Articles Written by Charles Vander Kooi
Taking over the family business
By Charles Vander Kooi
Family business agreements often take a form similar to that of 19th century American Indian treaties. “This agreement shall remain in effect for as long as the river flows,” which works fine until somebody builds a dam. The provisions aren’t well thought out.One of the most common situations occurs when a father retires and 1 of his sons takes over the business. Often, several of the sons, maybe a daughter, once worked for the company, but over time they go in different directions leaving the company with the remaining son at the helm.
From the beginning, there’s an understanding that the son gets to take over the company on the condition that he will provide for the parents’ retirement. They come up with a figure of how much the son will pay his parents monthly for as long as they live. It's based on what they need. Dad looks at Social Security and any savings and says, "We’ll need this amount every month to live comfortably in retirement." So, that's what they agree to.
Nothing is put in writing because it’s an agreement among family, a father and son who have worked together for years. Besides, they both agree on what needs to be done. Why go out and spend money on a lawyer?
Reality sets in
The agreement works for a time, but after awhile the company has a hiccup, part of the company’s market dries up, the competition gets tougher or the economy goes south. It becomes hard for the son to make that monthly payment. Even if the company continues to do okay, what if the parents live to be 100? The son could have 40 years of payments that ultimately add up to 4 or 5 times what the company was worth. Long after he’s paid for the value of the company, the son will continue funding his parents’ retirement alone with no help from his siblings.
His payments allow his parents to maintain the value of their estate without liquidating assets. The siblings will each inherit an even share of the parents’ estate when the time comes. In short, his overpayments will go towards providing a nice inheritance for his siblings.
It gets worse over time
The longer that original loose agreement goes on, the more everyone becomes settled into accepting and expecting it to play out to the end. And, it becomes extremely hard to reverse. I have come across companies in this situation. It is very difficult to go back and get any agreement as to any evaluation of what the company was worth at the time when it was taken over, how much the son has paid already, and when the end date should be.
The siblings who didn’t “inherit” the company don’t want to rehash those things. They thought they didn’t have to worry about mom and dad. Now all of a sudden you're trying to pull something off. You’re trying to back out of paying the money you agreed to, the money you owe because you got the business. The parents see it the same way.
What should you do?
For some reason people feel that when it has to do with family, you can't just sit down and have legal papers drawn up and get down to the nitty gritty facts as if you were actually buying this business. Not doing so leads to all kinds of conflict.Before transferring ownership, I advise you get a single attorney that will represent both you and your parents. You want someone who is going to be neutral, common sense and fair. The attorney will establish a fair market value for the company, and a fair payment plan. “If your son had to buy the company on the open market, he would have had to pay $150,000. That's the going rate with interest. He's going to pay $1,000 a month / $12,000 a year. In X years it will be paid off and the payments will end.”
Involve your siblings in the business transfer agreement process so that they will understand what mom and dad are signing. Establishing the payoff date puts everyone on notice that the family will have to come up with other plans for funding mom and dad’s retirement beyond that.
A financial planner may suggest the parents take out a reverse mortgage (if the house is paid off) to provide income when the payments end. If the parents do get a reverse mortgage, the siblings need to be aware that the income the parents receive from that will reduce the equity in the house and the inheritance for everyone. Instead of a $300,000 house free and clear, it's a $300,000 house with a $150,000 mortgage.
If mom and dad don’t have the assets needed for their continued retirement, then all the family members will need to chip in to support them, not just you.
I cannot over emphasize: If you take over mom and dad's company and you have siblings who are not involved in the company, you absolutely must get everything up and above board in writing with a fair price, a fair payoff plan and a follow-up plan for taking care of mom and dad after the payoff plan is complete. And everyone needs to understand the whole situation, or it can get ugly.
Charles Vander Kooi is President of Vander Kooi & Associates (VKA) helping business owners add more to the bottom line of their company's financial performance. VKA offers seminars, workshops and private consultations. Contact VKA by calling (303) 697-6467 or visiting VanderKooi.com.
