Family business transitions are one of the most complicated situations in business because there is a lot of money at stake and family relationships may be at risk.
One of the most difficult things to consider in a family transfer is “the number,” meaning the price that will be placed on the family business when transferring it from the first generation (G1) to the second generation (G2).
If you believe the way to handle this situation is to hire a third party to create a 40 page report that provides "the number," then you are probably making a mistake.
We find that families in transition need valuation advice, but not necessarily a formal valuation. That's because the ultimate price is a triangulation of three issues:
- The need. What is G1’s number; meaning, what is the amount they need or want? In many cases, this number is not the true value of the stock but a reflection of G1's personal retirement picture. Often, G1 leaders don’t necessarily want whatever they can get; they only want what they actually need.
- The range. What is a reasonable range of values for the business? You don't need a 40 page report to tell you this. Often, you can establish a reasonable range by engaging an expert who can help the family set some parameters for the discussion and then offer valuation advice based on that discussion.
- The capacity. What can the company handle? No matter the true value or the G1 number, the third consideration is the company’s financial capacity to handle the transfer, since it is usually the source of the cash flow to fund a payout. This is G2’s principal concern, as they will be the ones left to run the company to generate the cash to pay the G1 debt.
Valuation of private companies is never simple, but establishing “the number” in a family transaction requires an understanding and analysis of these three important considerations.
Mario O. Vicari is a director with Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email.
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