This is the second in a two-part series: Where Do You Want the Ownership of Your Company to be in 3, 5, or 10 Years? In this first post, we introduced the Ownership Transfer Matrix. In the this concluding post, we dive deeper into the ownership question.
Where Do You Want Ownership to Be in the Coming Years?
While there are many ways that ownership will transfer, many business owners will plan to pass ownership to their children. In the alternative, they may desire to sell to their employees over time. And some owners plan to sell their businesses — at some indeterminate time — to a third party buyer.
Pass Ownership to Children
Do you want your children to acquire the business? You can transfer ownership to the next generation in four ways:
- Planned gifting over time. You can, through annual gifting, transfer shares to your children. If the business is of some size and value, it will be difficult to transfer sufficient stock to enable them to acquire significant ownership positions. Other, more sophisticated planning techniques may be necessary.
- Taxable transfers of ownership. Substantial ownership can be transferred to the next generation through sophisticated planning vehicles like GRITs and GRATs and other initials that your tax attorney can talk to you about.
- Outright sale of ownership to the next generation. Some owners will need the proceeds of the sale of their business in order to retire. The children could acquire the company in a leveraged transaction or in a series of transactions over time. This could be accomplished with external financing in some situations, or it may require parental financing.
- Through the operation of your will. If you own all or a significant portion of your business at the time of death, ownership will pass in accordance with the terms of your will and subject to potential estate taxes, depending on the value of your stock at death.
Ownership could pass to the next generation through a combination of the above methods, as well. Tom Deans, author of Every Family’s Business, suggests that if your kids are not willing to buy the business from you, then it may be best for you to sell the business to a third party. You can then pass any accumulated wealth to your kids. His thesis is that if they are not willing to buy the business and pay a market price, then they are not committed to perpetuating the business.
In any event, where do you want the ownership of your business to be with your children in three, five or ten years? It won’t get there by chance. It won’t get there absent a conscious plan to transfer ownership. And while you are at it, be sure that the kid(s) is(are) committed to running the business. You don’t want a second or third generation flameout that would be devastating to the kids, your employees, and even you if you finance their purchase of the business.
Pass Ownership to Employees
Successful transitioning of ownership can be critical to the perpetuation of your business. If your plan is to transition ownership to key employees who can perpetuate the business beyond your time, it is a good idea to start at least a decade in advance of any plan you have for transitioning out of the business. There are a number of ways
Significant ownership can be transferred to employees in several ways, all of which take time.
- Sell stock to an ESOP. Employee Stock Ownership Plans can be used to acquire a portion of the equity of a business or, over time, all of it. I’m not generally in favor of 100% ESOPs at the outset because of the risks associated with highly leveraged transactions. If an owner sells stock to an ESOP, the ESOP can, through contributions and distributions, repay the debt acquired for the purchase. Once the ESOP has an established equity position, additional shares can be acquired. ESOPs are not for every company, but they are ideal for some companies to effect partial or total ownership transition.
- Sell stock to employees. In many firms, the logical market for one generation of owners is to sell stock to the next generation over time in an organized manner. This form of ownership transitioning is common among professional service firms of many stripes.
- Sell stock to employees with an equity partner. With proper planning, a company can be sold in a management buy-out transaction (MBO) where management is assisted by an equity partner, usually a private equity firm. The management team is usually able to acquire a noticeable share of ownership in transactions of this nature, particularly if the team is perceived as capable of continuing to grow the business.
These methods are not mutually exclusive, and ownership can be transferred through a combination of transactions over a period of time. Where do you want the ownership of your company to be in three, five or ten years?
As with transferring ownership to children, transferring ownership to employees will not occur by chance. That’s why I say it is necessary to start working on ownership transition a decade or so prior to the need. It will take time, and an owners options are significantly limited if he or she waits to the last minute.
Although interview performance and curriculum vitae are no doubt important factors as well, employing a new member of staff exposes your business, your team and your data to a lot of unknown quantities and risks. A background check by a private investigator should be standard procedure when hiring for sensitive parts of your business or for senior roles.
Sell to a Third Party
You may want to continue to run your company and eventually sell it to a third party, perhaps a financial buyer, or maybe even a strategic buyer. You may think that this plan for the ultimate sale of your business is satisfactory and that you don’t have to think strategically like when you pass ownership to your children or to your employees. If you think that, you would be wrong.In my experience, the owners of most companies do not sell their businesses as the result of a long-term plan. Most business sale transactions are initiated by outsiders or by circumstances.
I’ve written about the idea of having your company READY for Sale. Getting a company ready for sale and keeping it in that condition are things that do not happen by chance. If you work to maintain your company in a constant position of readiness, it will tend to be more profitable and more fun to work in. But keeping your business in a position of readiness requires strategic thinking and action for the same decade or more I suggest is needed to transition ownership to employees or children.
If you do maintain your business in a position of readiness for sale, good things can happen. If a serendipitous offer that is irresistible comes along, you will be ready. If you decide that you would like to sell sooner, you will be ready. If you change your mind and decide to sell to your employees, the business will be attractive and you will have more options. So I conclude this section with the same question for those who plan to sell ultimately to a third party. Where do you want the ownership of your business to be in three, five or ten years?
Whether you want to transfer your business ownership to your children, to your employees, or to eventually sell it to a third party, now is the time to begin addressing the title question: Where do you want the ownership of your business to be in three, five or ten years?
This is an important question whether you are the sole owner of your company, or whether you share ownership with others. Transition will occur, as we have see. Remember the Ownership Transfer Matrix. The question is, will it transfer on a timetable and to whom you desire and believe is in the best interest of your company, your employees and your family(ies).
If you’ve read this far, I hope the force of repetition has placed a single question in your mind for ongoing reflection and strategic personal planning.
Where do you want the ownership of your business to be in three, five or ten years?
Food for Thought
Several chapters in my book, Unlocking Private Company Wealth, address issues related to ownership transition. Chapter 19 discusses the concept of READY for sale. The book is available stand-alone for $25. Try the Ownership Transition Bundle, which includes my book, Buy-Sell Agreements for Closely Held and Family Business Owners (a $25 value) for $35 (plus s/h). Get the Ownership Transition Bundle here.
Until next time,