SYRACUSE — Case #1. A father was a minority owner of a printing company. Six months after the business was launched, he died suddenly. There was no written plan explaining ownership rights. The business was eventually sold for a substantial sum. After a decade of litigation, the family received nothing. Case #2. A mother died unexpectedly. Her three sons, who were never trained to run the business, found themselves in charge of a $10 million corporation. Despite millions of dollars in orders and a solid reputation, the company floundered and filed for bankruptcy. The assets were eventually sold at auction.
The fact that neither of these hypothetical companies had planned for ownership transition shouldn’t come as a surprise. The Monitor Group of McLean, Virginia reports in a survey that 82 percent of business owners have no written plan describing what they’d like to see happen when they leave the business. As difficult as it may be to discuss issues such as death, valuation, and family relationships, it’s critical to plan for the event and to review the plan at least annually.
The right way to do it
One company that has preached the planning gospel on ownership transition is the accounting firm of Dannible & McKee, LLP, headquartered in downtown Syracuse. Anthony F. (Tony) Dannible, the recently deceased, former managing partner, taught ownership transition for more than three decades to a nationwide audience. This reporter sat down recently to interview members of the firm’s executive committee to review their ownership transition.
“The first step … [seems counterintuitive] because you start at the end of the process and work backwards,” says Thomas V. Fiscoe, managing partner of Dannible & McKee. “But you need to decide what you would like to see happen to the business when you leave. Create a description of the goal and create a timeline. Then decide what you want to do after leaving the business. Often, having a plan is what’s needed to get owners to act.”
Second, “… select and groom your successors early,” Fiscoe notes. “Too many owners underestimate the importance to employees, vendors, and especially customers of the company’s continuity. You need to assess future owners early in the process in order to groom them for ownership and work with them on areas where they have no experience or are not adequately trained. At Dannible & McKee, we have a formal process where the current partners, who are all owners, interview any prospects and work with those candidates to improve their eligibility for an equity stake.”
Michael J. Reilly, the partner-in-charge of the accounting firm’s tax department and a member of the executive committee, stresses that “… this firm would never have grown from the original two employees to a firm of 80 if the partners hadn’t encouraged ownership positions to younger staff early in their careers.”
Reilly, who has co-authored a course on business valuation and ownership transition, adds a third point: “Too many owners have only a vague idea of the company’s value and often that’s inflated. There are a number of ways to value a company, but you need a professional to satisfy both potential investors and also the Internal Revenue Service [for estate and ownership-transition purposes]. It’s important that the evaluator be familiar with your business. For example, someone who focuses on companies with substantial assets may underestimate a professional-services firm with a solid client list and brand equity. It’s also critical that the investors approve the annual valuation to forestall any subsequent friction or even claims.”
“Which brings us to financing the deal,” Fiscoe states as point number four. “It’s not uncommon for candidates … [desirous of] a new or enhanced equity position to possess limited funds or assets available for investment. Our policy is to offer an extended payout period for up to six years, with the firm guaranteeing the transaction. There is no interest charged on the purchase of partnership units over time. The firm’s policy also requires partners to sell their total ownership interest by age 65 to avoid the concentration of ownership and the problems associated with redeeming large blocks of partnership units. Consequently, the partners are encouraged to sell small blocks of units over time.”
Reilly shares point number five. “The owner must understand the implications of income, capital-gains, and estate taxes on any transfer of ownership, both on the buyer and seller,” he exclaims. “Financing the deal is critical, but the impact of taxes can be substantial on the cost of acquisition and on net income. Structuring the ownership transfer can be as important as or more important than the price of the equity stake. For example, at a company organized as a partnership or as a limited-liability company (generally taxed as a partnership), investors can generally deduct the purchase price, which substantially reduces the cost to the buyer. In contrast, for companies organized as corporations, investors receive no deductions for the stock purchase until the stock is ultimately sold.”
The last step is the question of the transfer of power. “In some ways, the most difficult task for an owner is to give up control,” opines Reilly. “Most owners I know are ‘Type-A’, and many are used to making decisions quickly, often because they don’t share ownership. Giving up control can be a very, emotional issue for a seller. The point is that there are a number of ways to sell your interest without giving up control.”
When asked to identify the major problem in planning ownership transition, Fiscoe and Reilly respond as a duet: Owners don’t allow enough time. “The rule of thumb is that you should start when you are no older than 55,” avers Reilly. “I recommend that owners start even earlier, say 50 or before. It takes time to be sure your successor is a good fit with the company and well-trained to be an owner. You also need time to work with your team of advisers, which typically includes your CPA, insurance agent, financial planner, and attorney. They need to be very familiar with both the company and your personal situation to ensure a smooth transition. And the owner also needs time to think through the plan fully to be sure that it’s right for him.
“If we are dealing with an ownership of a family business,” Reilly continues, “the time required often increases, because there are deep, emotional issues to deal with. As an example, nearly all business owners want their children treated equally. It’s not uncommon for some of the siblings to be active in the business while others have no interest. Distributing shares to those who are not active in the business can destroy the enterprise, because non-active owners usually think the corporate value is worth more than the true market value. There are a number of ways to deal with this dilemma, which can be worked out in the planning process.”
Tony Dannible and Lance McKee, the founding partners of Dannible & McKee, “were a case study in how to handle ownership transition,” affirms Fiscoe. “They founded the firm in 1978 and at one point owned 70 percent of the firm. Lance decided that he would like to pursue his passion for wine, and sold his units over time before exiting to open a wine-importing business. Tony also sold off his ownership interest well in advance of his untimely death last year. Both encouraged and groomed others for a position as partner. Today, the ownership is well distributed so that no one controls a large block,”
The executive committee at Dannible & McKee includes Fiscoe, Reilly, and Kenneth C. Gardiner. Fiscoe joined Dannible & McKee in 1993, following a stint as an audit partner with an international accounting firm. He is a Le Moyne College graduate and assumed the managing-partner position in 2013. Reilly, also a Le Moyne College graduate, began his accounting career in 1979. In addition to his role as the firm’s partner-in-charge of the tax department, he also heads up its valuation and ownership-transition practice group. Gardiner, who is the partner-in-charge of assurance services and quality control, oversees audit and accounting services to the construction industry, manufacturers, and specializes in employee-benefit plans. He joined Dannible & McKee in 1981.