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Determining the Price of a Family Business
December 1, 2010

When a parent who owns a business intends to transfer the business to a new owner who is not a family member, it is obvious the business will be sold for the highest price obtainable. However, when the company is to be transferred to one or more of the owner’s children, the family has to decide if the transfer will be a full value sale, a complete gift, a sale at a discounted price, or a combination of sale and gift—for either full value or discounted value. This article considers the factors a family should consider as it decides how to price or value a transfer inside the family.

The determination of whether to sell or gift part or all of a family business is a highly personal and emotional one for the family. Parents and children usually wish to avoid difficult discussions about what the company is actually worth, how much control the founders will retain, how long that control will be maintained and other subjects which would not be present in the negotiations with a non-family purchaser. While understandable, a reluctance to confront potentially difficult issues can often delay the transfer or lead to hard feelings within the family later when misunderstandings arise.

Several common elements are usually taken into account when the family is trying to decide how to price the business for an intra-family sale or gift:

  • Parents often focus on how much retirement income they "need" rather than on how much the company is realistically worth.
  • At the same time, parents also wish to transfer the business to children at less than full value, to the extent they think they can “afford” to give up some retirement income.
  • Parents are likely to help finance a purchase and be aware of the risks involved.
  • Parents and children usually consider whether meaningful collateral to be given to the parents is available and whether giving collateral is agreeable to all parties involved.
  • Parents often consider making partial transfers of ownership over time, often including some gifting, to help bring down the price, but also to give the children time to prove their leadership capabilities and to give the parents a form of continuing control and collateral.
  • Children (and often parents) tend to focus on how much the company can afford to pay to either the parents or to the bank as loan repayments.
  • Parents and children eventually learn that in order to avoid tax problems, the transfer value must have a reasonable relationship to market value. Advisors are often brought in at this point to help structure the transfer so that the price reflects the point along the continuum of lowest to highest value at which the family desires the transfer to be made.
  • Some parents feel a full value sale is necessary to motivate the next generation owner(s) who might otherwise feel ownership is an entitlement.
  • Other parents think a full value sale is the best method of providing for children not active in the business since it increases the size of non-business assets in their estate, which will ultimately be available for the benefit of children not involved in the business.
  • Pricing can be affected by who is obtaining voting control and whether non-active family members have ownership and/or voting rights.

The value placed on a business to be transferred from parents to children involves many factors that don’t exist when a company is being sold to an outsider. Assuming the parents and children want that business to stay in the family, one of the first issues to consider is how much money will change hands between family members. Since competing goals exist (the parents' need for income, the business' ability to fund the parents' financial needs and the frequent desire of the parents to discount the transfer price to the children) the decision process of how to price the business—and whether to gift a part of it—takes a decidedly different route than when a sale is contemplated to a third party.

If you have any questions or would like more information, please contact Harold A. Laufer at 414-225-1423 or hlaufer@dkattorneys.com.

 

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