‘Family-Run’ Businesses Very Common
Small businesses that are ‘family-run’ are are quite common. Recent statistics show that 77% of new small businesses are operated with the significant involvement of a family unit, and 32% of ‘family-run’ business owners are apprehensive or worried about possible conflict upon the transfer of the business to the next generation. Unless the business is being ‘given’ to the next generation (which possibly subjects the recipient to the federal gift tax) or sold to a non-family member, the sale of the business to a family member will be necessary. Let’s explore why preparing for this possibility is critical, and how to best go about the selling process for all parties.
Formulate Exit Strategy for Sellers
The very first issue in regards to the sale of a business to a family member that must be address is determining why the seller wants to sell and therefore to what extent the seller wishes to remain involved in the business after the sale. When selling to a family member (invariably a part of the younger generation), the seller is usually retiring but often wishes to remain working in a part time role for an indefinite period of time. Sometimes the seller may be experiencing health problems or simply is worn out from operating the business and therefore wants a more immediate exit plan. The seller must clearly communicate his reason for selling and his post-selling plans to the buyer.
Formulate Transition Plan After the Sale
The most difficult part of the sale of a business to a family member may not be the purchase price. In fact, sellers are often more concerned that the next generation of buyers will be prepared and able to handle the day to day operations of the business. Conversely, the buyers of a ‘family-run’ business may also be more concerned with being able to run the business (and attain the same level of profitably as the sellers) professionally and shoulder ownership responsibilities. In order to address these and other very valid concerns by both parties with respect to the post-sale transition, both parties should formulate a written transition plan and make it a part of the purchase agreement or letter of intent.
Example of Issues to Address In Transition Plan
- Let us assume that Frank and his wife Barbara own and operate a kitchen and bathroom showroom from which the company sells and installs a variety of kitchen, cabinet, and bathroom fixtures.
- Frank handles some of the sales and estimating while Barbara deals with the vendors and handles the bookkeeping.
- Their two sons – Bill and Bob – work in the showroom and perform a variety of tasks.
- The family is now discussing the possible sale of the business to Bill and Bob.
- In order for Bill and Bob (the buyers) to attain the same level of profitability as Frank and Barbara (the sellers), they must know how to replace the labor of Frank and Barbara.
- Therefore, Frank and Barbara must clearly tell the buyers whether and to what extent they wish to remain involved in the business after the sale.
- Frequently, sellers such as Frank and Barbara may wish to keep working (in this case for their sons) for many years after the sale but without the burden of responsibility from being owners of the business.
- Or they may wish to sail around the world the day after the closing.
- In any event, Bill and Bob must still determine how many customers will be potentially lost without Frank’s special sales or estimating skills.
- They must also determine if any special relationships with vendors may be jeopardized if (or when) Barbara is no longer working for the business.
- Frank and Barbara must in turn determine whether the business can or will be successful with Bill and Bob running things.
- This will be particularly important if the buyers ask the sellers to seller-finance a significant portion of the purchase price.
- An honest discussion must inform both parties of what to expect moving forward so the transition plan is properly formulated.
Determining Purchase Price of Business Sales to Family Members
The simplest way for buyers and sellers within a ‘family-run’ business to determine a fair purchase price is to receive a business appraisal from a professional business broker or a Certified Public Accountant (CPA). A formal business appraisal (unlike a free ‘business valuation” performed by a business broker in the anticipation of pricing a business to list it for sale) determines the fair market value of a business for a set fee. The more complex and large the business, the higher fee the business appraisal will typically charge.
Best to Receive Business Appraisal
Of course, if the family members choose not to use a business appraisal, they are free to do so. In such cases, however, the parties to the deal should be advised that they may later regret this critical step. Without an unbiased third party establishing a base value for the business (with supporting evidence and explanations), then either the buyer or the seller may subsequently feel they did not receive full value for the business or overpaid for the business. This may lead to subsequent familial problems or even legal disputes.
Business Sales Should be “Arms-Length” Transactions
While selling a business to a family member does have major advantages (saving time and transaction costs), it may result in a lower or higher purchase price compared to its fair market value. This is for the obvious reason that buyers and sellers within the same family will not be dealing in an arms-length transaction. In order to be an arms-length transaction, the two parties to a business sale must be unrelated and acting in their own self-interests. Not only are family members related, but they may also be partially acting for the benefit of other family members rather than themselves. Such a transaction frequently results in a purchase price that is less or more than the fair market value of the business.
Selling your business to a family member may indeed be the right decision so long as there is a clearly agreed upon transition plan along with a fair business appraisal that determines the fair market value of the business.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.