A Second Difficult Succession Problem

Yesterday, I talked about a reasonably common succession problem.  It is challenging but does not tend to fracture families.  Today’s problem might.

Two of four children run the business.  Mom and Dad have retired.  Mom and Dad want to transfer the business to the operators to gain some asset flexibility and to allow the children to benefit from the growth that they drive.

How much is the business worth?  Easy, right?  Call in a business evaluator and move on.

Not so fast there.

Let’s argue that the business evaluator is of the opinion that it is worth $10,000,000 as a going concern.

That opinion assumes management is available.  Businesses with no management sell for a fraction, often a small fraction, of value.  In this case, the children are the management and if they pay $10 million, they will be buying themselves in the process.

Now, how much should they pay?  The $10 million or the $5 or $6 million the business might fetch with no  management.

The family crisis occurs when it comes time to deal with the other two children, or more commonly, with their spouses.

To deal with this, there must be a discussion about value and how it comes to be.  That value discussion is quickly followed by a good asset, bad asset discussion.

A good asset is one with no limitations or latent diminishment of value.  A business is a bad asset in some ways.  It is not very flexible.  It is fairly risky.  There are no obvious buyers, so liquidity is an issue.  There are more economic factors than can affect it adversely.  On the plus side it may earn a higher cash on cash rate of return.  These variables lead to problems with family businesses because in addition, there are emotional attachments.

Good asset, bad asset discussions will lead to understanding.

  1. Value is just a number and it is circumstantially flexible.
  2. Owning and being responsible for a business reduces lifestyle choices.
  3. Equitable estate distributions need not necessarily be equal estate distributions.

Ask, “Which would you rather have?”

  1. Equity in a business with the founder’s name on  the door.
  2. Cash in the amount of 60% of that equity value and the ability to do with it whatever you want.

Be prepared to work through that question with your successors and pay attention to the discussion.  It will lead you to an answer that preserves family harmony.

Solid estate and succession planning is about addressing the meaning of the transaction, communicating openly, and making decisions to implement a solution that everyone helps evolve.

Contact: don@moneyfyi.com  

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

2 Comments on “A Second Difficult Succession Problem

  1. Do you want real solution or just for the heck of argument? More questions are to be asked and answered; like .. Date the business began, type of business organization, incorporated, partnership, type of assets owned and many more. The other important issue is taxation on capital gain if ownership is now transferred to children. Mom and dad should be advised on the tax amount that will arise on the transfer. They should be advised on the most efficient way to save tax dollars and make everybody happy. Eduardo S. Tenorlas, CLU, President of Precision Insurance Services Inc.

    • All true, but details. All would be important if the transition can happen. The scene needs to be set strategically well in advance.

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