• 5 Alternatives To Traditional Retirement – US News & World Report June 7, 2010 http://money.usnews.com/money/retirement/articles/2010/06/07/5-alternatives-to-traditional-retirement.html
• Pew Trust – “Small Business Most Trusted! http://www.startupnation.com/blogs/index.php/2010/05/12/pew-study-small-business-most-trusted-institution/

Recent press mentions/quotes by John Reddish

• Six Ways For Small-Business Owners To Save Money
  http://online.wsj.com/article/BT-CO-20100630-705223.html (I’m quoted in this story; however an online subscription needed to read full article – the online only edition is $1.99 per week )
• There are SBA Loans to be Had – Courtesy of AOL Small Business – here are some tips (from me & others) on increasing your chances http://lnkd.in/a54xq9

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When the change is unexpected, and you haven’t prepared in advance you may not be able to protect your family business – and often your family – unless you can create an ad hoc solution – not always easy in times of stress.  It is much better to have in place, pre-arranged exit strategies that are acceptable to all involved.  The ideal time to create these exit strategies is when the business is started, or when everybody’s getting along and sees the wisdom in preparing for the future, not after a problem has arisen.

Here’s how to create exit strategies, and the underlying compensation plans that support them (plans that that take into account both equity and performance issues), as well as, some thoughts on how to more smoothly make a change when needed.

Prepare For the Future

The first thing the family must address when facing a change centers on performance differences – how much and how – family members get paid and how an individual’s pay may not relate to how much of the business s/he owns.  Many family businesses are run to take maximum advantage of the Tax Code, which can distort salaries, bonuses and benefits.  If someone leaves, and compensation has been distorted, it adds another complication.  It’s better to initiate a competitive (market or industry) compensation program before any potential challenges arise.  Salary termination, or a salary continuation program, based on a market salary can then be factored into a buyout.

In many family businesses the parents insist on dividing company ownership equally among the next generation.  When this happens, resentments can arise.  Those not working in the business are concerned with continuing to get the distributions and benefits they’ve become used to under mom’s and dad’s rule.  Their siblings working in the business are concerned with earning a good living, keeping money in the business and growing the business for their children, or for eventual sale.  What mom and dad paid those not working in the business is often seen as “allowance” money and as the business changes hands, continuing such payments can cause deep division within the family.  If the company gets financially stressed, things can become even ugly.

• Game Changers and Tools
  • What are considered friendly partings usually occur through retirement, sudden or accidental death, prolonged sickness and/or, permanent disability.  Insurance can fund many of these possibilities.  An agreed upon valuation and a payment plan, tied to the amount due, a reasonable interest rate and a timetable for the payout, round out the options;
  • Partings considered unfriendly usually occur through divorce (NB – unless protective steps are taken before a marriage, a family member’s ownership interest can be subject to marital distribution), some disabilities, financial failure, etc.  Insurance can cover some of these contingencies, but not all.  A payment plan and valuation are key in these circumstances, coupled with signed spousal consents (in which the spouse agrees to surrender all claims on business equity in exchange for a minimal sum, usually $10 or less), as appropriate;
  • When prepared in advance, these documents can cover all family members and all eventualities the business might face in the future.  They can also establish terms and conditions that will apply to bringing in new family members – both for jobs and ownership.  The plan, to be most effective, will need to include a regularly updated valuation formula.  Get guidance from your CPA, Management Consultant, and/or Business Appraiser.
• Family transitions don’t usually “fit” into traditional valuation models. Discounts on the value of equity for lack of control, long-term penalty periods and the like are not usually put into play, though rights of subsequent generations to business ownership are sometimes restricted.  Some approaches, and how they work, follow:
  • Gifting – each taxpayer is currently allowed to give tax free gifts of up to $13,000 a year to anyone they wish.  Gifting has been used frequently to transfer equity to next generation members.  If the business has a high value, however, it can take a long time to transfer.  Moreover, if the family member is not working in the business and the business does not pay dividends, ownership only has value upon business liquidation, or sale, something that is not usually attractive to other family members working in the business.  In addition, gifting opens the door to challenging future valuations, as it is seldom tied to an objectively determined value.
  • Buy-sell agreements between the generations and among siblings – this allows business ownership to be transferred, at a mutually agreed upon price and terms acceptable to all family members.
  • An ongoing valuation model – In transitioning from one generation to the next, it’s important to establish a fair price (that recognizes the needs of the selling generation for retirement funding and end of life care and the needs of the next generation to pay as little as possible for what would normally be inherited (in buying, though, many inheritance tax issues are bypassed.)):
    • An objective, expert generated, valuation should be commissioned by the business. Often the company’s Management Consultants and/or CPA’s will complete this work.  Valuation is both a science and an art and, depending on which approaches are taken (usually a valuation firm will calculate value based on several approaches – sales of comparable businesses, if details are known; formula approaches; cash flow or projected income models; and/or, net worth calculations; and/or, industry norms).  Using a number of approaches will generate a range of values that can be weighed and applied.  A final valuation amount will be the compilation of these values and leaves room for interpretation, while still being defensible if ever legally challenged;
    • Parental income needs in retirement should be considered. Often parents will tie their selling price to their income needs, expecting their payouts to fill in any gaps between retirement funds, investments, healthcare needs and Social Security.  If the business in already in the hands of the current generation, income needs in valuation should be indexed as closely as possible to the least affluent family member active in the business.  This indexing has the potential to blunt possible objections from family members not active in the business, wishing to challenge valuation on a fairness basis.

When That Day Comes

• What are the signs and what do you do when they occur?
  • The first sign is a pattern of consistent non-performance (against agreed upon terms and conditions of employment set for all family members);
  • A second sign is an aura of “poisonous” tension among family members; and/or,
  • A third sign is a family member’s failure to comply with agreed upon (collectively voted) family decisions and/or using “family” relationship as a basis for self-dealing.
• Asking a family member to leave, or tell other family members you’re leaving is a delicate matter.  When leaving is forced (performance issues) the news generally comes from the family  member leading the business.  When voluntary, the family member leaving can have considerable flexibility on how, and when, to break the news:
  • Any announcement must either identify and present performance and/or personality issues as objectively as possible, or agreement must be made that an “agreement to disagree” has occurred and a change is necessary.  I recommend using a three-strike approach to reaching any change based on performance – Strike 1 – Let’s talk about why current performance isn’t working and agree on changes to make the problem go away; Strike 2 – Review what was decided in Strike 1 confirm agreement on the Strike 1 resolution. Find out, what wasn’t understood?  This leads to, “let’s put a new agreement in writing.”  If we don’t correct the performance with this agreement and the problem persists, we both agree that you are choosing to leave the business; and, Strike 3 – “Our written agreement isn’t working for either of us, we consider this most recent incident your resignation.”
  • When a member is leaving, agree on (or, if needed, impose) a suitable transition period (normally better to do, ad hoc, rather than pre-define, since how a transition occurs can take edge off family conflict – the decisions are not just business, after all); and,
  • If possible, allow the departing member to decide how, what and when, to tell the rest of the family.

Removing a family member from the business is not easy and it’s not often pleasant, but protecting the business for the benefit of the last generation (who may be depending on the buyout monies for their retirement), the current generation (both those working in the business and those benefiting from ownership) and future generations, is a goal worth pursuing and worth doing right.

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What’s wrong with this thinking – and let’s take it point by point?
1. STRANGERS – Strangers shouldn’t be in business together. But let’s talk about friends, unrelated parties. If they have a dispute and can’t agree, shouldn’t they have someone who can break their deadlock? I once had a client, an INC Magazine “500” company that went bankrupt because their attorney didn’t put a deadlock provision in their policies and by the time I got there, things were so tenuous, they wouldn’t adopt one. That company is no more. I believe every company where a deadlock COULD happen, needs a deadlock provision.
2. STATE LAW WILL PREVAIL – Anyone who’s been divorced knows that breaking up is both hard to do, usually generates hard feelings and takes time – sometimes lots of time. Furthermore, equitable distribution only deals with a division of assets, not with the ongoing running of a business. Either owner can sabotage a business in the time it takes to get to equitable distribution – by gutting the cash, by interfering in transactions, in venting anger in the workplace. By the time you get to equitable distribution, sometimes the business isn’t worth much anymore. Divorce should never be one of your exit strategies. A deadlock provision can help avoid this. Supported by pre-established guidelines, the person voting the minority position, can help break the deadlock and keep the business alive.
3. WE’VE BEEN MARRIED A LONG TIME – Is wonderful news and I applaud long-term, happy, marriages. I also know that in first, second and third marriages, of whatever duration, the chances of staying together until one partner dies is typically never more than 50%. If you can’t rely on something happening, you manage the risk – with a deadlock provision – a cheap and easy safeguard just in case. (a clause like this can also be helpful in cases of mental disability that is not readily diagnosed, the third person voting the minority position, can help save the company by inserting objective, common sense.)

We normally buy health, auto and life insurance. We usually look both ways before crossing the street. In a 50-50 business “partnership,” a little prevention can save a great deal of pain.

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Ownership of the family business is often gifted more like an asset than as a treasured heirloom, with less though given to issues of being treasured or maintained.  It is seen as an entitlement or an annuity.  But ownership in a business is not the same as ownership of a bank account, or uncle Harry’s portrait.  A business has a life of its own and has its own identity.  Nobody is paying interest on its worth – it needs to be worked, nurtured and allowed to respond to its customers’ wants and needs.  If you are offered the gift of ownership in a family business, make sure you are willing to invest in the gift.  If not, ask for your inheritable interest to be converted to its cash value and paid.

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Trademarks and tradedress ( the packaging and design – how the brand is presented – the materials chosen etc.)  protect your logos, name, packaging and other unique design expressions.  When you claim and/or file for trademark protection, remember, you are locking in the design and it must be used consistently going forward, or you will risk your ability to enforce your rights going forward.

Consistent “presentation” and use (including use by your suppliers) are keys to protecting intellectual property.  You can’t protect it if you don’t use it consistently.

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How can you be open to the unexpected?

1. It’s not over ‘til it’s over.  Remember, you can be pursuing a course of action, but still make changes – even reverse course – until you reach your final decision point [I was once involved in a deal that was all but done when the owner changed his mind about selling at the closing.  “I’m not ready to go,” he said. No Deal Is Done Until the Papers Are Signed, Sealed and Delivered] ;
2. Never count anyone out.  As you get closer to your decision point people who you may not have considered may unexpectedly step up to be counted.  If you are too locked into your initial choices you could miss out on an opportunity you haven’t anticipated [in the sale of one family business, two sons were vying for control.  After a series of activities working together planning for succession, the brothers changed their minds, switched positions, and that changed everything];
3. Be alert .  Nothing happens in a vacuum, the marketplace, the economy constantly change.  Circumstances may reveal other possibilities you can take advantage of at the last minute [Last minute changes in a deal make it better for all parties concerned].

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Just as important, though, and often largely overlooked as an equally critical element of the process is the focus on succession’s meaning for the successor.  The new owner/leader will have his/her own set of transition issues as s/he takes on the role previously held by a predecessor and moves to make the job/company, his or her own.

Long-term transitions are usually destructive, pitting the outgoing leader against the newcomer, as they take charge and let go.  Usually not more than a 3-6 month transition is in order, if that long.  While the agreement of sale, may contain  a long-term employment/consulting contract for the incumbent, it will probably be bought out rather than lived out.  In management succession, the incumbent has usually left the organization or moved into another position without much of a transition (though the exiting person may be on call for a time).

Therefore, organizations with strong work flow processes and documentation tend to fare better than those with largely oral cultures.  Another strengthening technique for management succession is to include members of the work group in the selection process.  Making them part of the process often helps choose a better successor and begins to form bonds with the new leader even before s/he takes charge.

Whether engaged in an ownership or managerial succession process good systems and document and engagement of the people involved in making the succession work contribute to stronger long-term results.  Is your organization well poised for succession?

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There may be paid managers and staff to perform some or even all of the day-to-day tasks, but ensuring an adequate return on investment (blood, sweat and money) is the leader’s responsibility.

There are two components of an adequate return: time invested must be compensated through salary, benefits and perks; AND, money invested must be guaranteed a fair rate of return plus a premium for the level of risk assumed. Adequate returns do not just happen, they are achieved through planning and action. This commitment involves setting realistic, quantifiable goals; taking the steps necessary to attain the goals; measuring the results; and, adapting along the way.

The leader is responsible to ensure that the business invested in has a real business or community (if a non-profit) purpose. This means: being realistic about not throwing good money after bad; separating real, business activity from ego gratification; and assuring at least a baseline of security by taking prudent risks.
The leader is responsible to the people who work in the business. This involves: establishing organizational goals; providing direction about employees’ responsibilities in meeting these goals; setting standards of performance; and providing job performance feedback. Organizing work in this way frees employees to perform effectively because it assures them that their positions are not held capriciously at the whim of the leader and that their paychecks are not constantly in jeopardy. Taking this approach also facilitates identifying organizational successes and potential roadblocks. In a world of rapid change, a little perceived security goes a long way.

Finally, the leader is responsible to him- or herself, his/her family and other stakeholders to do succession planning. Timely, thorough (and flexible) succession planning can facilitate a smooth transition when the leader determines that: the business is no longer viable; s/he has personally had enough of it; or, it has just become time to step aside.

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