Adams Capital Is Uniquely Positioned to Structure and Resolve Family Business Transactions without Litigation.
Over the course of its existence, high-level members of a business will leave. Business partners — be they a family member or not — can decide to leave or sell their share in a business for a variety of reasons. Sometimes, an individual has inherited part of a business but isn’t interested in running it day-to-day. In other cases, their priorities or interests have changed. Sometimes, they are simply retiring.
Whatever the reason for the business transition, balancing fairness to the departing member with recommended practices for fortifying the on-going success of the business enterprise, can be complicated and nuanced if you haven’t planned for such an event. These transactions are complicated, particularly given the dynamic of navigating deep-seated family emotions.
Adams Capital, drawing on its vast transactional knowledge and years of experience working with closely-held family businesses, is the preferred advisor to structure (or resolve the issues which arise) in family business transactions. The optimal starting place for crafting an effective buyout strategy is in the business’ governance documents. Creation of a fair and effective buyout agreement before a departure is imminent (at business inception or when the business has reached its initial financial stability) allows the business realities and familial relationships to be heard and honored without the inevitable, additional burdens that arise once a departure is on the immediate horizon. When done timely and correctly, all expectations are clarified and relationships strengthened. But if these issues are ignored or handled incorrectly, the seeds of a permanent family rift will have been sowed.
In this post, we’ll review the options that family businesses have to implement a successful buyout strategy.
Litigation and Family Business Transactions
If you don’t plan, the announcement of a departure immediately triggers a confrontation with many family businesses defaulting to litigation. The usual assumption is that the legal process has an established set of rules that efficiently lead to a binding and fair result. Not true. The legal process is adversarial, volatile, and not well-suited to a prompt, equitable resolution. Even confidence in the finality of a trial court decision is sometimes misplaced. The trial court decision is binding, but that decision is rarely the end of court proceedings. Taking the litigation route often results in protracted arguments that last for years, compounding an already difficult situation. The legal treatises are populated with the names of well-known family disputes that have lasted decades. In the meantime, the family is suffering and the business is impaired.
For example, let’s imagine that two owners are litigating a family buyout agreement involving a few hundred acres of land. After a lengthy, expensive trial, the judge rules that they have to partition the land into two equal sections. In the absence of an appeal, most people assume this is the end of the transaction, but it rarely is. The question then becomes where to draw the line to partition fairly which takes into account often subjective market variables. Often, a judge will appoint an independent neutral party to make that decision. But the answer isn’t straightforward, so another dispute begins that must also be resolved, often through continued litigation.
Even when a family buyout agreement is honored, the victorious party might be left with little meaningful to show for it. Businesses have a much higher value than the amount of cash they generally have available on hand. So, if the buyout process requires that the existing business partner needs to be paid 25% of the value of a business, that business will almost certainly have far less than that available for a payment. Where will the money come from? If the departing partner must be paid over time, he will become a creditor of the business and will likely require a security interest in the business, which continues, rather than disentangles, family interconnectedness.
Obviously, litigation tends to be the most expensive, most time-consuming, and most uncertain route when it comes to family business transactions. Rarely is there a good “ROI” on litigation spending. There is a better way.
Mediation or Arbitration
Mediation and arbitration are alternatives to trials and are designed to reach a resolution in a less contentious setting. There are differences between the two solutions: typically, mediation is a more informal negotiating process while arbitration, while similar in some ways, has distinct advantages over having a jury of your peers determine the destiny of your business.
Mediation and arbitrations allow your dispute to be heard by decision-makers familiar with business in general and often with experience in your particular industry. Mediation is vastly less expensive than litigation but standing alone will often require some discovery of financial information and procurement of experts’ opinions before all the elements of an informed negotiation are in place and a reasoned, equitable outcome achieved. Notably, the mediator doesn’t decide the case but acts as a catalyst to bringing the parties to a consensus and agreement.
On the other hand, arbitrators do decide the merits of a business dispute. Arbitrations also are private and result in a final decision which is very rarely appealable, two features which compare favorably to the court process and explains why this approach is so popular among lawyers and clients alike. Arbitrations can be less expensive and generally move considerably faster than going to court. In addition, both these processes are more flexible than courts in terms of accommodating revisions to the scope and seeking settlement as circumstances change. They often are used in conjunction with one another.
Despite the lower cost and higher flexibility, mediation and arbitration share many similarities with litigation. It’s these similarities that often impair relationships and burden the family business during the process. Specifically, this process is still adversarial as both parties attempt to “win their case.” Each side digs in, trying to convince the other that their point of view is correct. This emotional, subjective component of the scenario often tilts the standing and outcome toward the family member(s) who have superior information access, debate, or persuasive skills. The need to make the case doesn’t always produce the best outcome. The incentive to conceal information produces distrust and long term resentment. In addition, mediators, arbiters, and supporting staff typically have legal backgrounds, and sometimes have more fluency in the manipulation of these processes than with emotional needs of the family or the practical needs of the business operations. There is a better way still.
Family business Transaction Consultations
Business transaction consultations bring to the table a professional with a financial background, accustomed to working with stakeholders to reach a fair deal. Successful consultants typically are focused on shaping consensus as what is best for the business rather than winning on behalf of their individual stakeholder clients. It isn’t about winning or losing, or even about persuasion. The goal is simply to solve the problem in the best possible way for everyone involved. Their engagement often spans the entire transaction, from negotiations to a final deal to its eventual execution and final payment. Ideally, they have been there from the beginning.
While less formal and less expensive than litigation, mediation, or arbitration, the goal of a business transaction consultant is simply different. When a part-owner leaves the company, most parties understand that he or she will need to be bought out. The conversation always comes down to price — how much will the buyout be, and how will we make it happen? To properly address those issues, it often makes more sense to involve someone who routinely deals with transaction structure, pricing, and terms — like a business valuation professional— rather than someone with a legal background.
Another benefit of consultations is that they can help both parties sort out the intricate details of an agreement, details that are often disputed in other resolution settings. Consultations can determine how an agreement will be performed in the future, not just what the agreement must entail. In the land example above, a court would order that a specific piece of land is divided equally. A consultant would help both parties figure out where to draw the line.
Finally, a consultation helps both parties arrive at a fair payout that won’t damage the business — and helps determine a business strategy to pay that price. Perhaps the business will need to take out a loan, or the existing partner will need to accept assets in lieu of cash. Because various possibilities are open during a consultation process, it is much more likely that everyone can reach a fair resolution — one that keeps family bonds and the health of the business intact. In one case our firm worked on, the price of the buyout agreement was well established, but no one could figure out how the business could pay the price without putting itself in jeopardy. Our firm helped determine the specifics of the “price,” which included a mix of property and cash. It was an outcome that wouldn’t have been possible in a litigation case because a trial judge would only set a buy-out price without determining how that price was to be paid.
Case Study
Let’s look at another example, one of my favorite cases of all time. Our firm worked with an 80-year-old woman who had inherited a 50% interest in this real estate company. When we called her family, they said a fair buyout would be $100,000. When asked for their reasoning, they said that was literally all the cash they had in the bank. We worked with them and showed that a fair price was over $4 million dollars. They understood the price but had no idea how to pay it. So we worked with them to take out a loan and hired a lawyer to draw up legal papers for the transaction. Our client walked away with $4 million dollars much more than the $100 thousand initially offered. Our primary mission was achieved to maintain a positive family relationship. This transaction was never about the money.
Choosing the Best Solution for Your Family Business Transaction
Exit strategies and buyouts are far more complicated than most owners predict. This is especially true for family businesses. Choosing the right option for your family business transaction can save time and money, helping the business continue to thrive and ensuring that the owner receives fair compensation.
Adams Capital always offers a no-cost initial telephone consultation to provide a sounding board to business owners struggling with these difficult decisions.
Please email us at tara@adamscapital.com or call us directly at 770-432-0308 to schedule a consultation or to learn more.