By Matt Donovan
Financial advisors play an important role when a client sells his or her business. If the buyer is a third party, your involvement may primarily relate to economic considerations, such as tax issues, investment strategies and asset sufficiency. But what if the buyer is your client’s child?
To your client, a sale to a child may appear easier than a sale to a third party. Your client may believe that the sale will go smoothly because the client and child are family—they trust one another, share the same vision and value the business’s legacy. Your client may also believe that selling to a child will require less legal work because of the child’s knowledge of the business.
Perhaps your client is right. Perhaps, however, your client ignores important issues when selling the business to a child. These hidden problems may be ignored because your client is confident—perhaps overly confident—that any future dispute will be easily resolved. If so, purchase and sale documents are viewed as a necessary formality, not the official agreement of the parties. Potential disputes may also be hidden because they are “family issues”—important, but not directly related to the business—and easy to ignore at the time of sale.
To help your client spot potentially hidden issues before a sale, here is a list of topics you may want to consider discussing with your client:
Role of Client. After the sale, will your client remain employed by the business? If so, in what capacity? Will client control major decisions and key relationships? Will client remain on the board of directors? Are client’s expectations known to and consistent with the child’s expectations?
Action items you may want to consider:
- Helping client think specifically about his or her role after the sale.
- Encouraging client to have detailed discussions with child about client’s role and compensation after the sale.
- Encouraging client, or client and child jointly, to prepare a written communication plan for employees, customers and vendors to explain the change in leadership.
Red Flag: Client wants to sell the business to child, but doesn’t trust child to run the business.
Family Employees. Can child hire and fire family employees? Can child determine compensation for family employees? Is tension likely to form if client sells the business to child and not another family member?
Action items you may want to consider:
- Encouraging client to discuss with child whether child can make employment and compensation decisions for family employees after the sale.
- Suggesting client to communicate with family, not just family employees, whether changes will or may be made with respect to family employment and compensation decisions.
Red Flag: Client says child will be in charge of family employment and compensation, but won’t share this information with the family.
Siblings as Co-Buyers. What happens if client is selling the business to siblings? Will each sibling have equal ownership? Can the siblings work together? Do active siblings resent inactive siblings or vice versa? Do all siblings have business sense?
Action items you may want to consider:
- Helping client to be practical about the business abilities and commitment of each sibling.
- Encouraging client to thoughtfully consider the siblings’ ability to work together without client in charge.
- If siblings are to receive equal ownership interests, you may want to consider suggesting that client consider what could happen to the business if the siblings cannot agree on key decisions.
Red Flag: A sibling does not respect corporate governance and believes job titles are irrelevant.
Business Direction. What happens when the client’s business industry changes? What happens when the business needs to grow or reinvent itself? Will client allow change to occur? Will child feel that change is in some way a betrayal to the business’s or the family’s legacy?
Action items you may want to consider:
- Recommending that client and child discuss possible circumstances when a significant business change or the sale of the business may be necessary.
- Discussing whether client will serve as child’s “bank” in the event the business needs capital to survive.
Red Flag: Client refuses to accept that the business may need to change in the future.
Client’s Estate Planning. Is client selling the business to child for full value, or is the sale a disguised gift? Does client have other children, and should the inheritance of the other children be equalized with other assets?
Action items you may want to consider:
- Discussing with client if he or she gave child favorable terms to purchase the business because child is family.
- Suggesting client consider the potential disparity in wealth between child and client’s other children if child purchases the business.
- Encouraging client to document in client’s estate plan whether or not child is to be treated equally with client’s other children, and the reason why.
Red Flag: Client’s estate plan does not match up with the expectations of some or all of client’s children.
Legal Documents. It’s tempting to have client’s lawyer prepare the transaction documents on behalf of client and child. Client and child may both like this idea to save money and keep things friendly. Also, child may not ask for legal counsel because child does not want to appear ungrateful.
Action items you may want to consider:
- Reminding client that the sales documents are important documents that protect both client and child.
- Suggesting client think carefully about what will happen upon client’s death. Will client’s executor, and in turn other family members, understand how to interpret the vague or ambiguous provisions?
- If child purchases the business with promissory notes, you may want to consider asking client whether he or she would take back the business or enforce child’s personal guarantee in the event of default.
Red Flag: Child is not represented by legal counsel and is generally unfamiliar with the terms of the purchase.
Hidden issues sometimes make selling the business to a child more complicated than a sale to a third party. Failure to consider these hidden issues may have a significant impact on the success of the transaction, your client’s financial wellbeing and the family relationships. When your client intends to sell the business to a child, you have a unique opportunity to deepen your client relationship by spotting and considering these issues before the sale occurs.
Matt Donovan is a Partner at Snell & Wilmer. He focuses his practice on matters relating to family wealth, with an emphasis in business transition, estate planning and administration, life insurance and charitable planning. Contact him directly at [email protected] or 303.634.2155.
