We’re coming into the season of giving. Everyone is doing their shopping, and
Santa’s elves are getting close to game time. For me, it brings to mind one of the biggest monetary gifts a business owner might ever make: a gift of their business.
When business owners decide to transition their business to their children, or key management, we often see part of that sale structured as a gift or discount. A business that would likely sell for $10 million in the open market, for example, may exchange hands for a $7 million buyout. The owners forgo the extra cash for the satisfaction of helping a new generation of leaders toward prosperity.
For business owners, this gift is a way to help
the people they love and reward the employees who contributed to their success. Plus, it’s a way to maintain their legacy, assuring the business will
stay in the community with its culture relatively
intact. But selling to family, even at a sizable
discount, is not without potential pitfalls. Here are some things to watch out for to make sure your gift doesn’t become a white elephant:
Make sure it’s on their wish list. Have a transparent conversation with your kids over whether they even want the business. Make sure they understand the pressures of ownership, including the financial obligations they’ll need to make. Be sure your kids, and their spouses, believe the rewards outweigh the risks.
Imagine the business falters. Perhaps new competition came in or a key customer got bought out. The new owners would have no control over factors like this, but it could be enough to cripple the business. Picture your kids scraping by to make the monthly payments while you enjoy a life of leisure in Florida.
It’s easy to imagine the resentment that could arise as the kids start to wonder if mom and dad made them pay too much. On the flip side, the parents will have their own difficulties if those monthly checks stop coming.
Then again, what if the business suddenly takes off and the new generation is able to live a lavish lifestyle that far exceeds what their parents ever did. Mom and dad might feel like they gave their kids too big a gift, particularly if they’re left out of this new success.
An impartial, third-party valuation helps negate a lot of that second-guessing. Before you negotiate a sale price, work with professional who has a true understanding of what’s transacting in your space, and what companies of your size, in your industry, have actually sold for.
Gift or burden? Even at a discounted price, selling the business to the kids sets them up with a significant financial obligation. Beyond the payments they’ll owe to mom and dad for the next seven to 10 years, they’ll likely need a loan to cover some amount of cash at close.
Securing those loans may require personal guarantees or second mortgages, big risks for anyone to take. Here again, it’s important your children’s spouses are supportive and equally willing to take on the risks of ownership.
One way we’re seeing people navigate the tricky business of selling to family is to involve a private equity firm as a majority or minority partner. In most cases, if private equity is involved, the next-generation owners won’t be asked to provide any personal guarantees.
The kids still get to enjoy the benefits of ownership and running the business on a day-to-day level, but with a much smaller risk. At the same time, the parents may get 80 to 90 percent of their money at close and lessen their risk as well.
What’s more, your children will benefit from everything private equity brings to the table, including fresh resources, strategic insight, and new business connections. A private equity partner can alleviate many pressures while simultaneously setting the business on a growth trajectory.
When gifting your business, it’s not just the thought that counts. Careful planning, honest conversations, and expert advice all help ensure your gift will be truly appreciated for years to come.
Scott Bushkie is principal of Cornerstone Business Services.