Family Business Matters

Before embarking on the succession planning process in a family business, completing a personal financial plan first for the senior/founding generation or departing shareholder is critical. It is ideal if business owning families start planning early and often for the financial fitness of all of its member/shareholders.

However, the long-term survival of the family business ultimately rests on the founding generation, and subsequent generations, knowing that they will be financially comfortable after they "leave the building" and transition their ownership to another family member or key employee. If junior family members have no financial acumen, the senior generation is unlikely to ever pass the baton.

The founder will gracefully exit the family business if there is adequate cash flow for the founder. If this can be planned in a timely manner, he or she is more likely to exit and still allow the business to thrive and meet its financial obligations.

In my experience of working with family-owned businesses, the future financial security of the founder inevitably becomes a focal point and some times a giant stumbling block to "letting go." Founders will not be very favorably disposed to transiting the ownership of the business to a child until their personal cash flow and long-term financial well-being is fairly certain.

For example, if the younger son is offering to buy the founder's stock using an installment note, if this same son could not manage to keep his lunch money in the sixth grade, the parent could be concerned about the dependability of future cash flow.

If all of the personal balance sheets of San Diego's more mature business owners were displayed at Qualcomm Stadium, there would be similarities among most of them: a high concentration in illiquid real estate (normally leased by their business), their (debt-free in most cases) primary residence, and, overwhelmingly, their very valuable, but still very illiquid business interest(s). (There is not sufficient space to adequately forecast what the balance sheets of junior family members would look like. Suffice it to say that the "liabilities" column most likely would have many more entries, which is a primary reason for the younger generation to get debt under control and become more financially fit, too!)

Without a well-diversified personal balance sheet, founders can be held "financially hostage" by the business until their death if they have not developed additional income sources, other than the family business. In addition, without having assets outside of the family business, it is rare that a founder will ever leave the corporate payroll, much less the executive offices.

From a succession-planning standpoint, if a founder doesn't have well-diversified assets, there is little flexibility available for designing appropriate income tax and estate tax-efficient ownership transition plans.

Sound personal financial planning goes hand-in-hand with successful business succession planning. Knowing what the founders need for their long-term financial security is the starting point of this process. What will it take in today's dollars, inflated by at least 3 percent until age 90 or 95, to cover normal expenses for the founder and his/her spouse? What additional expenses will they need to personally underwrite once the business no longer provides benefits such as a car, medical insurance, entertainment expenses for business purposes, and other similar items?

Next, identify what sources of income are available to replace the founder's salary/distributions from the business.

Estimating a reasonable total return from an investment portfolio and future distributions from a qualified plan, if there is one, are good starting points. In addition, there may be rental income from the business/tenant in the founder-owned real estate. Can the senior generation receive consulting fees on an as-needed basis? Can a private annuity be arranged with other family members to transition the business to them? (In light of today's low interest rates, a private annuity arrangement is a strategy to examine now!)

What kind of compensation will be paid to the founder if he or she remains as chairman of the board? How can benefits such as health care be maintained for the founder's benefit when he or she leaves full-time employment of the company? Is the founder's balance sheet going to still be used to collateralize the present financial arrangements of the business? Can a fee be paid for this collateralization arrangement? Has the founder loaned the business any personal funds that can be repaid, with interest, as part of the initial cash flow planning?

These inquiries about personal spending and sources of income are just a few of the important questions to answer when completing a personal financial plan for the senior family members. Once the financial plan is completed, it will be the foundation on which to structure appropriate financial arrangements to affect the transition ownership of the business to the next generation.

By not being reliant indefinitely on the operating business for income and a continuing return on investment, family members have more life choices available to them. For the family firm, financial fitness is every bit as important as physical fitness. The time to start is now!