Five Steps For More Effective Family Business Transitions

“An ounce of prevention is worth a pound of cure.”

According to Stephen Sayre and Mark Weisbard of law firm Dykema, this well-worn adage applies in spades to successfully exiting or transitioning a family-owned business.  Whether an owner is considering a sale or intergenerational transfer in the near or distant future, there are five important steps every owner should take today to make the transition -- whenever it ultimately occurs – smoother and more profitable:

• Have a Shareholders’ Agreement That Deals With Transitional Issues: The company’s shareholders’ agreement (which may take the form of an Operating Agreement for limited liability companies) should include buy-out provisions, including how buy-outs of shareholders may be financed by the company and other shareholders.  In addition, if the ownership of the controlling interest of the business creates the possibility of “deadlock” surrounding the approval of a shareholder buy-out or the sale of the company, the shareholders’ agreement should provide a method of breaking it.
• Keep Impeccable Financial Records:  If the transition involves the sale of the company to a third party, the transparency and reliability of the company’s financial records will be critical to maximizing its value in a sale.  Therefore, having a very strong CFO and a well-regarded outside auditing firm is important.  A commercial lender can also be an effective member of the company’s financial team if a long standing relationship exists.  Not having clean records and a strong team standing behind them can make buyers nervous, something to be avoided.
• Protect Intellectual Property: Even if the company attributes little value to its intangible assets, a prospective purchaser may disagree. The company must therefore have in place policies and procedures to protect its intangible assets, such as requiring new employees to assign to the company all intellectual property rights in their work product; consistently not disclosing trade secret or other confidential information to third parties without first requiring them to sign confidentiality agreements; and regularly reviewing internal development activities with patent counsel to determine if any inventions could qualify for patent protection.  Furthermore, for any company that derives value from its name or the names associated with its products and services, federal trademark protection should be secured.  Failing to protect these assets can substantially reduce the value of the business to a third party or expose the business to significant liabilities on the sale transaction.
• Conduct an Audit of Employee Benefit Plans The federal requirements for maintaining and reporting on employee benefit plans are complex, and the penalties for failing to comply can be severe.  In addition, cleaning up problems that have occurred in the past can be very expensive.  Accounting firms and law firms can audit family business plans well in advance of the exit transaction to ensure that they are squeaky clean before any potential buyer reviews them.  Better yet, the company should conduct the audit well in advance of any transaction and maintain the plans correctly along the way.  This will prove to be well worth the time and money spent on it.
• Plan on an Untimely Death – No one wants to spend time contemplating their own demise; however, not thinking about this topic could result in the business interests passing in a manner that  results in conflict among family members, particularly if only some of the beneficiaries have been active in the business.  In addition, as the owner of a family business, the transfer of the ownership interest may be subject to estate taxes.  Therefore, it is important to consult with an estate planning attorney early and often regarding how the interests should be held and strategies for minimizing, and planning for the payment of, estate taxes.

Although planning for the transition of a family business is a complex process involving financial, legal and personal considerations, taking these five steps will help put any family businesses on the path to a smoother and more financially-successful transition.

Stephen Sayre is a Member of Dykema’s Corporate Finance group. Stephen focuses his practice on middle-market commercial matters and acts as outside general counsel for companies that do not have inside counsel, leading transactional matters and managing commercial litigation, employment and tax matters.

Mark Weisbard is a Member of Dykema’s Family Business Transition and Business Services practice groups.