Turnover Time

 SUCCESSION PLANNING 01Is the next generation of your family business ready to take the reins?

By Bradford Dickson and Greg Spangler

Whether wholesalers or distributors take their business public, decide to sell it, choose to retire, become disabled or pass away, exiting a business can be a very sensitive topic – especially when it comes to turning the helm over to the next generation.

While it’s true that business owners can’t always control when and how the exit happens, they can be prepared with a succession plan in place. 

Generational Risks

Since 2012, we’ve seen increasingly more wholesale/distribution companies changing hands. Having a son or daughter follow in a parent’s footsteps and assume the ownership of a wholesale or distribution business is definitely in the minority. There are so many economic and familial dynamics involved that it’s not considered the slam dunk that it was with previous generations.
According to research from the Family Business Center:

* Even though nearly 70 percent of family businesses would like to pass their companies on to the next generation, only 30 percent will actually be successful.
* By 2017, it is estimated that 40.3 percent of family business owners expect to retire, creating a significant transition of ownership in the United States. Less than half of those expecting to retire in five years have selected a successor.
* More than 30 percent of family-owned businesses survive into the second generation. Twelve percent will still be viable into the third generation, with only three percent of all family businesses operating at the fourth generation and beyond.

The future success of a family business is only as strong as the next generational link. Rarely do adept and industrious parent owners produce offspring who are born with the innate business sense that exceeds – or even rivals – their own. To help improve the odds of the company’s survival, each generational transfer should be carefully planned, discussed and managed among family members. It’s important to do what’s natural for the family on both sides. For example, millennials tend to want more flexibility in their careers and may not really be interested in immersing themselves in the business to ensure the company’s success. Many would rather inherit the cash versus the 24/7 headaches that come with a multi-million dollar operation involving multiple distribution centers that are often supported by sizeable, and often very loyal, workforces. It can be a daunting undertaking for anyone.

Don’t Rush the Process
Perhaps the most common mistake parent owners make is rushing the process. Piling too much responsibility on children too soon in their careers within the family business can overwhelm them and lead to missed opportunities to truly learn the ins and outs of the wholesale/distribution industry. Inexperienced new leaders who are perceived as not paying their dues find it harder to gain the respect and loyalty of employees, many of whom may have been there since the company’s inception. Children taking over ownership of a company must prove that there’s substance behind their name. Having a step-by-step succession process in place that puts them in a position to gain the necessary experience, confidence and respect is key and should take place before the “official” transfer of ownership occurs. The following are the three most common methods of transferring ownership to children:
1. Outright sale to the child: This is not a typical transaction, as the child would have to come up with the cash to buy the business. While there are certainly different ways to orchestrate this type of sale (i.e. straight cash buy, leveraged buyout, borrow against company, borrow from the parent, etc.), most don’t have the stomach to leverage their lives, let alone the capacity to tap those types of funds, to buy a successful wholesale/distribution business. From a tax perspective, any gains or losses from the sale are attributed to the parent owners. 2. Outright gift to the child: Individually, each parent can make lifetime gifts (i.e. transfers) of up to $5,450,000?that means combined, mom and dad can transfer $10 million plus to the child (or anyone else) without paying up to 40 percent in transfer taxes. This is a fairly typical price for a small- to medium-sized wholesale/distribution operation. Again, there is no tax impact on the child. The parent owners pay transfer taxes on any amounts over the legal limit. 3. Combination of the two: Depending on what parent owners need in terms of retirement and/or their current tax positions, the transfer option that combines a partial sale with a gift can be used. For example, on a $100 million wholesale/distribution business, the parent owners can gift $10 million plus with no tax implications and orchestrate a sale to the child for $90 million, paying income taxes on any taxable gains. This approach often takes on a component of debt forgiveness if the parents finance a portion of the sale. A combination approach may also transfer the real estate separately from the rest of the business. The dynamics change dramatically when multiple children are involved when you start factoring in future marriages and potential divorces as well as a new generation of heirs. The potential for family in-fighting grows exponentially. Parent owners can address this issue by one of two ways. They can create a buy-sell agreement that governs how ownership will change hands. These agreements also specify how ownership interests are treated and mandates how owners will be paid for their interests in the business in all situations such as a sale, gift, disability or death. Parent owners can also create a trust that often helps determine the rules for how and when the children would receive and/or participate in the business. The trust is designed to set up controls, carried out by a trustee, to protect both their interests as well as the children’s.

Be Prepared and Be Realistic
There are no cookie-cutter approaches. Each business and family is different and has their own unique goals. However, there are some best practices wholesale or distribution owners can use as they map out a family succession plan:

* Make an effort to match objectives both for the parent owners and the children in terms of the decision to transfer.
* Understand the profitability of the business now and into the future. You want to pass on a business with great cash flow, limited liabilities and good market opportunities.
* Get the children involved in the business early. They need to be active in the business long enough to experience both the ups and the downs so they’re better postured to carry the stick.
* Develop an open line of communication. Don’t assume the kids want to take over the business. Forcing the business on someone who is not ready or willing to assume that responsibility is a recipe for disaster.
* For owners without an exit strategy, there’s no time like the present to start that planning. In order to truly maximize a company’s value, owners will need to develop a long-term plan, one that allows enough time to make the necessary changes within the company to help drive the metrics that actually create value and ensure a smooth transition to the next generation.
* Assemble a team of advisors such as legal, tax, investment banking, insurance, valuation experts or others with the expertise within the wholesale and distribution industry to bring value to any transaction and related activities. Success for family-run wholesale and distribution companies is measured by the peace of mind that comes from knowing there are succession plans in place that will result in maximizing the expected benefits during owners’ lives, for them personally and/or their children.

Bradford Dickson is counsel and Greg Spangler is a principal and manufacturing and logistics practice lead for Atlanta-based CPA firm Windham Brannon

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