Should you sell your family business to your family?

You’ve worked hard to build the family business from scratch, or perhaps you are the latest of several generations running the business. Either way, you must plan for the day you step down well before you intend to.

Why? Because when a business passes from one generation to another, there is much more than money at stake.

Here are four key considerations and strategies to ensure a smooth transition, preserving family relationships and goodwill as well as sheltering the business itself from any disruption in operations that can be caused by interpersonal problems.

Consider selling the business to family, not gifting it

This is a must for the sake of both parties. When the seller steps down, he or she needs to receive something in exchange for giving up control. If a seller gifts the business, he or she may feel there is still some ownership interest there, and conflict over leadership can arise too easily.

In the same way, the buyer needs to give something to the seller in exchange for taking control of business operations. Being gifted a business can foster feelings of entitlement that can grow into disinterest and neglect of the business. The potential for a buyer’s inattention to business operations must be avoided to the extent it can be.

For this reason, the seller should consider carefully which family member or family members are capable of carefully guarding and growing the family legacy. Selling to multiple family members rather than one might be the way to hold each of them accountable. And if the seller knows that those family members can’t or won’t agree on how to run the business, the seller has time in advance to train a manager to help them after the transition. Or, the seller could semi-retire, and be available for part-time consulting should the need arise.

The challenge for the seller, in this case, is to avoid overstepping his or her new role. It can be difficult for the seller to step back from control, so keep that in mind. The purpose of having a succession plan is to avoid family conflict, not create it.

Agree on the value of the business

The seller and buyer must both accept the valuation and sale price of the family business. How a business is valued will vary widely, but usually, someone appraising business will consider the following:

• The worth of the company’s assets
• A price-to-earnings ratio (P/E)
• A discounted cash flow analysis using a net-present value (NPV) calculator
• Any debt that the company carries

Another aspect of value these days is the effect, if any, of the global pandemic on the ability of the business to continue operations as usual or to pivot and adapt to provide clients or customers with the services or goods they need now, in a way that safeguards the health of employees.

A seller will also have to consider whether he or she wants to sell on the lower end of valuation or the higher end. That decision should be made based on the seller's need for funds in retirement.

Set forth the terms of the transaction in writing

It is not unusual for a family business to change hands without a written agreement, but frankly, this does not and will not serve the best interests of either party. Having the terms of the financial aspects of the transaction in writing will prevent any misunderstanding and help preserve family relationships.

For example, the seller may want to accept a percentage of net profit over so many years, so that proceeds from the business fund the sale for the buyer or buyers. The agreement should also set forth (in tandem with estate planning documents) what happens should the seller die before the transaction is complete. Will the buyers simply inherit? Must the buyers continue to pay, but make payments to the seller’s spouse? All of this can be decided and signed off on in advance.

Set forth roles and expectations on both sides in writing

The seller may also want to structure his or her departure from leadership, over time, and provide for this in writing. Why is this important? Because disagreements can and will arise during the transition, and having a plan in writing will set forth who has the final word, when.

Using these strategies, you will be able to avoid the most common problems with succession in family businesses.