Preparation For The Successful Transition of A Family Business – A Personal Approach

When contemplating the sale of any business, most owners and professional advisors focus attention on a checklist of items related to the health of the business. For example, preferably there will be adequate time to define a marketing plan and timeline, assemble an experienced team of professionals, work through common due diligence requests, ensure key management is in place, diversify and secure long-term sources of revenue, streamline costs, etc.  In short, business preparation should strive to (1) strengthen those factors that a buyer might find appealing and (2) remedy any potential issues that could detract from valuation during the diligence process. 

An approach focused on the health of the business is certainly appropriate. However, in a closely held family business, preparation focused solely on the financial health of the business is arguably incomplete.  Preparation of the owner who either founded or may have grown up as a second/third generation operator of a family business is often vitally important to a successful exit.  Further, issues related to the health of the business, such as who is best to lead the company into the future, are often complicated by emotion and family relationships. This article will address some of the personal considerations that may help prepare the owner of a closely held family business for what is often an emotional once in a lifetime event.

Personal Due Diligence Checklist

1.      Schedule Time: Long before a sale or internal transition is contemplated, many owners struggle with the conflict of finding time to work on the business as opposed to working in the business. An owner will need to block off additional time in his/her personal and professional schedule to be meaningfully engaged in the sale or transition process.  It is recommended an owner block off a defined period of time on a recurring weekly basis to focus on the sale or transition to maintain momentum and continuity. We use proprietary materials and consultation to help owners define priorities and roadblocks to enable them to find the necessary time to focus on the transaction.      

2.      Identify Goals: For some owners, a successful exit will be a sale at the highest possible price. Other owners seek to maintain a legacy for the business, whether the goal is to maintain a business namesake, care for family members/employees, or preserve relationships with customers/vendors.  There are owners who are willing to sell or transition a portion of the business and remain involved in management; others want to walk away as soon as possible. The goal(s) of the owner may vastly impact valuation, structure of the transaction, as well as payment of sale proceeds. It is imperative that the goals of the owner be established very early in the process.   

3.      Be Introspective: Each of us are impacted by psychological factors, biases, and our own natural behavior. These factors arise both prior to and after the sale or transition. In the case of a family business, an owner’s identity is often synonymous with the business being sold.  This can lead to an array of emotions when “letting go” and allowing a management team to take over. An owner should consider what life will look like post-closing within the lens of their natural behavior throughout life.  Someone who worked eighty hours per week may have difficulty adjusting to retirement.  Being home for lunch every day may also impact family dynamics. Objective tools may be used to gain valuable insight into the natural behaviors of the owner and, if appropriate, the owner’s family. These tools can also be used to assess if the right person is in the right seat on the management team.

4.      Financing: In a sale to a third party buyer, the owner often receives the sales proceeds at closing. However, a sale to a family member may require the owner to personally finance a portion of the sales proceeds through a seller’s note.  This not only lessens the cash received at closing, it also causes the owner’s financed sales proceeds to be at risk and tied to the buyer’s successful operation of the business. This can create conflict within the family. If there is sufficient time for a phased in transition of the business to a family member, an owner can sell small percentages of the business over time. This should reduce risk by allowing the owner to retain operational control for a portion of the seller financed transaction.

5.      Tax Mitigation/Planning: Through advanced estate planning well before the transaction, there may be an opportunity for some incremental value creation to occur outside of the seller’s estate, thus preserving more wealth for future generations.  In the year of the transaction, an owner may reduce tax liability by funding future charitable or philanthropic gifts through a private or community foundation.

6.      Financial Modeling: Modeling out pro forma after-tax proceeds and investment returns is important early in the process to help determine if the owner’s desired lifestyle can be maintained post sale. This is particularly true if the seller will finance a portion of the transaction. As with any financial model, the output is only as reliable as the accuracy of the assumptions. An expert in business valuation should provide a reasonable range for the value of the business. After an owner prepares a budget to determine his/her family’s annual need, the owner should then evaluate the expenses he/she has historically run through the business that will now be a personal expense.  An accounting professional should provide an assumption of the tax impact of the transaction. The projected tax expense as well as a stipend for “toys” and bucket list items should then be deducted from the sale proceeds. Taking the time to reach the most accurate assumption of investable assets, reasonable investment return, and owner expenses allows the owner to have peace of mind in modeling post transaction standard of living, estate planning and philanthropy goals.     

7.      Investment Planning/Management:  An assumed annual return on investable assets (the sale proceeds) is a critical component of financial modeling. It is vital that the assumed rate of return is not only realistic, but it must be in line with how the assets will ultimately be invested post-sale. Determining a post-sale investment strategy begins by defining the needs, goals and risk tolerance of the owner. If the sale transaction will result in more than enough assets to fund the owner’s needs and goals, an investment strategy that poses less risk may be appropriate. Conversely, some owners need or desire aggressive growth. An owner may consider parking the sale proceeds in a conservative investment for a cooling-off period post-sale to allow for investment planning and for emotions to subside.  A long-term investment strategy should be in line with funding the goals of the owner’s individual investment plan. The owner created the wealth; the post-sale investment plan should not take unnecessary risk that may result in a permanent loss of capital.  

These seven factors are merely a few of many considerations that should be explored when preparing an owner and his/her family for the personal life change that often accompanies the sale of a business. Dedicating time and attention to the personal as well as the business preparation can aid in the likelihood of a successful transaction.

The information presented is for educational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation of any particular investment or succession strategy.  Advisory services offered through Eubel Brady & Suttman Investment + Wealth Management.