The pirates’ exit strategies although quite brutal, were perfectly clear to the crew onboard. These are not necessarily the recommended exit strategies for family members, although, it may sometimes feel like these methods would be appropriate! The code of conduct or articles onboard ensured that the terms and conditions of exits were clearly defined and all crew members were aware of them. For family businesses, there are a number of circumstances for which the terms and conditions of exit should be clearly outlined – not just running away or keeping a secret. For a family business, their family business rules should outline the terms and conditions for voluntary exit, retirement, death, incapacity, and even termination.
The details surrounding each of these exits will not necessarily be the same, but will be clearly outlined so that all family members know what to expect in each of these scenarios.
Exit Strategies in a Family Business
Family members often end up staying in the family business longer (sometimes too long) than they would like because they are unsure of the repercussions related to leaving. They often have too many unanswered questions, therefore, the safest thing to do is remain in the family business. Some of these unanswered questions are:
- What value will I be paid for my ownership?
- Will the family business be able to afford my exit?
- What if we don’t agree to the value?
- Over what time frame will I be paid?
- Will there be an interest component tied to the outstanding balance?
- Who gets to purchase my ownership and will this create a problematic power dynamic in the family?
- If I sell my shares, will my kids still have a chance to join the family business and become owners?
Exit Strategies for the Pirates
These questions are much more complex than the issues the pirates had to deal with. However, the lesson from the pirates is to be clear about what each exit entails and what family members can expect. Can I expect to remain on the boat or will I be marooned? The answer to these questions for the pirates was crystal clear. Families in business should aspire to have terms and conditions for their exits that are just as clear as the pirates.
Family Business Rules
Families in business should ensure they have family business rules relating to exit strategies. These rules should outline the terms and conditions of each exit, which should also be clearly stated in the shareholders’ agreement. Some of the terms and conditions that could be considered are:
- If a shareholder exits within the first 5 years of joining the ownership ranks, that owner will forfeit any related growth. The goal of this is to ensure that ownership is not taken for granted and used to make quick cash. We want committed owners that will act as stewards of the family business.
- A mandatory age for retirement from ownership (i.e., 65) if there are potential or existing successors in the business. However, this does not necessarily mean a mandatory retirement from work! Some may choose to continue to work either full time or part time with the approval of the rest of the owners.
- A Fair Market Value (FMV) valuation will be completed to ensure the retiring family members get a fair value for their 20 - 30+ years of work
- A methodology for dealing with disputes with respect to the determined value
- The value will be paid over a PREDETERMINED time-frame. Some families will outline if the amount is between $1M - $2M it will be paid over 5 years, $3M - $5M over 10 years, etc. The idea is to ensure the person exiting is aware of what they can expect to receive each year, but just as important is that the business won’t be strapped for cash.
- What rate of interest will be tied to outstanding debt? Will it be tied to inflation or the Consumer Price Index (CPI)? Will the debt be secured by a General Security Agreement (GSA)? What happens if the company cannot pay the full annual payment? Is there an obligation to pay at least 50% of the annual amount? This should be clearly outlined.
- What happens if there are multiple family members retired or retiring at the same time? The company needs sufficient cash flow to operate effectively yet the retired owners need to know what they can expect from the company. An annual pro-rated maximum amount is often used to address this situation.
- In the case of termination, some family businesses will discount the value of the shares from anywhere between 10% - 25%. This is meant to reflect the cost of recruiting a new employee as well as the disruption to the business created by the termination.
- Life insurance should be used to fund part of the exit at death of a shareholder – this reduces the burden on the company as well as the family
- All the same considerations as for retirement
Whatever the terms and conditions related to each exit the important part is to have them predetermined, incorporated into the family business rules and even more importantly incorporated into the shareholders' agreement. The more details that can be predetermined such as timeframes, interest rates (tied to inflation or the Consumer Price Index) the better.
Stay tuned for Lesson 4 – Dispute Resolution Process! Your family may not choose to solve all disputes with a sword and pistol (although sometimes tempting), but there is a process you can use that is just as effective (and less violent)!
Please click on the links below to access the previous articles in the series.