time and effort. Often times the key to a successful transfer is appropriate
and competent legal counsel. While
it may seem obvious enough, the most seamless transition is often
based upon a comprehensive plan that ensures that all the legal aspects
are being considered. The unfortunate thing is that in most cases,
the common trend is to not have a plan at all.
This can result in all sorts of negative issues for the new
business owner and her predecessor. For most transferring business owners, the primary need
is to explain how the transition will be executed while also including
contingency plans should outcomes vary from initial expectations.
Therefore, the more detail provided around each action, the better.
Frequently, older generation business owners do not adequately prepare
for conflicts with the next generation, which can stem from opposing
views on how to handle the business itself, the staff, and external
relationships. THE RIGHT QUESTIONS Asking the appropriate questions and having the answers
outlined in a plan is crucial. The
proper business transition will answer several essential questions. Who will be the succeeding owner? Will it be one child, some of the children,
or all of the children? If
one child, will the transitioning generation provide for the others
in some alternative manner? If
two or all of the children, will all be active in managing the business
or will some be silent shareholders?
If some will be inactive owners, will the plan provide
some measure of protection for those inactive members?
Will the new owners be only those children who have previously
been active in the business? If
more than one child will be involved in the newly transferred business,
is the transferring generation assured that those children are capable
of working together? Will key staff from the previous regime be retained
or will the new owners bring in their own key staff members? Is the buyout of the business adequately financed?
Are financing terms favorable to the transferor, the transferee,
or both? Should the transferring
owner be retained as a consultant to ensure that essential previous
business contacts are retained so the business can continue to prosper?
Does the financing of the transition provide sufficient liquidity
to allow for the potential estate tax liability for the transferring
owner? Are all income tax complications
for the transferor considered? As can be seen, the issues to be examined are numerous
and complex. The optimal plan
is the one that takes into consideration all of these issues. Additionally, because of all of the potentially
conflicting issues, flexibility in the plan can be an asset. ELEMENTS OF THE PLAN In addition to asking the right
questions, counsel should be sure that the plan includes the appropriate
documentation required to transfer the interest of the owner, whether
it be a corporation, limited liability company, or partnership. It
is vital that the plan include all documentation required to properly
transition the owner’s interest. Counsel must also make sure that
there is adequate funding of the plan, both to ensure the success
of the business and to safeguard the financial well-being of the transferring
owner. Often times, companies might have an appropriate transition
plan in place, but the capital needed to sustain the ongoing business
is not fully secure. If the financial foundation of the newly acquired
company is at risk in any way, not only the new owners but the old
owner may be at risk. If the
transition is financed, the seller may not receive payment if the
continued success of the business is not assured. The viability of the financing must be discussed
in detail with the transferring owner. As mentioned earlier, reasonable
contingencies need to be outlined in the plan to address the possibility
that unforeseen circumstances may arise. This tactic will ensure that
the parties won’t be caught in a situation without alternative corrective
actions. For example, a parent may transition his business
to his children. After a few
years, one or more of the children may decide that an alternative
career better suits them. Documentation for the transfer of ownership
should thus contemplate how each child’s interests should be protected
or purchased in such circumstances. The last thing the parent wants
to create is animosity among his successor children. Counsel should also make sure
that reasonable arrangements are being made with business customers
to ensure that the business thrives after the transition. For example,
if a client is in the service business, keeping the lines of communication
open with customers will help ensure that they will remain with the
company through the transition. The transferring owner will be able to assist
in this transition of the relationship with customers. A primary consideration
is having an adequate legal/accounting team to guide not only the
transition but also the business into the future.
Generally, this transition works best if the current team is
left in place. However, the new owners may have their own advisors
that they prefer to work with. This should not be an issue if the
new team is kept abreast of all facets of the transition. HANDLING
THE TRANSFER Generally, business owners who
transfer the business to family members will do so by virtue of a
buy-sell agreement, a Grantor Retained Annuity Trust, or an outright
gift through a recapitalization of some sort.
A buy-sell agreement is a contract between the transferring
owner and the transferee. It generally will provide for contingencies
such as death, disability or retirement.
It is the essence of the plan. When using a buy-sell agreement,
the financing issues are of paramount importance and the new owner
should be sure to fully understand the different options. In most
cases, the business owner will want to be cashed out.
If not, financing terms should be understood and to the greatest
extent possible, guaranteed. In
transitions to family members, does the owner fund her own buy-out
through an insurance program, or a gift to the next generation?
Or does the parent insist on some stake for the next generation? Asking the right questions usually means less
confusion down the road. One further issue must be considered.
It is important in representing a client that all parties understand
who is being represented. An
ethical dilemma can be created if the attorney does not make it clear
that he represents either the transferor or the transferee.
The attorney should not represent both even where that is the
preference of the family. There are always going to be extenuating
circumstances that might impact the outcome of transferring ownership
(e.g., industry changes, market oscillations),
but having a well-thought plan in place for transitioning ownership
is the best way for business owners to avoid legal roadblocks once
the ink is dry. c TIMOTHY RIDLEY is a partner with Meagher & Geer. His practice focuses on wills, trusts, estates and related litigation. |
