Lee Oosthuizen

Certified Financial Planner®

Family businesses – leave a legacy

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Family businesses are genuinely the lifeblood of any economy.

They put food on the table and put the kids through school. They create desperately needed jobs. They pay their taxes and get involved in the community. These are the reasons why many people go out of their way to support small businesses.

But what happens to these companies when the worst happens and there is a tragedy?

We never want to think about this stuff, but we have no choice. A family business supports not just one household, but often several households. A lack of contingency planning in the event of tragedy can result in the collapse of the business and loss of income for multiple families.

Contingency planning

South African entrepreneurs are forced to navigate tricky regulatory requirements, load shedding, little or no economic growth, evolving B-BBEE requirements and more recently the Covid-19 lockdown.

It’s an absolute warzone, but plucky South Africans manage to get it right. Unfortunately, swimming in such rough waters leaves little time to think about contingency planning.

Without contingency planning, a life’s work can be reduced to ashes if the key leader in the company either passes away or is no longer able to work.

Run it properly or sell it

The primary challenge in these situations is separating painful emotions from objective business decision-making. Not only does the family need to recover from the loss of a family leader or a related tragedy, but they have to pick up the pieces of the business and move forward.

“This is what dad would’ve wanted” and “Mom always ran it this way” are great examples of the emotive language that comes to the fore at times like these.

Chances are that dad or mom would’ve just wanted the family to make the right decision for everyone involved, leaving aside any emotional baggage and without regard for societal norms or pressures.

Far too often, the assumption is that the family can simply pick it up where the founder left off. Nepotism is frowned upon in corporates and there is good reason for that: being related to the founder isn’t a good enough reason to be appointed as the next CEO.

In many cases, the family would’ve been better off selling the business and investing the proceeds instead. Without contingency planning though, the business cannot be sold. This leaves the family scrambling to run the business, often with an unpleasant outcome.

Succeed through succession

Succession planning should be the centrepiece of any contingency plan. Who is going to take over from the current business leader?

Funds should be allocated to headhunting and employing a new key-individual who has the required skills and experience to keep the business going. Ideally, this person should be hired with a view to sticking around for at least 5 – 10 years. This gives the family runway to decide whether to sell the business with a manager in place or keep it and earn dividends for a period of time.

Of course, many companies cannot afford a period of the founder and a successor both working in the business. In a perfect world, there would be an overlap and perhaps an equity incentive for the successor, but this isn’t affordable in smaller companies.

A life policy on the key individual (Key Person Insurance) can fund the hiring of a new manager in the event of the loss of life of the founder. The proceeds would be paid to the company and the business can move quickly to put a new manager in place. It’s not the optimal solution (vs. an overlap and handover period) but it can save the business from financial ruin.

Buy and Sell Life policy

This technique is appropriate where there is more than one shareholder in the business or where there is a party who wishes to acquire the shares in future. In the event of the death or incapacitation of one of the owner-managers, the other shareholder or new owner can purchase the shares from the deceased or incapacitated party.

The valuation would be based on a methodology agreed upon by the parties and reduced to writing in a binding Buy and Sell agreement. For example, such a methodology may be based on a multiple of sales or audited profit.

The problem is that the purchaser may not have the capital to execute the purchase, leaving the deceased estate or the incapacitated party without a way to realise the value in the business. This can be provided for through a correctly structured Buy and Sell Life policy.

It is critical to implement such a structure correctly, as the policy in place without a binding Buy and Sell agreement is a dangerous situation. An unscrupulous purchaser may elect to retain the proceeds of the policy without buying the shares, leaving the surviving family with no ability to sell the shares and no related amount to support the household.

Legally, there is nothing the surviving family can do to compel the recipient of the proceeds to honour the intended purchase. There has to be a binding contract in place to enable this.

Lift your head from operations and build a contingency plan

It’s difficult to pull yourself out of the day-to-day operations and build a contingency plan, but your loved ones may depend on you doing so. You’ve spent your life building your business – don’t let it fall apart in your absence.

Family businesses are important. Family legacies are even more important.

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