We Deserve the Best!
It has not been easy, the past year or more. I have struggled to support you and your staff and worried about what the pandemic has done to your ability to retire or step down. We have been through a lot together. Now I wonder what my owner will do with me as he begins to think of retiring.
The traditional solutions to enable a business owner to step down or retire is either a full sale or to put the stock in complex trusts with installment sales and formidable dos and don’ts to these arrangements. Either of these leaves the owner looking for a new job to provide support. With an average term of about 10 years and no oversight of the business, it sags in performance to such an extent as to be of little enticement to family who inherits it, as it becomes worth only a fraction of its former self.
A Capital Asset Is A Specialty Focus with Unique Requirements
Larger private businesses are less often sold and more likely to be involved in M&A event or to be held longer term by the family as the principal source of revenues for everything else. Still, every business and its family stakeholders are different in their wants and expectations.
Here are the options for the business:
1) A recapitalization of the business will be necessary
2) Full Sale — most expensive in terms of capital gains tax at rates of 15% to 20% of the total sale which has a basis (what the owner or founder invested in starting the business way back when) The difference between this basis and the agreed selling price is subject to capital gains tax. This tax nets from the amount of capital available to the family
3) a Partial Sale — cuts down on amount capital gains tax by doing less than a full sale
4) a Two-Step Monetization — minority stock buyback by firm for cash, business and owner now own 100% to stock
5) an Employee Stock Ownership Program — when there are employees who want/can afford to buy the business
6) Philanthropic or Charitable Interests — contributions of stock to charitable entities allow for sale of stock without incurring the taxes. Give but keep more.
These use firm advisers, analysts to work in conjunction with ‘Us. This also includes developing the skills and knowledge of others.
As part and parcel of the transition and post transition, this is the time to track revenues, profits AND Value and risks in the business. This also requires knowing the underlying metrics to monitor from the inside/out.
Pre-Transition
This is the period of determining the leadership traits and growth objectives of the business and assessing what the capital needs will be.
Will the new leadership be another CEO, or would a management team work best? In this phase we function as an interim CFO team and it would be the ideal time to find the replacement leadership and work with ‘Us to strategically map out the business strategic plan, identify improvements and to execute. It is also the time to get the owner out so he can, if he wants to be involved, work with ‘Us on his business.
Post Transition
Seldom are family members on the same page as the owner unless they have been working in the business. The sooner this is identified, solutions will then shift to business, owner, AND family. These drive the option chosen.
Owner & Family wants, or expectations drives the options here -
· If owner and family are not on the same page about keeping the business, a 2- step process solves the “show me the money!” attitude of many family members and may produce the highest value as minority shares may be bought back by the company for cash and the remaining stock will be sold at pre-determined time* or perhaps when a wealth transfer plan contemplated.
· Charitable giving saves the most in taxes — as shares of stock are donated — Charitable remainder/lead trusts or direct gifts all work if giving is an interest; give and keep more.
· How many shares of leveraged stock will be necessary to cover owner’s cashflow needs*
· Holding a leveraged operating business is equivalent to your own private equity with a new management team. A target endgame needs to be decided at the outsight for when this arrangement will end with a buyout or liquidity event for the last phase of wealth transfers.
1. This phase of wealth transfers was my original- when I was a normal person- background. It seldom plays well without an educational process with business families about trusts and trustee roles and proper structuring of family office vs family trust company for trust work.
2. This will require investment professionals, wealth management and trust professional to work with ‘Us and as a by-product, educate and enhance their skills
Then let us build the framework with you which is the road map for execution of the plan for the business and family wants.
- Shares of stock can be replaced by a managed portfolio of direct private equity.
What We Have Done, to Illustrate
A 9-figure business owner aged 62 thought to step down in 2018 and assumed his 2 sons would inherit and take over his business. It came as a surprise and inconvenience to him that this was not what they wanted. The owner was now stuck and unsure what to do. Neither the traditional sale nor stock in trust appealed to him. So, his CFO reached out to Carl and me to help. An initial set of conversations was held to clarify the wants and expectation of owner AND individual family members. It became clear that his 2 sons and 1 daughter preferred to get cash to invest or do their own things. What appealed most to the owner, after he accepted this, was a 2-step monetization process.
This required a several- million-dollar recapitalization of the business to buy back the minority shares owned by his children. An investment arm was created to the business and the children were named as principals. With the buy back, 100% percent of the company stock was owned by the company and the owner. He now revealed his personal goals to double revenues and to increase the bottom-line value of the company by 2x to 3x in 4 to 5 years, as this was when he now expected to step down. This became the target for getting new management in place and to allow the original owner to step down.
His kids were happily investing their money. But in less than 36 months Carl’s efforts achieved the owner’s revenue objective and outperformed the portfolio by 3x. By year 4, bottom line value was almost 4x. The client cashflow at the start, was $1.3million. By year three, revenues were tripled, and profits were reinvested. His cash flow rose to $1.6million.
2 years later we sat down with the owner to discuss his framework and any tweaks he wanted to make. We talked about an endgame for holding the business stock in favor of a merger or sale while its market and industry was still in a growth mode and relevant to the economy, and he agreed. We had set aside business stock to fund his lifestyle but as we moved forward a custom portfolio of private equity would replace that and Carl could monitor and tweak the holdings.
We recommend an off-site meeting for the family and investment and fiduciary advisors were also welcome to help the family understand the transition to wealth management, both investment and trust services as a normal part of the process. Trusts are unfamiliar and complex to the uninitiated. The role of a trustee, full versus directed, and the normal dos and don’ts on the part of the former owner is critical. Higher levels of trusts and installment sales come in play, for bigger businesses. I explain with diagrams and we will be available to help them with execution. The importance was to help them to embrace this as their next business, the business of family driven wealth management. It was equally important at this junction for them to gain trust in the expanded team moving forward.
Would you like to talk to ‘Us about what we can do for your business clients or your business?
We are easy to contact. Just pick and day and time and we will be available.
