When you own a family business, it’s not uncommon to keep the ownership among blood relatives.
But as your business continues to grow and thrive, you may find yourself identifying certain non-family members who could help take your company to the next level, even after your retirement.
Is transitioning to an employee-owned business the right move for you? What is direct equity ownership, and how can it change the landscape of family-owned businesses?
Below we’ll discuss family business financial planning and what owners should think about as they consider this unique business arrangement.
Understanding Equity Ownership
When it comes to family-owned businesses, the natural transition of ownership is to your next of kin or other trusted relative. But direct equity ownership is another option that, in some cases, could be beneficial to you, your business, and your employees.
Adding someone outside of your family to the capitalization table as a new owner is a consequential decision and one you shouldn’t take lightly.
Because this option is not for everyone, we’re discussing the risks, potential rewards, and alternatives for business owners to recognize.
When Would Equity Ownership Be Right for Your Business?
If you’ve identified a few strong candidates within your company to become a successor or partner, equity ownership may be a viable option. After reviewing the information shared here, consider talking over this possibility with them sooner rather than later.
These individuals should be capable leaders, passionate about your business, and prepared to take the reigns in the event of your retirement or passing.
Risks of Equity Ownership
We recommend keeping a very select number of people outside of the family as shareholders in your business.
The more shareholders, especially those who aren’t family, the more potential for turbulence within the company. For example, if these outside shareholders believed you (the founding owner) were taking too high of a salary, this could lead to ugly disagreements and even potential lawsuits.
Protecting yourself and your business means being highly selective in who gets equity ownership.
Benefits of Equity Ownership
If you’ve identified a potential successor who you know will do great things, giving them direct equity ownership is an effective and rewarding way to prove your trust in them. It’s a clean, official way to provide them with some skin in the game as an owner of your business.
The Importance of a Buy-Sell Agreement
As you begin giving your trusted successor equity ownership, you must work with an attorney to draft a Buy-Sell Agreement. These agreements protect shareholders from financial devastation or loss due to the “Four D’s” – death, disability, divorce, and discharge.
As an example, say your newest partner passes away suddenly and unexpectedly. Should your partner’s spouse, who has no working knowledge of the business, take his place as a shareholder? Probably not.
Another common scenario is that your shareholders disagree, and one wants out. What happens next?
That Buy-Sell Agreement initially signed by all parties helps outline the next steps for these typical examples. It’s an essential and effective document because it eliminates possible confusion or disagreement surrounding future concerns.
Alternatives to Equity Ownership
As we’ve emphasized before, you should only offer equity ownership to a few valuable and trusted employees. As such, this may not always be a viable option for business owners.
If this is the case, alternatives to equity ownership could include:
Phantom stock plans
Deferred compensation plans
Stock appreciation rights
Employee Stock Ownership Plan (ESOP)
These are effective ways to reward your employees’ hard work and loyalty without the potential headaches or risks associated with making them new shareholders. We recommend most business owners explore these options before considering direct equity ownership.
Employee-owned companies aren’t just internally attractive, they can make your company more attractive to potential clients and customers as well. In fact, recent studies show that consumers are actually more willing to buy from a company that they know shares profits with their employees.
While this can make for a unique succession plan for you, it’s still in the best interest of your business to be selective in who you trust to control your company.
The Benefits of Employee Ownership
At the end of the day, employee ownership encourages your employees to have more skin in the game. It allows them to participate in company decisions, shape the company’s growth, share in long-term innovation opportunities, combat financial inequalities, and more.
If this is an option you’re considering, we recommend giving Skin in the Game: Hidden Asymmetries in Daily Life a read first. This is an excellent book by Nassim Nicholas Taleb, which discusses the power of creating an ownership mentality in employees. When done right, direct equity ownership can increase the success of your transition plan and business as a whole.
Consider Your Options With Toberman Wealth
As the owner of a family business, the long-term success of your business is your top priority.
As an investment advisor, we help business owners like you discuss complex decisions, such as whether or not to pursue direct equity ownership. We’ll coordinate with trusted experts to help you cover your bases during this challenging decision-making process.
If you’re considering this option for your business, don’t hesitate to reach out to our team today.
Craig Toberman is the Founder of Toberman Wealth – a fee-only financial advisor based in St. Louis. He assists families and businesses with strategic financial planning and long-term wealth management. He has over a decade of experience in financial services and has crafted custom financial plans for hundreds of families and businesses.
Craig received a Bachelor of Science (B.S.) degree in Agricultural and Consumer Economics from the University of Illinois and a Master of Business Administration (M.B.A.) degree in Finance from Saint Louis University. He is a Certified Financial Planner (CFP), Chartered Financial Analyst (CFA) charterholder, and Certified Public Accountant (CPA).
Craig is a member of the National Association of Personal Financial Advisors (NAPFA), Fee-Only Network, and XY Planning Network.
Craig lives in the greater St. Louis area with his wife, Ally and son, Hank.