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Ownership Transfer And Succession In Family Business

One of the greatest challenges facing family businesses is that of successfully transferring ownership from one person to another; or from one generation to another. In some instances, health businesses are shut down when their owners become incapacitated or die. In many other instances, successors inherit a healthy business, which is forced into bankruptcy because of lack of available liquidity to pay inheritance taxes and other taxes.

Ownership Transfer And Succession In Family Business

Problems could also arise when the interest of one family member do not align with another family member or when the interests of the entire family (especially, succeeding members) and the business are not aligned (Loewen, 2008). Moreso, ownership and business roles involve different and sometimes conflicting values, goals, and actions (Carlock, Kets de Vries & Florent-Treacy, 2007).

Hence, wrongful or inappropriate transfer of ownership among other things has the potency of generating tension and unhealthy rivalry among family members. These underscores the importance of the construct of ownership transfer and succession especially in family businesses. To overcome this challenge, concepts like business exit planning, replacement planning, succession planning (About.com, 2015, Arieu, 2010), ownership transfer etc., have been developed.

In this article, our focus shall be limited to the essentials of ownership transfer and succession as it applies to family business. Specifically, we shall look at the general forms of business succession and ownership transfer and ownership transfer processes in family business.

See Also: Importance & Challenges of Small and Medium Scale Enterprises (SMEs)

GENERAL FORMS OF OWNERSHIP TRANSFER/BUSINESS SUCCESSION

Businesses can be transferred through a number of ways; depending on the nature and type of business. Funsten, Sznewajs, Duncan and Warner (2013) posited that generally, there are only three ways to transfer ownership of a company. According to them, the first is liquidation, the second is gifting; while the third alternative is to sell the business.

1.) Liquidation: In this case, the operations of the company are wound down. Usually, when an owner liquidated his business, he rarely gets the anticipated value. Some of the reasons for this include the fact when employees know the firm is shutting down, they might insist that outstanding jobs be executed at higher costs; sale of properties and equipment attract fees which must be paid in full. Moreso, when customers and clients know the business is about to be wound up, they are usually slower to pay up and honor their obligations.

2.) Gifting: This alternative According to Funsten et al (2013) works well if family members are actively involved in the management of the business and the gift is structured to avoid tax obligations that require a sale or partial sale of the company. However, this hardly works when the gifting is to persons who are not involved in the business, probably because other stakeholders like customers, employees and suppliers are often reluctant to accept new owners who they are not well acquainted with and are not sure of their ability to manage the business.

3.) Selling: With the option, acceptable price is exchanged for the value of the business. Owners may choose to sell internally or externally to third-parties usually at the open market. This appears to be more realistic and acceptable to most of the parties involved since it affords them the opportunity to negotiate terms and work out transfer modalities.

OWNERSHIP TRANSFER PROCESSES IN FAMILY BUSINESS

The Pros and the Cons.

When it comes to family business, the transfer process is not usually as simple and straightforward as it is with non-family businesses because family relationships often compound the transition problems. Issues like culture, nature of family and vested interests help to exacerbate the problems. These notwithstanding, three basic procedures of transferring ownership in family business have been identified. These are inheritance, gifting, purchases and other family transactions which may involve a combination of methods (Cornblatt, 2013; Funsten etal 2013; Parrish 2013). These are discussed in details below.

1.) Inheritance

This is a situation where ownership passes on to family members as birth right; usually the heirs apparent. Under this arrangement, successors need not pay any price or have any special qualification for this legacy to be quitted to them; except the fact that they are legitimate heirs or family members. Several cultures especially in African setting tend to support this mode of ownership transfer. While this may seem good, easy and favoured by many cultures, there are quite a lot of challenges, advantages and disadvantages associated with this mode of family business transfer.

Advantages: Since in this ownership transfer method, successors are already known,

  • It eliminates the initial problem of deciding on the transfer method
  • It encourages early preparation of successors for eventual take over
  • It requires less extensive succession planning.
  • It eliminates the problem associated with successors having to pay for ownership right such as ability to pay without disturbing the financial stability of the business, capital gains tax issues, and so on.

Disadvantages: Some of the inherent disadvantages include:

  • It may encourage laziness on the part of succeeding heirs, imagine someone inheriting a business he never laboured to grow.
  • In cultures that encourage only male successors, it is gender discriminatory.
  • It fails to answer the question of what happens when successors are either not interested in the family business or are ill-equipped to inherit and probably mange such.
  • Some business owners may find it difficult to completely handover and relinquish control; thereby making smooth transition, proper management and authority difficult.
  • The business might become a breeding ground for conflict and hostilities if the successors (in this case, children to whom the business is to be transferred) cannot agree among themselves on important managerial or operational issues.
  • In situations where the heirs do not like themselves or find it difficult to get along, they might be involved in endless litigations and may be forced to liquidate or sell the business. When this happens, the purpose of setting up the business as a family enterprise will be defeated.
  • Unresolved disputed between Founder’s and their children might stall the transition process.

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2.) Gifting

Family businesses can be transferred from owners to successors as a gift. In which case they are not required to pay for the acquisition. Successors in this instance do not necessarily have to be family members. They can be close/distant relatives, friends, employees, acquaintances or even strangers.

Advantages:

  • Since it is a gift, it eliminates the problems associated with successors having to pay for the ownership rights; such as ability to pay without disturbing the financial stability of the business, capital gains tax issues, etc.
  • It equally eliminates the problem associated with conflicting interest of family member-successors in the inheritance method.

Disadvantages:

  • A gift is a gift; and may not be appreciated by the receiver.
  • A gift though appreciated may be mismanaged since one may not have laboured or paid to acquire it.
  • It may require extensive succession planning especially when successors are not not family members.
  • Family legacy (with regards to the business) may be lost; especially with non-family member successors.
  • When gifting is to persons who are not involved in the business, stakeholders like customers, employees and suppliers are often reluctant to accept them because they are not well acquainted with them and are not sure of their ability to manage the business. This can be frustrating to the successors.

3.) Purchases or Selling

When ownership is transferred based on a consideration, purchase is implied. Usually, acceptable price is exchanged for the value of the business. The consideration may be financial, non-financial or a combination of both; as long as the owner-transferer considers it adequate. Depending on the agreement, selling might be in part or in whole. Owners may choose to sell internally or externally to third-parties usually at the open market. This appears to be the most favoured method because of the inherent benefits to the owner-seller, successor-purchaser and other stakeholders.

Parrish (2013) summed it up when he opined that most family business owners prefer to see their children who are active in the business as “successor owners” rather than “heirs”. According to him, instead of being silver-spooned beneficiaries of a lucky last name, owners want their children to share in their entrepreneurial spirit and take the business to the next level.

Advantages:

  • It ensures the successors are really interested in the business to the point of investing resources to own it.
  • It appears to be more realistic and acceptable to most of the parties involved since it affords them the opportunity to negotiate terms and work out transfer modalities.
  • It makes owners have something to fall back to as they hands-off the business.
  • It gives the seller-owner a feeling of a sense of fulfilment that yes; he did not just throw away his business but have value for his efforts.
  • Having some form of control (say, residual) over the business while payment lasts, helps the seller-owner to gradually adjust to life without the rights and privileges usually enjoyed.
  • It puts successor-owners on their toes to work hard to grow the business better than they met it so they can have returns on their investment. This is because the purchase price is supposedly the net worth of the business plus whatever they are ready to pay in excess (goodwill).
  • Sequel to this is the point that it affords successor-owners the opportunity to share in the entrepreneurial spirit of the owner-seller; thereby compelling them to take the business to the next level (Parrish, 2013).
  • Since successors have to pay to own the business, it eliminates most of the problems associated with the other methods of transfer especially those involving family disputes and inheritance rights.
  • It helps successors to be at ease and not be burdened with the feeling of obligation to the predecessor-owners who may want to be regarded as benefactors.
  • It enhances a smooth transition process as the terms are known and well spelt out.
  • By adopting the business approach, It eliminates the sentiments associated with gifting and inheritance methods.
  • It provides a platform for effective and unbiased evaluation of the business so as to ascertain its real worth.

Disadvantages: As good as this method may sound, there are some inherent downsides. These includes:

  • Working out payment modalities may be cumbersome and sometimes lead to disputes.
  • Where there are many interested parties in the purchase, agreement on purchase rights may endanger disputes.
  • In cases where purchasing-successors are employee of the business, it raises such questions as asked by Cornblatt (2013) “how do children, whose only income and source of funds is the business, find enough money to buy ownership and ti cash out the Founder’s without crippling the business”?
  • Experienced buyer-successors consider several factors like robust and varied customer base, distinctive and durable management and exceptional competences as conditions for purchase negotiations. This makes selling a challenging process only a few owners are able to overcome without a pre-planned and well thought out strategy.

CONCLUSION

This article focuses on ownership transfer and succession in family business, it entails the various ways by which succession in business can occur. It can also be seen that ownership transfer and business succession in family businesses can be a very challenging excercise which is capable of stiring up agitations and conflicts when it is inappropriately executed. Experts have advocated three major processes of effecting the transfer; with each of these having their own merits and demerits. These challenges can however be overcome through a careful and well thought out plan.

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Chris Esther

An experienced blogger whose top aim is to share knowledge and give out information.

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