Sometimes, the next leader of your company come from right inside your family. Perhaps your sibling has been working with you for years and is ready to take on the company. Maybe it’s a child.
Chances are, you are more likely to give or sell your business at a discount to your children than to discount it for a brother. Let’s assume your children have been a part of your company for as long as they remember and want to take on the company to let you retire. How would you structure something like this?
Determine the exit price you are willing to accept to transfer the business to your children. The first step is to determine how much you want and/or need to take from the business. Of course, you can give the business to your children outright, but remember the saying, “People value what they pay for.” If the new owner has nothing invested in the business, he or she has nothing to lose if things go awry.
I can share with you a story that will outline some things for you to consider and steps you can take to accomplish this goal.
Challenges And Opportunities
Stephen and Tammy are brother and sister. They have worked at “Dad’s IT Firm” for the past 20 years. Stephen handled sales, Tammy was in charge of service. Both have college degrees, but neither has ever worked outside of “Dad’s IT Firm” or done anything in business other than what they do in their current roles. Dad has made a fine living with his company and the two children never wanted for anything. Dad was a former business major and has a solid handle on finances and business management, two areas in which neither of his children ever showed any interest.
Dad just turned 70. He is ready to retire, and both Stephen and Tammy expressed interest in taking over the company. Dad likes this idea as they are both valuable and loyal employees and he would love nothing more than to see the business he built continue on without him. He’s concerned, however, the business part of running a business will get neglected without him there to manage it.
Dad begins to build his plan for a two-year transition of the company to his children. Neither child has the money to buy the company nor the business experience to successfully run it. Dad already knows you do not have to be an expert in IT to run an IT company, you simply need to be a good business person.
The Long-Term Plan
Dad sat Stephen and Tammy down for a long talk about the transition, explaining they needed to learn the business side of the business in addition to what they already know about the operational side and the best way to accomplish that is to appoint them to the Board of Directors. They had monthly meetings with department heads, discussed profits, the current market, and made business decisions together. He gifted them each $10,000 of stock in the company, careful not to exceed the $15,000 annual gift exclusion.
Stephen and Tammy were engaged but didn’t fully embrace the needed understanding of the business. Dad hired a business executive, Carl, and made him President of the company. Dad maintained the position of Chairman of the Board and still held the majority of the stock and voting rights.
The company owed Dad some money in shareholder loans that accumulated over the years. He was sure to be paid in full for those. The company provides quarterly bonuses to all employees based on profits. For the next two years, bonuses were paid to Stephen and Tammy, but the money went to Dad to buy his stock. This helped to condition Stephen and Tammy to learn to live without the quarterly bonuses as well as investing in their future through the company.
At the end of the two-year period, Dad received most of the money he wanted from his business. He sold the remainder of his stock back to the company’s treasury and had the company pay the balance previously agreed upon.
Dad continues to visit the company every month to close the books and ensure the business is financially stable and healthy. He maintains his position on the Board of Directors, but now plays a smaller part each quarter. Carl continues to oversee all operations of the business and help Stephen and Tammy manage the company. Stephen and Tammy are now enjoying the profits of the company because of the smart planning on dad’s part.
If selling to your children is something you’re seriously considering be realistic in their abilities. Set them up to succeed and take whatever steps necessary to ensure their success. Hiring a business executive is not cheap, but it paid off in this case. The executive took over dad’s salary, so it was not a major hardship, but it takes planning, patience, and a close eye on your company to make this strategy work.
Stephen and Tammy did not embrace their “new boss” right away, but through meetings and working together, they learned Carl knew much more about running a business than they did. In the end, they were happy to leave the hard stuff to him.
Dad was able to stretch the capital gains on the stock sales over three years. The first two years selling stock to the children, and the final transition in the third year. This made income taxes easier over time.
Make a list of what you want to get from the business. Make a separate list of what the business will need without you there. Develop your plan and timeline. Give yourself plenty of time to get it right.