Previous … Choose Your Family Successor(s) Wisely
2. Know the Financial Risks – To Your Retirement, To Your Family Successor
All business transitions are not created equal. Let’s quickly compare 3 scenarios from a risk perspective.
#1: Cash sale to a 3rd party buyer with no conditions. Obviously the lowest risk option, where sale proceeds are essentially liquid and can be redirected or reinvested. Value of the business is determined by the market.
#2: Sale to a qualified 3rd party buyer, but be required to carry residual involvement (financial, operational, performance, liabilities, etc). This is likely your next best option, and the most common. A much more typical scenario and assuming everything goes as planned – the payments get made, performance targets are achieved, liabilities get signed off, etc., you are clean. The distinction is, if a problem develops along the way (say payments), you are more likely to exercise your leverage and negotiations with a 3rd party (ie. to protect your retirement funds) than you would if selling/passing down to a family member, and would likely remain separate from the business. Value of the business remains determined by the market.
#3: Pass Down/Sell to a Family Successor. Some would consider this your highest-risk option. The transaction will be based on a calculated theoretical valuation, not true market value (which may be an issue for some family members). Deal structure will likely allow for specific family dynamics or circumstances. There is a stronger likelihood that Chris and the business will not have the necessary funds to support an outright purchase, therefore a greater likelihood and size of a loan or vendor take-back mortgage is at play, with higher associated risk. The payment schedule will depend upon Chris and the business’ continued success. If problems develop with Chris or the business, you will likely find it more difficult to negotiate within the family, there will be a greater likelihood of being drawn back into the business (to help out Chris), and you may find your retirement fund and estate at risk along with Junior’s livelihood. This can literally put the family into disarray.
The above scenarios are of course simplified. However, some owners overlook both the financial risk and risk to the family of the various options. Despite the pride, best of intentions, and sentimental enjoyment of passing down the business to family, you could inadvertently be increasing the risks to all concerned without careful consideration. Given only a 30% survival rate of 2nd generation businesses, individual circumstances have to be examined very closely.
Possible initiatives to mitigate your risk…
- Scrutinize your sell versus pass-down options carefully given your particular circumstances and needs; be realistic and objective about the risks and how they can be managed or reduced.
- Keep communication open and engage those family members directly affected. It’s a shared risk.
- Read other sections of this article and develop an objective and disciplined success path for your family and your business.
- Stop telling yourself that the 70% failure rate won’t apply to you, your business, or to Chris.
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