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Passing the torch Common sense considerations when transitioning your family business Kay E. Gray, CGA, TEP Tax Partner T +1 604 443 2109 E

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Presentation on theme: "Passing the torch Common sense considerations when transitioning your family business Kay E. Gray, CGA, TEP Tax Partner T +1 604 443 2109 E"— Presentation transcript:

1 Passing the torch Common sense considerations when transitioning your family business Kay E. Gray, CGA, TEP Tax Partner T E June 5, 2012

2 Agenda Common characteristics Governance Strategic planning Transition of leadership and ownership 10 things Passing the torch Attributes of a thriving family business Questions

3 The family business Common characteristics Founder has voting control of company Family wealth is not diversified High investment of "sweat" equity Operations are often micro-managed Strong, long-term relationships with employees and customers

4 The family business Common characteristics Immediate family is often involved at some level: The founder's spouse….. –Sometimes a co-founder and owner –May be employed in an administrative capacity –Is often consulted on key decisions

5 The family business Common characteristics The founder's children…. –Frequently employed by the business at an early age, often as a first job out of school –In families with multiple children, usually one child will be given more opportunity –Generally over-paid in the early years, and under-paid in later years

6 The family business Common characteristics Governance –Small board of directors - sometimes just the founder –Little attempt to diversify strategic thinking –Rarely guided by a strategic plan

7 Governance Who should be on the board of a family business? What is often lacking is a connection between the board of directors and the family. –Family advisory board – next generation of shareholders –Input into strategic planning process –Financial information and minutes of meetings of board of directors

8 Governance Strategic planning There should be an integrated process for developing the strategic direction for the business, particularly around succession planning

9 Governance Who are the stakeholders? Those who are ultimately dependent upon the profitable continuation of the business: –Founder and spouse –Minor children and disabled adult children –Employees –Creditors

10 Strategic Planning Stakeholders must have input into strategic plan If the objective of the strategic plan is a long-term continuation of family ownership, the process for the transition of both leadership and ownership must be a key component. Ownership vs. Leadership

11 Strategic Planning Transition of leadership and ownership Question: When is the right time to build succession planning of the leadership and the ownership into the strategic plan? Answer: It's always the right time. Any strategic plan that does not contemplate the sudden loss of the key decision-maker leaves the business, and it's stakeholders, at risk.

12 Family business - transition of leadership Process Who will be the next CEO? 1.Clarification of strategic objectives. 2.Assessment of talent against the objectives. 3.If a family member is identified, ensure that he or she is up for the job. 4.Plan the transition, with checkpoints and milestones to be measured and evaluated. 5.Follow through.

13 Family business - transition of ownership Process Ownership can be easier to transition than leadership. The quickest way - on death: Passing of control and equity By way of will No will? - passing intestate

14 Family business - transition of ownership Process Ownership can also be harder to transition than leadership The slowest way - before death: Gift of equity and control Sale (i.e. for real money)

15 Family business - transition of ownership Sale of the business A full price sale of the business to a child or to multiple children should not be dismissed as unrealistic. The sale price: –Can be paid out over a period of time –May be more viable by splitting up the business assets and selling at different times

16 Tax-effective strategies Sale strategy Sale of founder's shares to a child at FMV: Financing issues: –Bank debt –Promissory note, with or without interest (but usually with security) Income tax issues: –Lifetime capital gains deduction –10-year capital gains reserve

17 Tax-effective strategies Estate freeze strategy New shares issued to next generation at nominal cost: Founder exchanges common shares for fixed-value non- voting preferred shares Preferred shares are redeemed during retirement years out of business profits Timing of transfer of voting control? Hybrid strategy – tax effective

18 Transition of ownership Estate freeze – other benefits Effective for introducing new shareholders that have little capital to invest Shareholders may have direct ownership or indirect ownership, such as through a discretionary family trust Separate classes of shares can allow business profits to be "sprinkled" among different shareholders (i.e. family members)

19 Transition of ownership Estate freeze – pitfalls While an estate freeze is very effective for a transition of (the future) ownership, it is not effective for the transition of leadership The transition of leadership must be achieved through a separate process that is more closely aligned with the strategic objectives of the business

20 Transition of ownership Estate freeze – pitfalls The founder retains control of the board too long, hindering the effectiveness of leadership Voting shares (i.e. control of the board) must be transferred at the right time

21 Transfer of ownership Relinquishment of control Appropriate security for founder can be difficult: 1.Shareholder's agreement: Matters requiring founder's approval Preferential distribution of profits to founder Change of control clause Special share rights and restrictions 2.Voting trust/escrowed shares 3.General security agreement over business assets 4.Personal guarantee and/or second mortgage

22 10 things I've observed about family businesses 1.Founders do not adequately or objectively plan for a transition of leadership 2.Founders are rarely ready to retire until the day they choose to retire or the day they are unable to work 3.It is difficult for a founder to be objective about the leadership abilities of his or her child

23 10 things I've observed about family businesses 4.Divorce-the process is much more complicated if they founder's spouse is involved in the family business, either as a shareholder or as an employee 4a.Second spouses (and children's spouses) employed in the business can be the ruin of it. 5.If identified as potential leadership candidates, the founder's children should be encouraged to seek outside employment and experience from an early age.

24 10 things I've observed about family businesses 6.If ownership of the business is to be retained, ensure that passive assets (i.e. land and buildings) are segregated from active assets (equipment, employees, etc.) to facilitate a flexible ownership structure. 7.If the founder wants to create discord between his/her children, make one the boss of the other 8.Founders need to consider the important role of employees and creditors in managing a successful leadership transition.

25 10 things I've observed about family businesses 9.A family business that cannot profitably support the founder's family while employing a non-family member in the leadership role should probably be sold rather than transitioned through an estate freeze. 10.If the founder wants to piss off the family, he/she should die at work without a will, with no insurance, and no transition plan for leadership or ownership.

26 Passing the torch Above all, the founder must communicate with the family: Consider creating a family creed or statement of values to live by, both as a family and as a business. Create a forum for regular discussion Talk to the family about wealth and the importance of the business to the family's future Talk about retirement and the transition of leadership Listen to the family's opinions on strategy for the business

27 Family business – sustainable and strong Attributes of a family business set to thrive 1.Common objectives have been defined. 2.Common values/behaviors/principles have been determined. 3.Everyone's role and responsibility is clear. 4.Individual roles are determined by putting the firm first.

28 Family business – sustainable and strong Attributes of a family business set to thrive 5.Leadership is relentless and disciplined in conducting business processes. 6.Leadership is content, but not satisfied, with the level of profit. 7.Communications structures and process are in place. There is clarity on which decisions should be made: Without discussion and communication With discussion and communication With discussion and no communication.

29 Family business – sustainable and strong Attributes of a family business set to thrive 8.Decisions are made in a respectful manner privately, then supported publicly. 9.Tricky issues are raised, discussed and dealt with. 10.There is clarity among the various roles (family, owner, leader). 11.Principles, work habits, and education is promoted to the next generation.

30 Family business – sustainable and strong Attributes of a family business set to thrive 12.There is a deliberate effort to avoid a spirit of entitlement in the next generation. 13.Everyone is held accountable. 14.There is clarity on the principles that will guide compensation related to each role. 15.Regular meetings occur to review progress on objectives, values and other matters that pop out of points 1-14.

31 Questions? Thank you!


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