Drama-free Owner Buyouts in Family Business

You don’t have to look far into the popular press or on television to find stories of drama-filled buyouts involving a family business owner or a group of owning family members. What’s harder to find are examples of families that consolidate their ownership group with minimal angst or conflict. Why is that? In short, some families have agreed on a process for buying out shares, one that is widely seen as fair.

Having a clearly defined, agreed-upon process increases the likelihood that family shareholders, whether exiting or staying, will accept the outcome and move on, even if they don’t like the result.

This article explores approaches families can use to navigate ownership buyouts smoothly and with minimal conflict. We aim to offer practical guidance for families dealing with buyouts both with and without a pre-existing process in place.

Family Owner Mindset Matters

When it comes to owner buyouts, family mindset matters. A family culture that accepts a member’s desire to exit their ownership position, either partially or fully, sets the stage for drama-free transitions. Having the option to exit is powerful. It gives owners a sense of control and personal responsibility, often resulting in greater engagement in their ownership role.

Importantly, providing a way to exit that does not disrupt business operations or the remaining ownership group is a key ingredient in reducing conflict.

The reasons for wanting to exit are varied and personal. These include funding other life goals, such as college tuition or a home purchase, diversifying their investment portfolio, fatigue with the business relationship, or a risk appetite that differs from that of other owners. Interestingly, when a choice to exit exists, it tends to lower anxiety within the family ownership group and increase the likelihood that owners will want to stay invested. After all, who wants to be in a business relationship with no option to leave?

Another helpful mindset shift is to view ownership as an investment in the family enterprise. With this perspective, families are more likely to respect the rights of all owners, regardless of how they came into ownership (through gift, inheritance, purchase, or a combination) and their role with the enterprise (whether as executive, governing owner, or passive investor). This contributes to positive relationships, a sense of belonging, and open communication.

Lastly, families that prioritize both the collective well-being of the family system and individual needs of its members create a better environment for exiting owners to remain connected to the family. This guards against feelings of guilt and shame for choosing not to be an owner and makes it less likely that other family members will judge or ostracize them for that decision.

Likewise, prioritizing the well-being of family members reduces the likelihood that someone will have ill feelings toward the family and seek to monetize in a manner that damages the remaining family owners.

Come to an Agreement Using a Fair Process

There are two situations that are common among our clients. The first involves an agreed-upon process already in place before an owner seeks to have their shares bought out. The second occurs when no such process exists, and an owner or group of owners begins to seek liquidity for their shares. We will share experiences related to both scenarios.

In either case, feelings or beliefs about what is “fair” will inevitably arise. In the end, what is fair means “doing things the way we agreed to do them.” So, coming to the agreement itself, it is important to apply fair process guidelines, such as those outlined in the box below.

The Smith family was transitioning from a sibling ownership group to a cousin ownership group. The third generation (G3) included three owners with equal shares, ranging in age from 59 to 70. The fourth generation (G4) consisted of ten cousins, ages 16 to 42.

Fortunately, since G2, the Smiths had maintained well-defined legal documents outlining share liquidation, annual liquidity limits, and minimum redemption amounts. However, over the past decade, the family’s focus had been primarily on employment and leadership development. As a result, the G3 owners had neglected to educate the cousins about the ownership documents and estate planning structures governing ownership transfer.

Although the family had a history of healthy exits, the current procedures were a mystery to the emerging generation of owners.

When we started the education process, the cousins were eager to learn. We brought in the business and estate attorney and the tax advisor to explain the legal and financial implications. We also addressed the complexities created by the growing number of shareholders. Equal ownership was no longer practical, and we tackled the challenges related to future company sales and individual liquidity needs.

These conversations built trust between generations. The family committed to annual reviews of the shareholder documents and ongoing education on topics such as direct and beneficial ownership, liquidity, and share redemption. This new education program unified the cousin group and normalized the idea of exiting ownership — without exiting the family.

When No Structure is in Place

Unequivocally, there is less likelihood of drama if the process for determining a transaction price is already agreed to. But what happens when there is no owner buyout process in place and a family member expresses an interest in exiting?

The first step is to reach an agreement on a structured decision-making process about the owner buy-out. Beware of starting the conversation about “price” directly. If you cannot agree on a process for determining the price, it is highly unlikely that consensus will ever be reached on the number itself. Focusing on the price too soon often leads to tense situations with owner buyouts and the process becomes a court system process. Taking the time to deliberately develop a process is the best option in the absence of a pre-existing structure.

Below we share a few examples of what has worked well for a drama-free owner buy-out when the structure must be created contemporaneously with a transaction.

Example 1: Sibling Buyout Using an Auction Process

In one situation, two siblings who were 50/50 operating owners concluded that continuing in business together was not a healthy option for themselves, the family, or the business. Both were capable leaders, each interested in sole ownership, and the business had a strong enough equity position to support a leveraged buy-out.

The siblings engaged with a facilitator to work with them to develop an agreement for determining the price and transaction terms. After considering multiple options, they agreed to an auction process to determine the price. The structure and terms of the transaction (including stock sale, closing date, payment terms, etc.) were also agreed to ahead of the auction.

Key elements of the auction process included:

• The siblings were the only bidders.
• A coin toss determined who would choose to bid first or defer.
• The bidding opened at 8 a.m. on Day 1 and concluded at 4 p.m. on Day 2, with a break from 4 p.m. on Day 1 to 8 a.m. on Day 2.
• A maximum of two hours between bids was permitted, allowing time for each party to caucus with their respective advisory teams.

Bidding concluded by noon on Day 2 when one sibling chose not to respond to the final bid. The transaction closed within 90 days.

The primary reason why this process worked out for the siblings in a drama-free manner is that neither sibling knew whether they would be the buyer or the seller, thereby helping to rationalize the eventual transaction price. Both were also equally knowledgeable about the business and how to effectively lead it.

Example 2: Multi-Branch Family Buyout with Facilitated Valuation

In another situation, a family with four ownership branches included both sibling and cousin owners and a mix of operating and non-operating participants. One branch, which had no members working in the business, concluded that they no longer wanted to keep their investment at risk and wished to sell their shares. Shares were held equally by each branch.

Without an agreement as to how an owner buy-out would work, the owners recognized the increased risk to family relationships. They agreed to engage in a facilitated process to arrive at a transaction price, terms, and structure suitable to all shareholders.

Elements of this process included:

• The facilitator conducted interviews with the G2 and G3 owners to develop a deep understanding of their respective hopes and goals.
• Through facilitated discussions, the ownership group agreed that approval of a process for determining the price would be approved by a two-thirds super-majority vote of the shares.
• The facilitator selected a valuation expert, and they teamed up to develop and deliver an educational program on valuation fundamentals to all shareholders.
• After the educational program and additional facilitated discussions, the ownership group came to an agreement, by a super-majority vote, that:
• The interest of the exiting owners would be valued by the valuation expert.
• The valuation of shares would be on a marketable minority basis.
• The share value determined by the valuation expert would be the transaction price.

The valuation was completed, the transaction documents were prepared, and the company purchased the shares of the family owners who desired to exit.

If You Lack a Structure, Start with Process

If you find your family’s enterprise without the structure for an owner buyout, come to an agreement on the process first. Consider these questions when designing a process tailored to your situation:

• What are the precipitating factors that are prompting the owner buyout?
• What is the status of the relationship among the parties?
• What foundational knowledge about valuation is needed across the shareholder group?
• How will we decide on the process to determine the price and terms of the buyout?
• Is there alignment with and commitment to ensuring a transaction takes place?
• What is the size of the ownership group?

In Closing

A healthy family owner mindset and a structured process developed using fair process guidelines are critically important to drama-free owner buyouts. Although there can be a considerable investment of a family ownership group’s time in developing a fair process ahead of or in conjunction with an anticipated transaction, doing so will increase the odds of a smooth transition. The pay-off: a result that most people most of the time can live with (even if the outcome of the process is different than they wanted) and a higher likelihood of sustaining family relationships.