Neil Sedaka was right — breaking up is hard to do, especially when it’s a family business.
In addition to the interpersonal relationships, the financial aspects can be overwhelming. Trying to accommodate individual preferences can lead to poor decisions that may affect families for years to come.
Family business dissolution strategies can take many forms. For example, the business may be sold to an unrelated third party, sold to employees through a leveraged buy-out or an employee stock ownership plan (ESOP) or sold, given or transferred by inheritance to family members — or a combination of all three.
The sale to an unrelated buyer is generally the easiest exit. The seller seeks the highest price on the most favorable terms and attempts to limit exposure to post-closing liabilities and conditions. The seller may be required to sign a noncompete agreement, to assist in a management transition, continue to operate the enterprise as a subsidiary or division of the buyer’s entity or leave the premises on closing and never return.
The sale of a business to existing management or employees can be tricky. The employee managers will need to negotiate the price, terms and structure with their boss, magnifying the normal stresses of any negotiation. Each side feels the other is being unfair under the circumstances, because each has contributed significantly to the business.
For example, the buyer may argue for a lower price because the seller has taken too much out of the enterprise in the past, and significant new investments in plants and equipment are needed to remain competitive. The seller often feels the buyer has been more than fairly compensated in the past, and all the necessary resources to allow the staff to prosper are being provided by “his” business.
If the transaction is not consummated, the buyer often ends up looking for a new career and the seller for a new key employee.
The disposition of a business to family members poses a unique set of complications and hazards. Perhaps the family won’t or can’t pay cash at closing, so how will the family indebtedness be collateralized? For example, will the children or siblings be required to give their personal guarantee, secured by their homes or the voting stock of the enterprise?
Business owners should also realize that adverse income, gift or estate taxes can result. Because of the possibility of a transaction being designed to benefit the natural objects of the seller’s bounty, related party transactions come under greater IRS scrutiny. And while the tax risks can be easily addressed, the interpersonal issues which arise among parents, children, siblings and in-laws may prove insurmountable.
Traditional succession planning requires parents to make uncomfortable choices such as designating specific successors and deciding their responsibilities. This is where the plan hits the ultimate bottleneck, because the parents are reluctant to address these critical issues. It is not unusual for the parents themselves to disagree on these matters, and the decisions can create family acrimony that lasts for years.
A much more effective plan is to reverse the system, called “bottom-up planning,” which places the responsibility for the decisions with the successors. Often with the help of a facilitator, family members determine among themselves their titles, a compensation system, percentage of ownership, who will have authority over daily operations, what decisions should require consensus and a plan for resolving discord.
It is not unusual for the successors to devise strategies compensating family members not employed in the business in order to achieve fairness in the context of overall family planning. Their willingness to be fair is often a revelation to the senior generation.
The dissolution of a family business can be frustrating and exhausting without a plan. Whether the decision is made to sell the business outright, transfer it carefully to faithful employees or enlist the involvement of the next generation, a plan is vitally important.
As Neil Sedaka wrote, “Think of all that we’ve been through …. breaking up is hard to do!”
JAMES S. AUSSEM is a partner in Brouse McDowell’s Cleveland office. Reach him at (216) 830-6830 or [email protected].
