Over the past few years, I have experienced an acceleration of family businesses giving serious contemplation to their plans surrounding transition. In cases where a transition to the next generation makes sense, proper planning can provide options and efficiency for the transfer of ownership.
You can start planning by first establishing a framework. There are some relatively small steps you can take now that will provide you with greater flexibility down the road. Below are some tips on three common planning tools to consider.
- First, if your business consists of just one class of stock or units, consider recapitalizing the ownership structure into voting and non-voting categories. Doing this does not change the ownership percentages for the existing owners. What it does do is provide the current owners with a mechanism to retain control if that becomes an important factor as part of a transition. An owner can sell or gift the non-voting units or shares and hold on to a majority of the voting shares. This allows for equity ownership to transfer but still allows the senior generation to maintain control.
- Another consideration is performing a stock split. This is often done simultaneously with a recapitalization. When executing on a stock split, you are providing more shares to be available to transition and doing so allows for more precision because each share represents a smaller percentage of ownership. Take for example a company that has only 10 shares of stock. Each share represents 10 percent of the total value of the company, whereas, a 100:1 stock split will create 1,000 shares with each share representing only 0.1 percent of the total value. This allows for a smaller price per share and increased precision about how much value can be transitioned at one time.
- A third consideration when establishing the framework for a transition is to evaluate various types of alternate income streams to an exiting owner. These payment streams can often be structured as a deduction to the business, which provides some tax efficiency while at the same time satisfying the income needs of the owner looking to exit.
The transition planning process is also a natural time to take a fresh look and begin to update the governance of the family business. This includes updating the shareholder agreement, preparing a management emergency plan, and even starting an advisory board.
As you can imagine, some of these items take months, while others can take years to implement. Having a game plan and chipping away at it over time will provide the family with a variety of options and peace of mind.