Don’t put the cart before the horse

February 01, 2014

Carl Harrington was devastated when he was forced out of his ownership of Carmichael Manufacturing by his cousin Josh. Carl believed they had a reasonably good partnership and would never in a million years have thought that Josh would oust him from the family business their grandfather had founded over 70 years ago. How could this have happened?

Jim Thorne never discussed his thoughts, ideas or future plans with any of his family so when he died suddenly there was no identified leader among the equal heirs. His wife struggled to keep the business running while the kids fought among themselves about what was the right direction for the business.

Abe Goldberg is upset over the accusations flying as his children vie for autonomy. He can't understand what went wrong. He always took such care to reward his children equally in order to avoid any competition.

Ryan Holt is peeved that his siblings disagree with his renovation plans for the car dealership. These upgrades are essential to the continuity of the franchise agreement and ultimately his business. He desperately needs their support.

What caused these problems?

Many family business squabbles are the result of putting the cart before the horse - implementing well-intentioned business, ownership and tax management strategies without adequate forethought or discussion around their potential impact on personal or family relationships. Consider the negative effect these technical solutions had on the four situations above.

Carl and his cousin Josh had a shotgun clause for an exit strategy. Josh, a silent partner not involved in the management of the company, wasn’t happy with the way Carl was running the business and activated the shotgun clause. Unfortunately, Carl wasn’t able to arrange financing in time and had to accede to Josh. Not only was Carl's life thrown into a tailspin, the action severely destroyed relationships between the two branches of the family.

While Jim Thorne was able to take advantage of tax savings through gifting considerable share value to his three children, he also created an “accidental partnership” among siblings who had no idea that they would end up in business together. Unfortunately, this accidental partnership didn’t come with any leadership or decision-making instructions.

Abe Goldberg is alive and well, and actively managing his tax liability. His four children all receive equal bonuses and directors' fees even though only two of them have a management role in the company. Now the kids are fighting over who works harder and who deserves more compensation.

Frank Holt truly thought he was doing the right thing when he left the car dealership to his son Ryan, the only one of his four children interested in taking over. To be fair to the others, he gave them each a one-third share of the property and outside investments. He didn't foresee Ryan having to ask his siblings to re-investment in the property because the “franchisor” ordered a complete overhaul of the building! Nor did he foresee that strained relations would result from his “fair and equitable” estate plan.

Our wealth transfer process

Through vehicles such as a family trust or a shareholder agreement, the advisors to the above business owners actually created policies with outcomes that the families didn't expect or fully understand - policies that dictated the terms for compensation and future ownership or leadership of their clients' business.

There is no doubt that the financial, legal and management professionals who advise entrepreneurs and privately-owned businesses are highly-qualified, extremely protective of their clients and adept at saving them money. The part that is often missing is the communication - the discussion about how a proposed solution or strategy might impact individual stakeholders and the family unit.

Our wealth transfer process was designed to ensure you don’t fall into the same trap, but rather take the time to consider the implications of all common business tactics before adopting them as your family and business policies. The diagram below maps out the steps in the communication journey to more effective shareholder agreements, family trusts or other tax management strategies.

Wealth-Transfer-Process-(1).png

Had the “what ifs” of the tactics suggested to Messrs Harrington, Thorne, Goldberg and Holt been more thoroughly explored using the model above, these business owners might well have chosen a different strategy, or at the very least consciously accepted the liabilities that came with each solution.

In continuing our exploration of the approach to preparing for a change of leadership and ownership of your business, our next article will review the critical components of an effective Shareholder Agreement. In the meantime, if you require assistance or more information, be sure to contact your BDO advisor or a member of The BDO SuccessCare team at 1 800 598 6400.

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