When Succession Is Not an Option

Succession is an important issue for family business owners. Many assume that a family member or members will follow them as head of the business. Sometimes, however, succession within the family is not possible, and selling the business to an outsider is the most feasible solution.

The Importance of Family Harmony
In some situations, business owners must weigh family harmony against the succession of one family member to the business. Perhaps the family cannot agree on which family member or members should operate the business, or how it should be divided. If family members get along now, they must ask if they will get along as business partners. If two out of three brothers go into the business, will they allow the third brother to change his mind five years down the road? In many cases, family harmony may be more important than keeping the business.

Intangibles Assets
Another situation where selling the business may be better is where family members will not be able to capitalize on the intangible assets that make the business successful. Often, a family business's largest asset is not recorded in the company's books and records or quantified on the company's financial statements. It is that intangible value referred to as "goodwill."

Types of goodwill vary from business to business. Goodwill may be close personal relationships with customers or a keen knowledge of the marketplace in purchasing raw materials for the business. In some cases, it's a patent or the technical engineering reputation in designing a product to meet customers' needs.

Some businesses have leaders who motivate the troops, and some have operators who efficiently run the production floor. Years of quality work, meeting deadlines, superb customer service, knowing suppliers, creativity in the eye of a storm and innovation to adapt to market changes are all part of goodwill.

Goodwill is an integral part of a business's success. Every family business owner must determine what characteristics create the business's goodwill and then evaluate whether these intangible assets can be continued by other family members. When an owner cannot transfer the knowledge or experience that embodies goodwill, it may be better to maximize the value of the business by selling it, including its reputation for outstanding goodwill, to an outsider.

Selling the Business
Family business owners may be experienced in running and managing a business, but most will be selling it for the first time. This may be a time of great stress for owners trying to sell businesses that have been passed down to them, but it is crucial that the sale be handled correctly. If is isn't, owners could lose at any given phase of the sale — valuation, negotiation or the closing.

ESOPs
An employee stock ownership plan (ESOP) may be the first option to consider, especially if the management team has the ability to operate the business successfully. ESOPs are an effective way to transfer ownership in this situation, since employees are already familiar with the business operations and standards for continuing the high level of goodwill. The government also offers considerable tax benefits to owners who sell their businesses to ESOPs, and there are additional benefits as well.

Here's a partial summary of benefits:
• If the ESOP owns 30% or more of outstanding company stock, the seller may roll over the proceeds into qualified replacement securities — stocks or bonds of U.S.-based operating companies, either publicly traded or closely held — without paying capital gains tax until the replacement securities are sold. If the seller dies while holding the replacement securities, his or her heirs get a step-up in basis and capital gains are avoided entirely.
• The ESOP is the only employee benefit plan legally permitted to borrow money to make investments — either to purchase existing company stock from a shareholder or to purchase newly issued stock. If the ESOP purchases newly added company stock, the proceeds may be used for any corporate purpose.
• Both interest and principal payments on ESOP debt are tax deductible company expenses.
• Dividends paid on ESOP shares are tax deductible.

To top it off, surveys have shown that on average, ESOP companies financially outperform their non-ESOP counterparts. Given all these advantages — an attractive employee benefit, a powerful estate planning tool and a source of tax-advantaged borrowing for the company, an ESOP is worth looking into for your company.

Finding Likely Buyers
Companies related to your business either horizontally (companies in the same industry) or vertically (suppliers and customers) make likely candidates for buying your business because of their familiarity with the industry, your business and your competitors. They will also be aware of the goodwill aspects to be valued in your business, which could make the transaction easier than with those who are not as familiar with it.

In looking for a buyer, you'll need to talk to an investment banker, broker or family business advisor. Any of these advisors should have a broad range of contacts and experience with strategic transactions. Investment bankers typically charge more because they spend time researching demographics, industry trends and the company's historical financial data. Because they typically charge more for their services, they tend to work with larger family businesses ($50 million or more).

Your best bet is to talk to a family business consultant or a trusted advisor regarding the sale of your business. Either one can act as your negotiator and should have networking contacts in the industry. Don't underestimate word of mouth for turning up potential buyers.

Before You Sell
The family should plan an approach for the sale of the business and discuss it with the board of directors.
You will probably want to build the value of your business before putting it on the market. You can several factors that will affect your business's value:
• Develop a well-trained and stable work force add greatly to the value of the company.
• Build a creative and established management team to assure consistency in work product and quality.
• Stabilize your revenues and profits so potential investors will be able to project their success if they purchase your company.
• Maintain your facilities and equipment so potential buyers won't feel justified in lowering the price based on outdated equipment and failures.
• Make sure your computer information system is up-to-date and useful for managing your financial records and pertinent company information.
• Have your business plan at hand to show potential buyers that you are goal oriented so that they won't think you are selling a floundering business.

Reaping the Benefits by Planning Ahead
Deciding to sell the business and finding a buyer is an emotional and time-consuming process. Maintaining family harmony and maximizing the proceeds often make it necessary to seek a successor outside the family. Attorneys and accountants should also be consulted before implementing the plan. With proper planning and the use of advisors, everyone can reap the rewards.