HELPING FAMILY MEMBERS REACH AGREEMENT ON THE ‘KEEP OR SELL’ DECISION
Updated: Apr 28, 2021
The following rules can help family members reach agreement on the ‘keep or sell’ decision.
1. Don’t tiptoe around hard issues. Its better to have shouting matches than to let issues fester for fear of offending someone. Families often don’t realize the damage they are inflicting when they allow their business to provide under-performing family members a safety net, or when everyone pretends there isn’t a problem.
2. Review your governance policies, and be willing to change them to give inactive shareholders a voice. All shareholders should have the same goal – to increase shareholder value. Including unhappy family members in family governance provides a mechanism for putting difficult issues on the table.
3. Negotiate a buy-sell agreement with options to buy or sell shares during your lifetime. If your current agreement doesn’t provide lifetime options to buy or sell, say at age 70 and then again at 75, then consider amending it. No one wants a newly widowed spouse to negotiate with 30-something next-generation owners. A “put” or “call” option in a buy-sell agreement is not an automatic trigger; it simply means that if either side wants to buy or sell, the provisions are in place without further negotiation.
4. Use a realistic valuation methodology and regularly update it. Establish a price, based on a fair-market formula and keep it updated. This can help curb unreasonable expectations about the value of one’s shares, especially for inactive family shareholders who often hold non-marketable minority interests. Agreeing on one appraiser or one methodology in advance can save time and money and prevent later conflict.
5. Communicate operating results and explain how they affect share value. Valuations are typically based on three- to five-year rolling results, weighted so that the most recent period carries greater impact. Future, projected cash flows may be significantly different from the company’s results in recent history, so teach your shareholders about the potential effect of operating trends, interest rates or business decisions on the future value of their shares.
6. Benchmark the family business against industry peers. When reporting results to shareholders, compare your financial results (and financial ratios) with those of other companies in your industry. If your results are consistently below the norms, then some changes in management or strategy are needed.
7. Create a fair dividend or distribution policy. If dividends are meager (because they are income-tax inefficient), consider the tax inefficiencies against future litigation (or buyout) costs. You might develop a different perspective. Family capital should be fairly rewarded, through dividends or distributions. Patient family capital involves a lower cost than outside capital – but its not free, and it deserves a fair return on commitment.
8. Separate the family dividend from compensation – the urge to deduct may backfire later. Too often, the thinking is, if you’re going to pay family, you might as well take as large an income tax deduction as possible. This can create unrealistic expectations while ignoring personal performance. Compensation should be based on individual contribution and level of responsibility. Letting the income tax impact drive family compensation decisions causes problems down the line, since family members may come to believe that the business “owes” them an ongoing income.
9. Implement a “tag-along” agreement (or amend your buy-sell agreement). Sometimes elder family members hold on to family business shares in anticipation that the next generation might sell the business to a third party in the future for far more than the current valuation price. Current owners may be reluctant to sign a buy-sell agreement for fear it may not give them their best price. Under a tag-along agreement, if an internal family sale occurs and the business is later sold to a third party for more than the seller received in the family sale, then the seller participates financially on the third-party transaction. The term of the participation is usually five to ten years, and the percentage of participation declines over time.
10. Be willing to substitute owners (of necessary). If family members are adamant about diversifying or liquidating their ownership, consider one of the many corporate recapitalization techniques available through a mezzanine fund or equity investor as a temporary solution. You replace one owner group with another, but the new group should agree to do what is on the best interests of the company – and will want to get their money out within a prescribed time frame.
A cautious and respectful process may take a year or more but can result in favourable agreements and potential (or actual) transactions that both sides view as “fair.” For most business families, what’s “fair” is not highest price (for a seller) or lowest price (for a buyer); rather, it’s a price and terms that lead to a graceful exit. For some, keeping the business is best for the family. For others, selling the business opens up new opportunities and solves family problems.
Family Legacies www.family-legacies.com is a multidisciplinary family business consulting company. Our consultants are leaders in their respective fields including; Family Business Consulting, Strategic Planning, Financial Planning, Wealth & Risk Management, Corporate Finance, Business Transitions & Exit Planning - Buy, Improve, Grow & Sell Businesses, Commercial & Family Law, Executive Coaching, Leadership Development & Facilitation, providing our clients with a professional and integrated multi-disciplinary service.