By Bryan Borzykowski
François de Gaspé Beaubien always knew he and his two siblings would one day take over the family business.
His father, Philippe, started Telemedia, which at one time was a leading Canadian media, magazine and telecom company. He trained his children to be owners from the beginning. “Most entrepreneurs look at what's next," said de Gaspé Beaubien. “My dad already had his career planned." That plan included an exit and eventual passing the business to his children.
The family had many discussions about what it takes to run a business with relatives, but they still had lessons to learn when the children took over in 1999.
De Gaspé Beaubien’s father gifted the company to him, his brother and sister; something they were grateful for. In hindsight, De Gaspé Beaubien believes a smoother transition would have been reached had he bought the company outright. Since he hadn't transferred funds, their father felt he was still entitled to share his opinion about the direction of the business.
“When I told him I wanted to get out of the magazine business, he was adamantly opposed," said de Gaspé Beaubien, who eventually turned Telemedia into Zoom Media, a company that operates television and music systems in gyms around the world. “So I sat with him and said, 'when you handed over those shares, did you really hand them over?'"
"If we had purchased the company with a check and a payment schedule then it would have gone much better."
This is just one of many lessons entrepreneurs should learn before selling a business to their children. Here are four more tips for a smooth transition:
1. The Right Valuation
While selling a business to a family member is not the same thing as selling to an outside buyer, in both cases the owner must determine the fair value price of the company. But what fair value means can vary depending on the buyer.
The actual valuation process should be the same for everyone, said Dean Deutz, a private wealth consultant with RBC Wealth Management in Minneapolis. You should look at cash flows, debt, potential customer base and more. The difference comes in the valuation number you use.
The price is typically based on a multiple range. A business could be valued at between 15 and 20 times earnings, for instance. If you sell to an outsider, you'll take the high end of the range. When you sell to a family member, you usually take the low end, Deutz said.
But taking the low end only works if you don't need the income from the sale, he added. Some people will want to charge their children the higher amount because they need the money for retirement.
2. How To Pay
Typically, when a business owner sells, the buyer will pay for the company upfront or in installments over a period of time. But when a family member buys a business, money tends not to change hands right away.
Generally, the children will pay the purchase price over a number of years out of the cash flow of the business. It could be three years, or a lot longer—depending on company cash flows and the financial situation of the parents.
In the U.S., family members who loan money to other family members can get a special interest rate, said Van Pate, a wealth strategies consultant with RBC in Charlotte, N.C.
The current Applicable Federal Rates— the name given to these special family rates—is 0.48 percent annually for a loan of less than three years, 1.77 percent for a loan of between three and nine years and 2.74 percent for a loan of more than nine years. By comparison, the bank prime rate is currently at 3.25 percent.
While you can agree to a higher rate, you can't charge a lower one or it may become a gift, said Pate.
“As long as the loan is negotiated at at least that applicable federal rate, then the IRS considers it a bona fide business transaction," he said.
3. Giving A Gift
If you charge a lower rate or hand over shares of the company for nothing, it's considered a gift. While de Gaspé Beaubien advised against this route, business owners who are financially secure may want to hand over the company to their children for nothing in return.
Tax considerations may also factor into the decision of whether to sell or gift. In the U.S., you can gift up to $5.43 million in assets before capital gains taxes are owed, said Pate.
If a couple owns a company, their lifetime gift amount would double to a combined $10.86 million. While the business owner may not have to pay tax on the gift amount, the cost base of the business will transfer to the beneficiary.
Say a business costs $10 million, but it was originally purchased for $1 million. If the parents sell the business to their child, then the new adjusted cost base will be $10 million. If it's a gift, the cost base stays at the original purchase, which means the child will owe tax starting at $1 million when they sell. If the business grows in the offspring's hands, taxes owed could be significant, said Pate.
4. Get It In Writing
Family business is often conducted with a handshake, but verbal agreements can cause problems. An owner should have a shareholder agreement in place outlining who gets to vote, board member responsibilities and how shares should be valued in the event of an exit.
“As soon as there's a shareholder agreement in place, it becomes much easier for the golden generation to get the exit discussion going with the next generation," said Olivier de Richoufftz, president of the Montreal-based Business Families Foundation, a not-for-profit organization that helps support family businesses. “It will become clear what they want to receive for their business."
For a sale, a buy and sell agreement should be created. This includes details such as business valuation, an amount paid, a payment schedule, whether the parent will be kept on payroll and receive an income, and whether the parent can still be involved in the business.
This is something de Gaspé Beaubien didn't do, but realized later he should have. “My father just handed it over," he said. “We should have had a sale agreement with a third party valuation."
It helps to bring in experts to facilitate this often-lengthy process. It may take years for parents and children to reach a point of an exit, and it can take a decade before the purchase price is paid off. You may also want lawyers, accountants and financial advisors to help navigate the emotional territory that comes with selling a business to family.
“You need an advisor team in place who can talk about their experiences and guide families through the pros and cons of various paths," said Deutz.
Today, de Gaspé Beaubien runs multiple businesses, including Zoom Media, and he's invested in companies his siblings run as well. While his two preteen children are too young to know if they want to be in the business, he's already preparing for the transition.
“I'm convinced that there will be family members in this business," he said. “I'm starting to talk to them about it."
RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.
Bryan Borzykowski's writing focuses on investing, personal finance, small business and technology. His work has appeared in the New York Times, CNBC, CNNMoney and BBC Capital, among other publications. He's also written three personal finance books. Follow Bryan on twitter @bborzyko.
