Handing over a family business is a notoriously difficult way of cashing in your chips, but it really doesn’t have to be. Keep reading to learn a very simple methodology that we’ve seen work time and again.

Stand firm: keep your profits

So many business owners assume they have to fold right at the beginning of any family succession plan, i.e. as soon as the planning starts they relinquish control of their business, they lose the share of the annual profit they’d been drawing for every year they owned the business. But why does this need to be the case?

Play your cards right and you can incentivize your children to buy you out with profits they’ve made for YOUR company. That way, everybody wins: you keep the income and cash flow you are used to, and then anything the company makes above and beyond that will be used to gradually buy your share of the company.

 You kids are buying their way into the business with their own sweat equity!

The right conditions

Of course not every company is able to do this – it does depend on the individual situation. Our method assumes that the following is in place:

• The family member(s) you are looking to pass on the company to are willing and capable to take over
• Your timeline for the sale/handover is fluid and flexible
• You are confident in the future landscape of your industry and market
• You have a stable and mostly predictable profit history

If any of the above is not in place then it probably isn’t wise to hand over your business by incentivizing the family members, but if you have the adequate stability, keep reading for a very simple method that could benefit everybody.

The method

Firstly, work out the annual sum you need to make from the company. Then from there you need to value the company using your EBITDA and an agreed multiple. And now for the fun bit:

Set up a bonus incentive for your child, based on annual profit. Let’s say your annual profit last year was $250,000 and that figure is what you wanted as the baseline. From there you can set a compensation structure that bonuses your child any profit or shares the company makes over that sum. If it was to make $300,000 in the year coming up then that’s $50,000 that can go towards a buyout, either as a lump sum of cash or it could trigger a share option in the firm.

Flexibility

The good thing about a deal structure of this nature is that it can be easily tailored to suit both parties. Both the buying party and the selling party have a shared interest in the business being successful and increasing in value, as well as the fact that family members who have worked in the same business together are likely to have a greater amount of trust in each other than would be the case in a ‘normal’ sale transaction.

The shares on offer can be flexible, the length of contract doesn’t need to be rigid; even the value of the business can be created arbitrarily for the sake of tax and estate planning.

What if the company doesn’t grow?

It might sound like there is a lot of pressure on future performance, but in reality the consequences of the company not growing as predicted are easily manageable.

In the event of there not being enough profit to give away/enough profit to acquire shares, your share of the business would remain the same as it always was. Of course, if you absolutely wanted out of the business in two years and the business didn’t grow enough to enable your child to make that happen, then that’s a different story.

But as discussed above, if you don’t have the flexibility to ride out a scenario like this then transitioning to a child on the basis of incentives is the wrong deal in the first place. If, on the other hand, you do have flexibility with your own situation and you have the trust and confidence in your child’s ability to drive your company forwards, then an incentivized deal really is a great way to go.

* For a brilliant insight on all-things succession planning, check out this interview we did with John Schindel