I wrote an article two years ago about the alternatives a business owner has when it comes to selling their business. Selling business to family adds lots of additional issues to consider.
Terms of the Deal
Is this a cash deal? Most small business sales are not, so usually there is financing involved. Whether it is a bank or seller financing, this makes things more complicated. With a cash deal, you walk away, but when a bank finances the deal, there may be strings attached, and if you finance some of the sale, you still have a financial interest in the business. Banks, even the SBA guaranteed loans, will look at the experience of the buyer. Have they worked in the business for a long time, how old are they, do they have experience at any other business? If the bank is not comfortable with the buyer’s abilities, they may require the seller (you) to stay involved in the business for a period of time, or they could even ask the seller to guaranty the loan.
Owner’s Continued Involvement
Whether staying as a condition of a bank loan or because of owner financing, having the seller involved in the business past the sale makes things tricky. Creating a situation where the buyer is not clearly in charge creates a no-win scenario. If he/she is successful, then they receive none of the credit. Fail, and they’re at fault. Ideally, in either a bank loan or owner financing situations, the seller will act as an advisor only. They should meet with the owner off site as any investor would, and ask the questions an investor would ask about management performance. If the buyer wants advice, it should come in the form of experience share, not “this is what I think you should do”. Again, if the previous owner just tells the new owner what to do, the situation is no different than if he/she were at the business helping to run it. The buyer can’t “own” the success or failure of their choices.
Having the seller involved is extremely difficult in parent/child situations, especially if the child has not had meaningful work experience outside of the business. Employees, customers, and vendors have a hard time transitioning their interactions to the child, even in the best of cases. An assertive or protective parent can also have a very hard time letting their adult child do their own thing. The parent wants to keep them from failure, and in some cases actually limit their success from a misplaced sense of ego.
Taking the Business Back
What if the relative can’t hack it, and the business tanks? What mechanisms are in place for the seller to “repossesses” the business with the least amount of disruption and damage? This is a delicate balance when a seller is doing the right thing and staying out of the day to day management. Have an agreed scorecard that shows key performance indicators (KPIs) about the health of the business. Set acceptable lower levels that everyone understands, and communicate expectations of consequences. Ideally it should be just like any other investor/management relationship. Investors set expectations of management about what the performance of the company should be, and assuming that management agrees to it, they must be accountable to those expectations or risk being replaced. Management being your son or daughter shouldn’t change that relationship. Where people run into trouble is by bringing all of the garbage of their relationship outside of the business to the table. Sometimes it’s just not a workable arrangement. But if expectations or performance and consequences of failure are agreed to up front, then it should come as no surprise to fire them.
Depending on the timeframe and the condition of the business, maybe the two can agree to bring in a third party manager. That allows the next generation to retain eventual control of the business, and allow the seller to receive the financial value for the business that he or she needs for retirement. Keep the ultimate goals in mind, transitioning the seller out and maximizing the value of the business for the seller and for the subsequent generation.
The Taxman Cometh
I’ve always told clients to not let taxes be the tail that wags the dog. Do what makes business sense, and then determine the most tax advantaged way to do it. Selling a business is no different, but when involving family members and taxes, there is another layer of complexity. Let me give you an example. Say the parents have developed a substantial business that is worth $5mm to a third party buyer, but because of other financial assets, they only need $1mm from the sale of the business to fund their retirement goals. They want to help Junior out so they only charge him the $1mm they need, not what the business is worth. This very likely triggers income, gift, and estate tax issues.
In many cases, what is good for one party is not necessarily the best for the other. My best advice is to involve tax and legal help from the beginning. If you can use the same advisors that will certainly save on costs, although many professionals will not advise both sides. If everybody agrees upfront to hold the professional harmless for these conflicts, it usually speeds things up using the same advisors as well.
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