Transitions in the Family Business: Hope Is Not a Strategy

Transitions in the Family Business: Hope Is Not a StrategyIf last week’s post summarizing the third panel from the Transitions in the Family Business: A Conversation with Family Business Owners and Leaders event piqued your interest in selling a family-owned business, you may have more questions about the sale process. As part of the Transitioning to a New Owner panel, Frank A. McGrew IV, managing partner of McNally Capital, shared his top 10 questions that family business owners and leaders should ask before pursuing a sale of their business.

  1. Is your business ready to sell? Any buyer’s due diligence process requires a thorough evaluation of the seller and the seller’s business. Is your business ready for this examination?
  2. Are you personally and mentally ready to sell your business? It is easy to be consumed by the immediacy of the sale process. Before exploring a sale, ask yourself: What would I do next and for how long? How much money do I truly need to live on if I sell my business?
  3. When is the right time to sell? How will you know when the time is right? What are the trigger points to watch for, and how do you measure those?
  4. How much is your business worth to you? How much will another buyer want to pay? What is the likely range of these values?
  5. Who is the best and/or the right buyer? Are there certain buyers you do not want to approach or sell the business to? This could include competitors.
  6. How can you increase the odds of success in your favor during a sale and transition process?
  7. How can you maximize the purchase price and net proceeds from the sale?
  8. How can you quantify and better understand the principal risks for your business and a transaction process before you begin?
  9. What issues must be addressed before beginning a sale process?  For example, these could include legal, environmental or customer/supplier issues.
  10. Who and what are the most appropriate outside experts and resources you need to utilize for a successful outcome? Frequent players include a transactional attorney, a banker, a wealth management advisor, and a trustee. Perhaps most importantly, who will “quarterback” this process as your client consigliere?

After reflecting on and answering the questions above, potential sellers will be better equipped to succeed in a sale transaction.

This blog post was co-authored by Frank A. McGrew IV of McNally Capital. Frank is a Managing Partner and leads the Merchant Banking efforts at McNally.

Transitions in the Family Business, Part III: A Successful Sale

Transitions in the Family Business, Part III: A Successful Sale This post is Part III in a three-part series summarizing and exploring Transitions in the Family Business: A Conversation with Family Business Owners and Leaders, a recent event for family-owned-business leaders that Bradley’s Family Business Advocates team co-hosted with Warren Averett. The event consisted of three panel discussions: Transitioning to the Next Generation, Transitioning to Nonfamily Executive Management, and Transitioning to a New Owner. See Part I of this series on Transitioning to the Next Generation, and Part II on Transitioning to Nonfamily Executive Management.

This post highlights the third and final panel’s discussion on Transitioning to a New Owner. In this panel, our speakers discuss their families’ experiences in selling their businesses. Selling a family-owned business is at the same time a complex business decision and a complex emotional decision. Depending on how ownership and control of the business are held within the family, realizing the rewards of a multigenerational effort through a sale will likely require the approval of multiple family members. Any number of factors may play a role in a family’s decision to sell its business — a new generation may be unavailable to take over, the family may want to pursue a new or different venture, or an offer may be too good to refuse.

Whatever the motivating factor, selling a business, especially a family-owned business, is almost always a once-in-a-lifetime experience. What may have taken several generations to build can easily be squandered in a bungled sales process. For this reason, families should engage competent advisors as soon as possible. A typical transaction requires input from a transactional lawyer, investment banker and accountant, among others. This team should add value by working together to structure a deal that accomplishes the family’s goals, whether that is protecting the family’s legacy, maximizing sales proceeds, facilitating a tax-efficient transfer, or limiting the family’s post-closing liabilities. When the time comes, experienced advisors help families analyze competing offers, which can include comparing different kinds of buyers (e.g., private equity versus strategic buyers) or different types of considerations (e.g., cash versus shares of the buyer’s equity).

Sellers have a natural tendency to underestimate the time and resources that will be required to successfully close a transaction. Although the due diligence required for every transaction varies, with few exceptions, buyers require a thorough evaluation of the seller and the seller’s business prior to signing on the dotted line and wiring funds. Throughout this process, families are challenged to maintain their business’ value, while negotiating and executing a handoff to the new owner. Deal fatigue is a serious threat not only to the proposed transaction, but also to a family’s existing business operations. A terminated sales process may disrupt existing relationships with customers and suppliers, open the door for competitors, and frustrate future opportunities to sell the business. Families aware of these challenges at the outset are better able to prepare for them as they may arise.


For related discussions, see ESOPs: An Alternative Exit Strategy for Family-Owned Business, a post on using an ESOP transaction as alternative to the traditional sales process, and Should You Hire An Investment Banker To Sell Your Family-Owned Business?, a post on the benefits of engaging an investment banker.

Transitions in the Family Business, Part II: An Outside Perspective

Transitions in the Family Business, Part II: An Outside PerspectiveThis post is Part II in a three-part series summarizing and exploring Transitions in the Family Business: A Conversation with Family Business Owners and Leaders, a recent event for family-owned-business leaders that Bradley’s Family Business Advocates team co-hosted with Warren Averett. The event consisted of three panel discussions: Transitioning to the Next Generation, Transitioning to Nonfamily Executive Management, and Transitioning to a New Owner. See Part I of this series on Transitioning to the Next Generation.

This post highlights the second panel’s discussion on Transitioning to Nonfamily Executive Management. In our second panel, each of our speakers had a role in a family-owned business that successfully transitioned to nonfamily management.

An initial challenge these businesses face is to identify a manager the family trusts to write their business’ next chapter while maintaining the family’s legacy. Some families feel most comfortable looking to their existing relationships with employees and service providers when transitioning to new leadership. One of our panelists discussed his business’ transition of managerial control to a long-time outside advisor. In this case, the family’s business was placed on a firm foundation with an advisor who had worked for decades with the family in connection with their business and personal affairs. Here, the “trusted advisor” became the trusted leader.

Another panelist discussed his family’s nationwide search for a new manager that involved interviewing numerous candidates and resulted in the business hiring a true outsider as its chief financial officer. This solution uniquely addressed the family’s need for a fresh perspective while also adding a veteran administrator with significant industry experience to help manage the business’ rapid growth. Ultimately, the family was able to rely not only on the candidate’s proven track record at a large public company but also on the confidence the family gained from an extended search and interview process.

After gaining the family’s trust, nonfamily members face unique challenges in being integrated into the day-to-day operations of a family-owned business. One panelist cautioned new managers from immediately implementing disruptive changes to the business. In a closely held family business, new managers must balance the benefits of such changes with the risk of alienating existing employees (and, perhaps, the family owners).

On the other hand, new managers must establish their authority. There is no one way to maintain this delicate balance, but consistent communication and engagement by the family, the new management and other stakeholders is crucial. New managers need both the unambiguous support of the family and the latitude to manage the business.

Stay tuned for our next post addressing the third panel’s discussion on Transitioning the Family Business to a New Owner.

Transitions in the Family Business, Part I: Caring for the Goose

Last week, Bradley’s Family Business Advocates team co-hosted Transitions in the Family Business: A Conversation with Family Business Owners and Leaders with Warren Averett. The event consisted of three panel discussions: Transitioning to the Next Generation, Transitioning to Non-Family Executive Management, and Transitioning to a New Owner. This three-part series of posts will summarize and explore each of these panels.

Transitions in the Family Business, Part I: Caring for the Goose

Attendees of “Transitions in the Family Business: A Conversation with Family Business Owners and Leaders” look on.

The first panel focused on how to plan and execute the intra-familial transition of leadership and control of the family business. One panelist analogized the family business to the famous goose from Aesop’s fable The Goose with the Golden Eggs. You know the story: One morning, a countryman goes to the nest of his goose and finds a glittering egg made of pure gold. This pattern of behavior repeats itself daily. Then, as the fable says, “As he grew rich he grew greedy; and thinking to get at once all the gold the Goose could give, he killed it and opened it only to find nothing.” The wisdom of this fable was not lost on these panelists; teaching younger generations the desire and skills to care for the goose may prevent them from killing it. How can the older generation instill in the younger generation these values?

First, the family can draft and use a mission statement to organize multiple generations around a common goal. This statement gives purpose and focus to the operation of the family business and the family’s management of it. Involving younger generations in the drafting of a mission statement can create buy-in at an early age, which may ward off a “kill-the-goose” mentality.

In addition to mission statements, families can also draft and implement specific policies to help align the generations. For example, some families may have an employment policy that requires family members to work outside of the family business for a certain amount of time or at a certain level of success prior to working for the family business. Family members then must prove themselves outside the family business, which may ease an intra-family management transition at a later date.

Other families may have a policy requiring a certain number of all-family meetings per year. A policy addressing how equity in the family business will be divided at each generational level could also be important. An independent family consultant may be hired to assist in drafting these policies. Having pre-determined policies in place can help prevent conflict down the road.

Using Different Classes of Stock in a Family-Owned Business

Using Different Classes of Stock in a Family-Owned BusinessRecently, Facebook announced that it would withdraw its plan to issue Class C no-vote stock. Facebook had proposed issuing a new class of Facebook stock that would have had the same economic rights as the existing Class A and Class B shares but would have no voting power. Facebook, however, already uses a multi-class stock structure, with Class A shares (which trade under the ticker “FB” on Nasdaq) having one vote per share and Class B shares (which are owned by Facebook insiders, such as Mark Zuckerberg) having 10 votes per share. While Facebook is a public company with many shareholders, family-owned businesses may also benefit from having different classes of stock.

A class is one group, or type, of stock that has identical rights; every share within a class is the same as every other share in that class. It makes sense, then, that issuing different classes of stock allows a company to give different rights to different groups of shareholders. Most notably, a company can concentrate voting power in one class of shares, which allows the holders of that class to retain control, while giving the economic benefits of stock ownership to all shareholders.

In a family-owned business, multiple classes of stock can enable certain members of the family to maintain voting control over the company. By issuing to themselves a class of voting stock (with either one vote or multiple votes per share), the first generation family owners can preserve their power to elect the board of directors and therefore control the company. A different class of stock with reduced or no voting power can then be issued to second- and third-generation family members without worrying about how they will vote in director elections. Therefore, while the founders may be economically diluted over time with the issuance of a different class of stock to children and grandchildren, their voting power remains concentrated. This multi-class stock structure can assist families in transitioning the business to younger generations.

One cautionary note: If your family-owned business is taxed as an S-corporation, consult with an attorney and an accountant before issuing a different class of stock. While voting and non-voting stock are permitted in an S-corporation, both classes of stock must have the same economic rights. If the classes of stock have different economic rights, the company’s S-election may be terminated.

2018 Will Bring Increases to Annual Exclusion, Gift and Estate Tax Exemptions

2018 Will Bring Increases to Annual Exclusion, Gift and Estate Tax ExemptionsThe IRS has announced that the gift tax annual exclusion will increase from $14,000 to $15,000 in 2018, which will allow donors to give up to $15,000 ($30,000 combined for married couples) per donee each year without incurring gift tax or using the lifetime gift and estate tax exemption. In addition, the lifetime gift and estate tax exemption will increase from $5.49 million in 2017 to $5.60 million ($11.2 million combined for married couples) in 2018. Finally, the generation-skipping transfer tax exemption will similarly increase to $5.6 million. With respect to annual exclusion gifts to non-U.S.-citizen spouses, the amount will increase to $152,000 in 2018, up from the current $149,000. These recently announced increases are the result of inflation adjustments. To determine the strategies available to you to take advantage of these increased exemption amounts, please contact one of the members of our Family Business Advocates team.

ESOPs: An Alternative Exit Strategy for Family-Owned Businesses

ESOPs: An Alternative Exit Strategy for Family-Owned BusinessesOne of the most difficult challenges for owners of family-owned businesses is finding a way to turn their equity in the business into cash. Also, after putting years of hard work into a business, owners often have a desire for the company legacy to continue when they leave. They often want their employees to have an opportunity to continue working and growing the business after they have retired.

For some business owners, the answer to these issues will be to turn over the company to a family member or sell to a competitor. However, many owners do not have family members interested in running the business, and outside purchasers may be difficult to find. Furthermore, even if they can be found, many buyers will only want to buy the company for its assets and have no desire to continue the business, or they may want to continue the business in a way that is not consistent with the owner’s objectives.

Employee stock ownership plans (ESOPs) can be an attractive and tax-favored alternative for a family-owned business looking for an exit strategy. For the owner of a C corporation, proceeds on the gain from the sale of stock to the ESOP can be tax-deferred by reinvesting them in the securities (including both stocks and bonds) of other domestic companies, subject to certain requirements. If such replacement securities are not sold prior to the owner’s death, no capital gains tax is ever due on the gain recognized by the sale of the company stock to the ESOP. Unfortunately, this deferral opportunity is not available to the owners of S corporation stock. However, if the company is an S corporation, limited liability company, or partnership, it can convert to a C corporation before the sale in order to allow the selling owner(s) to take advantage of such tax deferral.

Following a purchase of company stock, for a C corporation the full amount of the loan incurred to finance the purchase (including both interest and principal) can be paid with tax-deductible dollars using company contributions to the ESOP. For an S corporation (100 percent owned by the ESOP), the corporation will not pay any federal income taxes, and the additional cash flow will help fund the repayment of the loan.

ESOP sales can be accomplished all at once or gradually. For the company employees, no contributions are required to purchase the owner’s shares, as the ESOP loan will be repaid by annual company contributions to the ESOP. The owner will ordinarily stay with the business. The ESOP stock is owned by a trustee who votes the shares; however, the company’s board appoints the trustee, so changes in corporate control are usually nominal.

An ESOP is a special kind of tax-qualified profit sharing plan, similar in many ways to a 401(k) plan, and is governed by the same law, the Employee Retirement Income Security Act. Company stock purchased by the ESOP is held in a trust for employees meeting minimum service requirements and generally allocated to employees based on relative pay. Accounts are distributed after the employee terminates, although there are rules that can extend the time for distribution including while the loan incurred to buy the company stock is being repaid.

Good ESOP candidates are generally companies with sufficient cash flow to pay the debt obligation incurred for the purchase of company stock and with adequate payroll to make contributions sufficient to pay such debt. However, it is important to know that ESOPs are not simple arrangements. There are a number of complex issues that need to be addressed in any ESOP transaction, and ESOPs are not right for every company. The company cannot be precluded under the covenants governing its existing debt obligations from incurring the additional debt necessary to affect the ESOP transaction. The owners must be willing to sell their shares at fair market value, as determined by an independent valuation firm retained by the ESOP trustee, even if an outside (strategic) buyer might pay more. Management continuity is also very important.

An ESOP may be a good exit strategy for your business.

Withdrawal of Proposed Tax Regulations Affecting Availability of Valuation Discounts to Family Business Owners

Withdrawal of Proposed Tax Regulations Affecting Availability of Valuation Discounts to Family Business OwnersIn September and December of last year, we posted blog articles discussing the Treasury Department’s issuance of proposed regulations under Section 2704 of the Internal Revenue Code (sometimes referred to as the 2704 proposed regulations) that could have significantly impacted the valuation of interests in family-owned businesses for estate and gift tax purposes.

On October 2, 2017, the Treasury Department and the IRS announced that the proposed regulations will be withdrawn in their entirety. The proposed regulations, targeted at curtailing artificial valuation discounts, could have reduced (or even eliminated) discounts (primarily, lack of control and lack of marketability discounts) historically used when valuing gifts or other transfers of family-owned businesses.

Among other factors cited by Treasury, the proposed regulations are being withdrawn because compliance with the regulations would have been unduly burdensome on taxpayers and could have affected valuation discounts even where discount factors were not created artificially as a value-depressing device.

The withdrawal of the proposed regulations means that family business owners who transfer ownership of part of their business to younger family members will still be able to make transfers at values that take into account appropriate valuation discounts. For example, a transfer of a 10 percent interest in a family business from parents to children does not represent a controlling interest in the business. The 10 percent interest is also not readily marketable and cannot be sold quickly like publicly traded stocks and other marketable securities. Therefore, discounts for “lack of control” and “lack of marketability” may still be applied to arrive at the value (for gift or estate tax purposes) of a minority, closely held business interest whenever the interest is transferred.

If you are interested in making transfers of ownership interests in your family business, the members of our Family Business team are available to discuss the various strategies available to you.

Laying the Foundation for Success: Structuring the Board of Directors in a Family-Owned Business

Laying the Foundation for Success: Structuring the Board of Directors in a Family-Owned BusinessMy husband and I are about two weeks shy of completing construction on our new home, so outside of work, construction is our life. In construction, the concept of compounding defects means a defect in the foundation compounds as you build up, impacting everything from the framing to the drywall. This concept applies to family-owned businesses as well. Failure to build a corporate governance structure makes a family-owned business susceptible to conflicts of interest, family infighting, and other inefficiencies, impacting everything from the CEO to the future growth of the company.

The board sets the overall strategy and policies of the company, so your corporate governance foundation starts with structuring the board of directors.  As the overall governing body, the board elects the officers of the company and provides oversight of management without getting into the day-to-day management of the business. In a family-owned business, the board may take family politics into consideration, but fiduciary duties dictate that the board must act in the best interest of the company, not any individual shareholder. These concepts give the family the ability to rely on the board to challenge management, set long-term goals, and engage in conflict management when necessary.

Given the role of the board, the family-owned business must determine the best structure for its board.  Requirements for the board are typically set forth in the company’s governing documents (e.g., bylaws or operating agreement). Here are a few questions to consider when structuring your board:

  1. How are directors elected to the board?
    Shareholders or members elect the directors to the board. The company’s governing documents may require that a nominating committee nominate qualified individuals before they may be voted on by shareholders. The governing documents may also set forth certain qualifications for directors.
  2. How many directors should be on the board?
    Applicable law may require a minimum number of directors, but otherwise, the company has the ability to set a range for the required number of directors. Typically, an odd number of directors is preferred to prevent a deadlock.
  3. Should the directors have staggered terms?
    The board may be divided into different classes of directors with staggered terms. Utilizing staggered terms promotes continuity on the board, but makes it more difficult to replace an entire board if the shareholders are dissatisfied with the current corporate strategy.
  4. Should the board include non-family members?
    This can be a difficult decision for family-owned businesses, and the answer may depend on the current stage of the business. For example, a family-owned business in the first generation may prefer a closely held structure of a limited number of family member directors. On the other hand, a family business on the third or fourth generation may be better served by including non-family members who can bring a fresh strategic perspective or a new experience base to the board.

Just like a strong foundation ensures that a building will weather the test of time, putting a strong corporate governance structure in place sets the family-owned business up for success as it grows and experiences generational shifts.

Succession Lessons from The Crown

Succession Lessons from The CrownAt my daughter’s urging, earlier this summer I watched the Netflix series The Crown. The Crown is the story of the reign of England’s Queen Elizabeth II. The first season presents the transition of the crown from King George VI to daughter Elizabeth due to the king’s untimely death. Recall that George VI became king because his brother, King Edward VIII, abdicated the thrown (a/k/a: quit the job) to marry an American divorcee. That is a succession story for a future blog.

As I watched the 10 episodes, my thoughts gravitated to the difficulties of leadership transition in family businesses. I can’t help it — it’s what I do. In the case of Queen Elizabeth II, the transition of leadership in the family business (and what a business it is!) was an emergency succession. The good news is that there was a long-standing succession plan in place. But, although there was a plan, the transfer of leadership was not easy. It seemed especially hard on Elizabeth’s younger sister, who was not chosen for the job, and the former king’s executive team, who now had to answer to a leader who was just a 25-year-old “kid.” It happens all the time!

As you know, Elizabeth persevered. In fact, she has now been Queen of England for 64 years. That’s what we call a successful transition of leadership.

Leadership transition from parent to child in a family-owned business is challenging.  I noted a few factors in the successful, though difficult, transition portrayed in The Crown that may be helpful in your own “kingdom.”

  • First, Elizabeth knew from very early in life that she would take over from her father at some point. The expectation was set well in advance of the transition.
  • Second, since all stakeholders – family and executive team – knew the plan, all were focused on educating, mentoring and training Elizabeth for the role. They all had ample time and proper motivation to make certain the transfer of power would be successful.
  • Third, the family and executive team understood, ultimately, that Elizabeth’s success was paramount to the success of the nation (i.e., the business). They put the “the crown” before self to support and aid the queen. Elizabeth also understood and embraced her duty, accepting that she had a duty not only to her family, but also to the entire British Empire.
  • Finally, she had an incredibly strong COO – Prime Minister Winston Churchill.

The prime minister knew the history of the family and the empire.  He had been with “the organization” for a very long time. He also held strong views about how the organization should be run and shared his wisdom with the queen. But through the transition and her early reign, he remained doggedly loyal to her and often served as a buffer. Churchill’s support for his boss and commitment to her success was unflagging.

Most family-owned businesses don’t resemble the British Empire, obviously, but lessons from The Crown do translate to these businesses in many ways.

  • If the desire is to have the next generation lead the family enterprise, start the process at birth. Teach the next generation about duty, not just to the family owners, but also to the employees of the company and their families, and to the communities where those families live.
  • Educate, mentor and train the next generation in the business. Teach the history and customs of the family and the business. Employ the next generation in the business from the ground up, and send them out into the “empire” to get to know the people.
  • Make sure the executive team understands the goal of a successful leadership transition. Involve the team in the process. Emphasize to the senior team that their support and aid is essential – failure is not an option.
  • Finally, if you can hire Winston Churchill as your COO . . . . do so!

God Save the Queen!