Tag Archives: stock

Legacy and Evolution

Jennifer Pendergast
Jennifer Pendergast

One of the key differentiators of family businesses is a committed ownership group who are proud of the legacy their family business represent.  Research shows that family businesses outperform non-family businesses, and this focus on the importance of legacy is one of the contributors to superior performance.   However, an overemphasis on the past can also have a negative impact on family business performance. 

Ability to change is also important.  Every generation is different, and requires different structures and rules to succeed.  Take just one element – ownership structure.  In earlier generations, many family business owners created a structure where stock was consolidated in the hands of those who involved in the business.  Many felt the alternative of entrusting ownership to family members who may not be as interested in the business could lead to non-employed owners getting in the way of family management’s ability to make decisions.  Further, some thought it unfair that those not involved benefit from the hard work of those involved in the business by participating in the financial gain created by employed owners. 

While this model of ownership may have served a family and company well in the past – as the business evolves and typically gets larger, there can be many benefits to cultivating a group of informed and committed owners who are not employed in the business.  In the interest of brevity, lets just focus on the financial benefits. 

By limiting the ownership group, family businesses may limit the pool of capital available for investment in the business.  For instance, if a business founder has 3 children, only one of whom goes into the business, and he decides to give the business to that child, he will often make a financial gift to other children to treat them equitably.  That money could have been used to fund business growth.  Or, if he gifts shares to all three children at a young age but requires them to sell back their shares to the company if they decide not to pursue a career with the business, again the business capital is limited.

A great strength of family businesses is the patient capital they have by virtue of an ownership group that is interested in managing the business for the long term.  This mindset leads family ownership groups to support management decisions that contribute to long-term business success even if they may not show immediate results.  In fact, research shows that family businesses invest more in R&D and employee training than non-family businesses.  The benefit of a larger ownership group is that they provide capital at a lower cost with a longer time horizon than other investors (including banks) – providing their businesses with a significant competitive advantage.   

So, let’s circle back to legacy.  A commitment to the principles that served the business well in the past is important.  Equally important is a thoughtful analysis of what changes need to be made as the business evolves.  Just as it would be impractical to use a typewriter to generate business correspondence today, it may be impractical to maintain the same ownership requirements from generation to generation (or the same employment requirements or other elements of the family legacy). 

Honoring legacy is important, but if part of that legacy is a desire to maintain the business for generations to come, perhaps a new addition to the legacy needs to be an ability to change.

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Adding owners to the family business

Norbert Schwarz
Norbert Schwarz

At some point in their lives, many family businesses face a decision regarding whether to authorize and issue non-voting stock or not. This common strategy can be very helpful in accomplishing tax and estate planning objectives as well as adding family members to the ownership structure without necessarily giving up voting control by the senior generation. However, unlike marketable securities held as financial investments, ownership in closely held businesses, whether voting or non-voting, carries with it important considerations not usually apparent in open market investments.

Some of the factors to be considered when expanding ownership in the family business are whether the prospective owners are perceived to have the following:

  • Shared ownership values
  • A strong sense of stewardship toward ownership in the business
  • Willingness to support board, management, employees and the shareholder majority
  • High level of Trust with other owners
  • Constructive participation in family meetings
  • Commitment to teamwork and collaboration
  • Strong personal bonds and relationships with other owners

When these qualities are present, the chances of future conflict within the ownership ranks is generally minimized.

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CFO Issues

We were recently with a forum of 10 non-family CFOs of large family businesses. When asked what are the “family business” issues most on their mind, they responded with the following (in no particular order):

  • Airplane use
  • Incentive compensation
  • Board effectiveness
  • Keeping family shareholders informed
  • Dividend levels
  • Assuring stock redemption funds
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Is Google a Family Business?

by John L. Ward

You likely noted the news that Google is doing a stock split – doubling its shares, but without the new shares having a vote. The rationale: The two partner founders argue that they can be more long-term. Together they control and assuredly will secure 58% of the votes.

The move reminds us of the article we wrote about Google when it first went public in 2004.  Read the article.  Click Here

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Succession Webinar Questions Answered

Tools of the Trade: Two Experts Talk About Family Business Succession

Q. How important are buy-sell agreements and clearly established valuation methods for family shareholders? What are typical valuation methods?

A. A buy sell agreement is a succession planning tool that; (i) protects existing shareholders against transfers of ownership to nonfamily members or parties they do not want as “partners;” (ii) provides for a well thought out method of transferring management and ownership of the business to the next generation; (iii) addresses when and how an existing owner may be able to sell their ownership interest; (iv) provides a means of valuing the business in the event of an ownership transfer; and (v) determines how payments will be made to a transferring owner in order to protect the ongoing viability of the business.

Common valuation methods are; (i) annual determination of value by the owners; (ii) a formula approach; or (iii) determination of fair market value by independent appraisal.  Additional information on business valuations can be found at www.MandAlawyer.com by clicking on the tab on the left side of the home page titled “Business Valuations.”

Q. What are your recommendations for pre/post nuptial agreements for family members working in the business who do not have ownership but may be having ownership in the future?

A. Many families use pre and/or post nuptial agreements to protect assets that were acquired before marriage and to keep shares within the family.  The effectiveness of such agreements is dependent upon state laws so discuss this with an attorney before making such a requirement.  If you do want to require agreements of this type before someone is allowed to become an owner make it should be discussed and planned well in advance of engagements.

Q. Do you advise to sell to a family at a discount price?

A. Generally, minority owners are the ones that face a possible discount on the sale of their stock.  Whether or not there is a discount applied may depend on whether the event triggering the sale is voluntary or mandatory.  If the minority owner just “wants” to get out versus a buyout due to death or disability, it is more likely that there would be a discount.  Discounts tend to give majority owners an unfair valuation advantage and are generally avoided in buy sell agreements.

Q. What range of discounts do you typically see for minority interest and lack of control? 

A. Discounts are generally due to lack of marketability and lack of control.  These discounts also overlap.  Lack of marketability discounts range from 20% to 45% for privately held ownership interests and minority ownership discounts also range from 20% to 45%.  Different appraisers apply these discounts in different ways and in different combinations, but rarely would the total discount exceed 40%.

Q. Where are good places to find advisers to help with providing ideas for liquidity for the outgoing generations? We have found that local banks don’t provide the level of experience or expertise required.

A. For information on selecting advisors see www.MandAlawyer.com and click on “M and A Professionals” on the left side of the home page.  The right professional “team” is the key with the right leadership.

Q. What’s your experience with what family members are involved? Spouses and partners are the people I struggle with – how involved should they be?   

A. It is important to clearly define family for the purposes of ownership.  If spouses are allowed to own some provision may need to be made for the business to purchase their shares in the event of a divorce.  Life-partners are treated much the same as spouses in most states and therefore, would need to be considered the same as spouses.  There is no simple answer but there needs to be open discussion within the family and good documentation of decisions for future reference.  Since spouses and in some cases life-partners are influential in raising children who will be the next generation their cooperation and participation in the family business continuity plan is often critical.

Q. Can you review the valuation process you described with the two owners and two envelopes bids?

A. The simplest form of the “shoot out” is when two partners (A and B)  provide bids for the company in sealed envelopes. The envelopes are opened at a meeting of the parties and the highest bidder has the right to buy out the other owner.  If the A is the highest bidder and does not buy out B’s interest, then the B, the lower bidder, has the right to purchase A’s ownership interest at the price bid by B.  In a multiparty shoot out the rights would go from the highest bidder, in order, down to the lowest bidder.

Q. How is stock valuation different than an appraisal?

A. They are the same.  Stock values should be set based upon an appraised value.  Share prices increase when valuations increase.

Q. What are the unique concerns for succession of a C corp? My retirement fund is currently 90% company stock.

 A. The fact that a “C” corporation is not a pass through tax entity (C corporations are taxed at the corporate level and the shareholders are also taxed on dividends from the C corporation) requires additional tax planning to make sure the buy sell agreement, current ownership structure and future business operations are all structured in a manner that minimizes the double tax.

Q.  Is there any published stuff out there on typical valuation methods for private companies for those with minority interest?

A. Google “discounts on minority interests” and you will find volumes of material.  One of the leading writers on this issue is Lance Hall with FMV Opinions.  Applicable information can be referenced through FMV’s web site at www.fmv.com.

Q. What are the steps to help a family transition to a family business office if they have not considered it before?

A. Generally, a family office is useful when a family reaches a size and net worth that can support central functions such as investment planning, tax planning, philanthropy and even clerical services.  If the separate needs of the family are placing an inappropriate burden upon the staff of the business it might be wise to consider a family office.

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