Wealth Management Classics - Earning Money, Spending Money, Managing Money - Family Business

Author: Mark Fitchett (USA) / Country: Mainland China
Publisher:
Publish Date: 2006-05-01
Features: Parents are planning to retire and pass on the business to an heir. However, using the fair market value (IRS standard) as the valuation standard for stocks can create unrealistic expectations for the parents and cause the company to lose funds needed for growth, which will inevitably harm the interests of all family members in the long run. Only by understanding the needs of the retiring owner and the company's ability to pay can the value of the business be better determined, facilitating the transfer of ownership. If the capital base is significantly diluted with each generation, no business can maintain its market position, let alone grow. Many older business owners have a mistaken belief that they can fully "realize" their investment during the generational transition of the business, a belief that poses a serious threat to the continued operation of family businesses. Unfortunately, family businesses are forced to sell every day due to this "realization." Part of the reason is that older leaders have no sense of their financial goals and needs at retirement. Although they can read balance sheets and operating budgets, they are completely unconcerned about personal expenses. In short, they don't know how to use their investment portfolio to cover daily living expenses. Additionally, there is a more important reason forcing businesses to fail to continue—older generations' equity is often calculated using the "fair market value" when considering business succession plans. Of course, a responsible succession plan may also use "fair market value," not just for IRS reasons. But it is only a benchmark, not an absolute truth. "Fair market value" is only reflected in the eyes of outsiders. Buying 51% of the company's equity is far more expensive than buying 10%. The price paid by competitors for the company's stock also differs greatly from that paid by venture capital firms. Unless the owner is willing to sell most of the company's equity, the true fair market value of the stock will never be known. But besides the IRS, who else cares about these details? If everyone hopes for family businesses to pass down through generations, then the only thing to do is to create a succession plan that aligns with the interests of both the family and the company. To prepare enough funds for the business's succession, the first step is to understand the needs of the retiring owner and their spouse, as well as the company's ability to pay without jeopardizing future growth and viability. A thorough discussion of these two standards can help family members clarify their goals, provide them with data to support their decisions, and determine whether business succession is feasible. Before explaining the succession process, let's look at a simple example that reflects the unique aspects of family businesses.
Dilemma
Dad initially started a small business, which has now grown into a rather successful company. Like most entrepreneurs, Dad and Mom have invested almost everything into the company. Over the years, they have borne financial risks, worked day and night, and been generous with their investments, which has led to the company's success today. To outsiders, they appear to be rich Dad and rich Mom. However, upon closer inspection, it turns out they still owe the bank a significant amount of money. Dad's salary, including daily allowances spent on running the business, has remained almost unchanged in the past decade. Moreover, they have not prepared a comprehensive retirement plan. What's concerning is that the product cycle in this industry is very short, and to maintain market share, they must pursue growth. It seems that this is not enough—both the company and the family have spent a lot of effort selecting the heir: their daughter. The daughter is very intelligent, holds an MBA degree from a top university in the U.S. Midwest, is respected by employees and peers, and most importantly, is completely dedicated to the family business. Everyone, including her