Transitioning Ownership.Successful family businesses thrive through the will and expertise of their owners. Whether that business is a manufacturer of machinery or a provider of business services, it is created, nurtured and ultimately grows because of the owners particular vision and a natural desire to see it realized. While such an accomplishment is a worthy legacy, for many this legacy is only fully realized when the business successfully transfers from one generation to the next. As important as this phase of a business is, many family businesses make no plan, formal or otherwise, for the succession of their life s work. When considering transferring a family business from one generation to the next, there are two main financial strategies the business owner might consider: gifting and leveraged recapitalization Leveraged Recapitalization A strategy where a company takes on significant additional debt with the purpose of either paying a large dividend or repurchasing shares. The result is a far more financially leveraged company. Notes: This is often used in risk arbitrage. . With gifting, a business owner essentially gives away his or her business to a successor or successors, in small pieces over time to minimize taxes. Gifting shares of a company early, before growth or other factors increase the value of the business, significantly lowers the tax exposure. Leveraged recapitalization is when a company takes a loan to replace some of the owner s equity. This allows the owner(s) to gain some liquidity while keeping the business with the family. While each option is equally viable, using them together in a family succession plan offers the dual benefits of reduced tax exposure and increased control of their company. For a family business, gifting stock while the company is still privately owned is often a good idea. A parent can give a child $10,000 each year without being taxed. If the value of the stock at the time of the transfer is $5 a share, each family member can receive 2,000 shares each year. If the company is sold later, the ultimate sale price is often higher than the valuation used when the shares were gifted. Leveraged recapitalization is a financial tool that reconfigures a company s capital structure consistent with the goals of both the family and the company. This method enables family members to gain partial liquidity from their investment while retaining a significant ownership stake. The retiring owners receive the funds for their retirement and are free to diversify diversify To acquire a variety of assets that do not tend to change in value at the same time. To diversify a securities portfolio is to purchase different types of securities in different companies in unrelated industries. their assets. In financing a leveraged recapitilization, the capital needs of both the family and the company need to be considered. The financing used to fund the retiring owner s distribution needs to be carefully examined in relation to the overall capital requirements Capital requirements Financing required for the operation of a business, composed of long-term and working capital plus fixed assets. of the business. The amount of capital a lender is willing to offer varies depending upon the company s size, assets, current cash flow and the owners risk profile. It is important to know the different types of loans available to family businesses to best match the loan structure with the business. Asset-based loans An asset-based loan is a loan, often for a short term, secured by a company's assets. Real estate, A/R, inventory, and equipment are typical assets used to back the loan. The loan may be backed by a single category of assets or some combination of assets, for instance, a advance funds to the company, based on the value of their accounts receivable accounts receivable n. the amounts of money due or owed to a business or professional by customers or clients. Generally, accounts receivable refers to the total amount due and is considered in calculating the value of a business or the business' problems in paying , inventory, equipment, and real estate. This loan structure may make more funds available at a lower cost, with a more flexible repayment Repayment The act of paying back a debt. Notes: Everyone has to repay their debts eventually. See also: Debt, Defeasance, Loan schedule and fewer covenants than other types of loans. Another type of senior debt is a cash flow loan. In order to qualify for this type of financing, the company must be able to demonstrate consistent cash flow. These loans can be more expensive that asset-based loans, have a faster repayment schedule and more stringent covenants. A hybrid structure loan such as Fleet Capital's Family Business Succession Loan combines the secured aspects of an asset-based loan with the cash flow of a business to enable the lender to extend financing beyond the value of the collateral collateral (kəlăt`ərəl), something of value given or pledged as security for payment of a loan. Collateral consists usually of financial instruments, such as stocks, bonds, and negotiable paper, rather than physical goods, although . Finally, when senior debt may be insufficient or the repayment schedule too restrictive, it many be necessary to find a private equity firm or mezzanine mez·za·nine n. 1. A partial story between two main stories of a building. 2. The lowest balcony in a theater or the first few rows of that balcony. provider to invest in the company in the form of equity of subordinated debt Subordinated Debt A loan (or security) that ranks below other loans (or securities) with regard to claims on assets or earnings. Also known as "junior security" or "subordinated loan". . For family business owners, preparing for a day when they will walk away from all they have built and pass their business on is stressful, and a decision that may be driven as much by emotion as by economics. For many, transferring the business to their children is the ideal option. But transferring ownership of a business from one generation to the next requires careful managerial and financial planning Financial planning Evaluating the investing and financing options available to a firm. Planning includes attempting to make optimal decisions, projecting the consequences of these decisions for the firm in the form of a financial plan, and then comparing future performance against . A lack of planning could cost owners a sizable siz·a·ble also size·a·ble adj. Of considerable size; fairly large. siz  a·ble·ness n. portion to their wealth, or worse yet, the family's control of the business. The best way to maximize the return on a lifetime of hard work is for the business owner to develop a transfer of ownership plan that evaluates the financial needs of both the family and the company. By employing the same sort of vision used to establish and operate the company in the first place, more family businesses will see their way to the next generation. John Roberts is Senior Vice President of Fleet Capital Corporation in Sherman Sherman, city (1990 pop. 31,601), seat of Grayson co., N Tex., near the Red River; inc. 1858. Originally on a stagecoach route, it is a highway and railroad junction. Manufactures include electronic equipment, processed foods, military equipment, and metal products. oaks. |
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