Bruce Werner specializes in governance, strategy, finance and M&A. Author & Experienced Outside Director. Kona Advisors LLC.
A mom and dad in a small west Texas town had built a nice bookkeeping business for themselves. Their two sons had developed their own careers, one in consulting and the other in technology.
As the business grew, they realized they needed help, and the consultant son became CEO. But Mom and Dad still owned the business.
At the point that Mom and Dad wanted to plan their retirement, they realized they needed a mechanism to transfer the equity between generations but weren’t sure how to do it. There was no reason to consider selling to outsiders since the son was an effective CEO and wanted to take over the business. Yet, they needed a liquidity mechanism.
In an initial conversation, I explained the Three Circle model of family business, and with that was able to structure a resolution process.
A family business consists of three overlapping circles, and each needs to be understood:
Family – Who is considered family? Does it include in-laws and cousins, or only direct descendants? As the numbers grow, everything gets more complicated, and the economics get diluted.
Ownership – Who owns equity, and does it have voting rights or not? Many families have two classes of stock, so that economics can be equally shared, but control is limited to a few individuals.
Business – Who works in the business, and in what capacity? Some may be executives, and others may work in a non-executive capacity.
With that, I posed these questions to bring things back into focus:
• Does everyone agree on who is in each circle?
• Who and how are decisions made in each circle?
• Is there accountability for behaviors in each circle?
• How is conflict dealt with in each circle, or is conflict ignored?
The truth is, it is fairly hard to conduct succession planning without being realistic about these questions and understanding all of the soft issues. If there are real deal-breakers, then the sooner you understand them, the more successful you are likely to be.
Using this as a jumping-off point, I highlighted a number of issues that they would need to contend with moving forward:
How to secure financial security for Mom and Dad?
It is hard to transition into retirement if your future is uncertain. Running the numbers, and knowing that there is a margin of safety, is the first step on the path to a successful succession. Since the business was modest, it wasn’t obvious that a buyout would fund retirement. So, we needed to consider a growth strategy to ensure that the buyout would hit their magic number.
Are there non-economic legacy issues to address?
Once Mom and Dad know they are secure, do they still have non-economic goals to achieve? This usually includes reputational or philanthropic goals, in addition to trying to control what happens to their employees after their retirement.
Part of the retirement plan included providing their grandchildren with college funds and support of their church and local community. This meant we needed to refine the marketing component of the growth plan and make sure they could execute the new business plan successfully. It also meant they would need to work a few years longer to achieve their goals.
Is it family first or business first?
Every family business makes a choice, as it is not possible to put both family and business first. Businesses can be successful either way, although “business first” families don’t always function as well. This may not be due to the business.
The real question is whether or not the second son was part of the plan or not. There had been no discussions yet on this. Since he was successful on his own, there was reason to believe he would want to invest in the business and trust his brother to do well. How might this work out to everyone’s benefit? We needed to explore if his participation in the new ownership group would help make the math work.
Is there consistency in ownership, compensation and distribution policies?
After the parents are out of the ownership structure, they will still have thoughts on issues between their sons. The CEO son was paid a salary but did not receive distributions. The second son received nothing from the business. How should this be handled during the transition years? Do the parents want both kids to be equal in the succession process or not?
If the outside son had voting rights but did not depend on the business for his livelihood, it may create a conflict between the children. But if he was purchasing equity, would he not want voting rights as well?
These issues can be sorted out, but they need to be enumerated and assessed.
What about tax planning?
Effective tax planning usually impacts the timing of these decisions. One thought was to transfer some of the stock to the grandchildren now, to avoid estate taxes, but that went against maximizing their retirement plans. There was also a question about getting the stock out of their estate within their lifetimes so that they knew it was done.
So, if those are some of the important questions, how do we go about finding answers?
Well, it starts with a conversation. In this case, the family communicated reasonably well, so a facilitated conversation uncovered thoughts and feelings, and we were able to create a process to outline the issues and possible solutions. We then worked through each branch of the decision tree.
We spent some time talking about their family values—what was important, how did they want to live and what did they want to be remembered for, both by employees and in their small community.
With hard work and perseverance, we were able to build a roadmap to get them from today to their desired tomorrow. We also were prepared to adjust the plan, if need be, since we understood all the options.
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