Family Business Matters

In light of the present worldwide financial crisis, many family business seniors are undoubtedly putting off their succession planning, using the current uncertainty as their major excuse. However, unless the founder is planning on holding onto the business forever, now is precisely the time to start serious financial planning to determine how a founder can become financially independent, without relying on the family business for his or her entire life.

(I also suspect that some members of the second and third generations think that this is their time to structure a buyout of the founder's interests, due to lower valuations of the family business and/or family-owned commercial real estate and due to the extremely low interest rate environment. Note to family business founders: be prepared for the next generation to approach you about this kind of ownership succession strategy!)

However, before any family business founder feels comfortable even talking about management and ownership succession strategies, more than ever the family business owner needs to be on sound personal financial footing. This may be a difficult goal to achieve during these recessionary times. However, there is no time like the present to take stock of the family business founder's personal balance sheet and personal cash flow to begin planning for his/her longer-term withdrawal from the family business.

First, let us look at the founder's personal balance sheet. In addition to the family business owner's personal residence, normally, the assets with the most zeroes are the commercial rental income property and his/her business interest. Although these two assets may produce income to the household, they are illiquid, are heavily dependent on the family business' continued success and will be considered part of the entrepreneur's estate at his/her death, unless additional planning is done. This means looking at ways to diversify the family business founder's personal balance sheet.

There may be illiquid, "dead assets" on his/her balance sheet which can be converted into income-producing assets. An example of this would be vacant land bought more than a year ago, which may have appreciated in value, yet provides no cash flow. With federal capital gains rates still at 15 percent for assets held longer than a year, it might make better financial sense to sell the land, pay the taxes, and invest the net proceeds for increased personal cash flow, before tax rates increase in the future. As interest rates are low now, re-financing mortgages and business loans is an appropriate strategy to use as well. This will lighten the load on the founder's household and his/her business!

Another balance sheet item to review is the family business founder's personal investment portfolio -- if she/he has diversified away from the family business. Is the risk tolerance still appropriate? Can any losses be harvested now to offset capital gains in the future, if the owner decides to sell the business at some point? Is the allocation still appropriate for someone who will "retire" in the next three to five years?

Next, the family business owner needs to determine what cash flow is needed to support the household, pay income taxes, and provide some leeway for "fun." What demands are there on the dollars coming into the household? What is the amount needed to cover any remaining (newly refinanced) mortgage(s) or debt the household has? Does a child still need college funds? Is an elderly parent going to rely on the founder for added income? Can the family budget be reduced, without compromising the founder's lifestyle? What expenses can be eliminated completely?

Knowing what the newly revised annual budget is, and the impact that inflation will have on this amount is critical, as this will guide the method and terms of the eventual succession planning for the family business founder.

Once the cash flow needs are revamped, the family business owner should inventory all reasonable and dependable sources of income, exclusive of salary, bonuses, and benefits provided by his/her business. The idea is to discover what income OUTSIDE of the business is available to supplement spending needs, once the founder no longer receives income from the family business. Some of these other income sources might be: dividends, investment interest, net rental income, retirement portfolios, annuities, director's fees, royalty fees, licensing fees, installment notes, and distribution of previously taxed income of an "S" corporation.

After the family business founder/senior carefully studies his/her balance sheet, expense schedule and income sources, he/she can decide whether there are competent family or nonfamily employees who can operate the business profitably enough. Can this be done without the owner's daily presence or leadership? If so, perhaps holding onto the business and deriving continuing income from it is a strategy to consider, if selling the business is not something the founder embraces.

Management transition is the second part in the succession planning process. Are the family executives or nonfamily team members capable of keeping the business running? Can they expand it further? Will it be more profitable in the future? Is additional training and motivation required to make this happen? Does the founder trust the key family employees to run the business effectively? Is the family business founder willing to base his/her retirement income cash flow on the expertise of the child who is to take over as President of the family business? (Especially if this child was the one who continually lost his/her lunch money?)

Recessionary periods provide an excellent testing/proving ground to see if members of the "next gen" can contribute meaningful to the family business and hold it "steady" during trying times such as these.

If the family business founder decides to rely on current family executives to run the business during his/her retirement, rather than immediately departing from the business, the owner can structure a gradual, planned withdrawal from the business. If the founder is planning to simply "retire," but retain the business, with enough lead-time, it may also be possible to design supplemental retirement income plans prior to his/her actual retirement from the business.

After determining what is necessary for the founder's long-term financial independence, if it becomes clear that the business must be sold, merged, closed down, or restructured, ownership transition strategies can better be evaluated in light of the founder's overall financial fitness needs.

Before deciding which management or ownership succession strategy will work best, knowing his/her total financial picture is the first step for any entrepreneur. This may sound counterintuitive, as the current economy forces all business owners to closely watch expenses and make appropriate tactical changes to ensure that their businesses have a future. However, particularly for the family business founder, doing some thorough personal financial planning now will pay huge dividends in the future, as recessions do end and markets do rebound at some point!