Every Tuesday from 6–7pm, Baltimore’s CBS Sports Radio airs AHA! Business Radio, a show produced by Allan Hirsh Advisors. Hosted by the eponymous Allan Hirsh, AHA! Business Radio offers expert advice to business leaders and features interviews with visionary regional executives, founders, entrepreneurs, innovators, and changemakers.
AHA! Business Radio’s February 18, 2016 broadcast featured a conversation with Michael N. Mercurio, Chair of Offit Kurman’s Business Law and Transactions Practice Group. Mr. Mercurio is an accomplished business attorney, corporate advisor, and speaker who helps entrepreneurs and business owners through all stages of their organizations’ lifecycles, from formation and expansion to sales and transfers.
During the show, Mr. Mercurio and Mr. Hirsh discussed what companies of all sizes, including family businesses, should do in order to plan a successful exit strategy. If you missed the episode or would like to read the transcript, we are pleased to present Mike’s interview, in 4 parts.
This interview has been edited and condensed for clarity.
ALLAN HIRSH: One of the areas that I think is very interesting, having been in a family business, are the strategies that need to be thought about in succession planning when it’s to the next generation. I was actually fourth generation in a family business, and made a decision to close it down because of the internet. We were in the publishing business. There were some interesting transitions we went through with my dad, and he had it with his grandfather. What are some of the things that business owners should be thinking about if they believe their children or child is capable and ready to take over a business?
MIKE MERCURIO: The first thing is that they should talk about it. You alluded to that. Listen, there’s nothing harder than running a business, unless it’s running a business with your family, right? Because, in the end, every Thanksgiving, you face your family. Every Christmas you face your family. You go to work with your family. It’s very difficult when you have family, and the family’s in the business, to separate the two. The thing I’ve run across is that in families, the positioning, hierarchy, and the stereotypes that one grows up in the family have a lasting influence. If you were the lazy kid, for example, it’s very hard for your father perhaps to ever see you as something other than the lazy kid. So, you find that it’s the challenge in family businesses and in planning. I’ve had clients where the father may be in his 80s and he’s the CEO, and he really should transition, and his son is in his 50s or even 60s. And the son says, “I’m a 60-year-old man. I’m the president of my company, but my father sees me as a 6-year-old kid—I’m still that dumb 6-year-old kid that was lazy and forgetful—but I’m really beyond that. I’ve grown up, I’ve matured.” But you can’t break through. At least, I’ve found most family businesses have a hard time breaking through the stereotypes.
I had problems with my sister breaking through that stereotype. My father was fine. He turned over the business to me when I was 33. He decided he didn’t want to run it anymore and he loved to be out there selling and doing that part of the business. He said look, “You know how to run this thing, you run it. I’ll work for you.” And we transitioned it. But my sister couldn’t understand. She moved back from North Carolina and really couldn’t understand. She saw me as a lazy athlete who didn’t do much, and wanted to come back into Baltimore and become a major part of the business. It’s not necessarily the father–son or the father–daughter. It could be a sibling problem.
Yeah, the sibling problem. Especially if one sibling or two siblings are in the business, and two siblings aren’t in the business. Or, one sibling put 20 years of his or her life in the business, and suddenly Dad brings in the sibling that was the prodigal son in, and says “We’ll split it 50/50!” And you say, “Well, I just spent 20 years of my life working hard for this business, perhaps even taking less than market salary and doing everything you needed, Dad, and now you’re going to bring in son #2 and give him the keys of the kingdom—half?” It’s a tough dynamic and as we said earlier, you go home for Thanksgiving. Try having Thanksgiving after you gave your sister a performance review in the family business.
Been there. [Laughter] How about giving your father a review? One of the things that also deals with big problems in family businesses is when you have a transition where one or two of the family members are in the business and there are others that are not. They’re interested in the money. They’re not interested in reinvesting the money into the business in order to grow the business and develop more value, which is what we talked about earlier—you reinvest in the business you create better value down the road, hopefully, if you’re investing it properly—whereas those that are heirs or shareholders, because they’re siblings, want the money. They want those dividends. They want their percentage of their membership in the LLC.
The problem magnifies the more successful the business becomes. I have a client I’m presently working with, and they’re fourth- or fifth-generation family business—so very successful by all matrices, but what’s happened is over the years, as the family has naturally grown, the older generations have gifted their shares or their allotment through to their kids. Well, as you get further and further away from the founding generation and the fact that your shares were gifted to you, you run into two problems. One is the problem that you referenced, which is a problem that, “Hey, I don’t have the same mindset. I didn’t found this business. This is an investment to me. When am I getting my distribution?” The second thing that you run into is that more and more shareholders that you diffuse out. These people aren’t putting in capital, so where’s the first place the business gets its working capital from? From the shareholders—at least that’s where, theoretically, if you can’t get a bank loan or you can’t get a full bank line of credit, that’s where comes from. Good luck trying to get these from your Grandpa Joe’s third cousin.
One of things we really need to do is think about if a family member’s coming in, or is in, how do you transition? Say there’s only one child in the business: What are some of the things an owner should be looking at to try to help transition that to that next generation?
One of the things that they need to do is assemble a good team of advisors. Not to be too self-promotional, but it might be the largest legal transaction and financial transaction that that person ever goes through, and so as I alluded to earlier, for many closely held business owners most of their wealth is tied up in the business. So, you need to get a good accountant. You need to get a good attorney, because it’s really a specialized area of law—exit planning—it involves taxes. I’ve always said this: taxes drive every transaction. Every transaction is tax-driven. You need to figure out, “If I gift it to my son, what are the tax implications there? If I have him purchase it, are there tax implications for me or for him? Do I need all of the wealth that I currently have in the business, or can I use techniques to pass wealth onto the next generation through maybe transfer of ownership interests?” For example, “I don’t want to give up control, but maybe I’ll pass non-voting shares into the next generation so that they get some of the wealth or some of the equity value, but not any of the control.” Generally it comes down to control. Once you can figure out the wealth side of the equation, you have to figure out the control, and that’s always the biggest one. Most people in business are successful because they’re highly motivated, and they like to be in control. Allan, I was actually surprised that your dad just gave up control, and I guess he thought it was right.
There were exiting circumstances. We were forced by Union Bank at the time to go into chapter 11.
He was at a place where he was willing to, and he made peace with, giving up control?
Absolutely. It also gave us an opportunity at the same time to restructure the ownership. We were a C corporation, and we actually set up a voting convertible preferred, which gave him dividends and interest, and fixed his value if we ever went and sold. I got voting common, so that I as the owner—and now the leader—got the opportunity to grow the business and get the rewards for that growth. That was the structure we came up with, with legal and accounting advice.
Mike Mercurio: Yeah, so you did this like a freeze transaction. Sometimes it’s very daunting, “Where do I start?” It’s okay to start incrementally okay, meaning “let’s tackle one item.” Maybe it’s death of the founding class, or disability, but start someplace and then you can build upon it.
He had started prior to that and began transferring some of the shares of the core company to me, but it was a very interesting way to solve the problem that benefited both my dad and myself in the business. Then, the business came out of that chapter 11, 18 months to the day, and we just grew and flew for the next almost 20 years. So, it was really the right thing and the right way to do it for us. And there are many ways I know of doing this—you’re the expert on that, but there are a lot of ways to do it: whether it is gifting whether it’s buying shares, but it depends on the relationship the family has and how they want it structured.
You know, we haven’t talked about timing, but timing is really important. Many businesses go through lifecycles, and there are ups and downs, and to be able to hit your business at the peak time to transition is really important.
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