Joe and Marge Ingomar died without planning for succession or making a will. Their 4 children (Mark (48), John (45), Paul (44) and Mary (41)) have inherited equal shares of both the business corporation and the business real estate. Mark and John manage the business, serve families and are committed to maintaining a high profile in their community. Paul and Mary live 125 and 300 miles away respectively. Paul teaches in high school and Mary operates her own flower shop.
Mark and John pay themselves salaries well above the going rate for non-family members doing their jobs. The company provides their cars and country club memberships. The company also provides a car for Paul and Mary as well as their cost of operation. Each of the 4 share equally in the profits from the real estate corporation (approximately $30,000 each).
The business has been losing call volume AND experiencing shrinking sales averages for 5 years. Mark and John have done their homework and developed a plan for reversing this trend. This plan will require significant capital investment (approximately $1,000,000) and has a good chance of succeeding. The bank has approved a 90% loan but requires personal guarantees from each of the owners. Paul and Mary have refused to sign unless they get more money out of the business. This, in turn, will make it even more difficult (even if Mark and John’s plan works) to cash flow the business with the new loan.
With the implementation of the plan the business has a chance to grow in value. If they do nothing the future is even clearer: continued decline in revenue, cash flow and enterprise value. They have reached a stalemate in negotiations. They have agreed to bring Alan and Bill in to try and move things forward.
We often have to shake up our client’s thinking in order to focus their attention on what they really want. What people want, as you might expect, is never universal in a group.
So, we laid it out as follows:
- Sell to a third party & cash out
- Mark and John buy out Paul and Mary
- Pay Paul and Mary salaries equivalent to Mark and John
- Milk the business until everyone is too old to care
1. Mark and John really believe they can turn this business around. They really like what they do and don’t want to get out. More important, a business on the decline has significantly less value than one that is growing no matter how many calls it is doing. So option 1 was eliminated.
2. If Mark and John buy out Paul and Mary they will be cash strapped for at least 5 years. This will effectively kill their turn around plans. So option 2 was eliminated.
3. Paying Paul and Mary equivalent salaries would further hamper cash flow and probably would result in the bank declining the loan. Moreover, since they are not active in the business it is unfair to Mark and John. However, since Mark and John pay themselves above the going rate for their job class they were effectively enjoying benefits that were not commensurate with the equal risk shared by ALL the shareholders.
4. The big question in a “milk – the – business” strategy is: “Can you last long enough for it not to matter?” Effectively, the choice here is to drain your permanent wealth to survive today. That choice was off the table too.
In the end the group was able to recognize that the value of the company was there single greatest asset and they needed to do what they could to turn it around. As a compromise Mark and John agreed to pay Paul and Mary a reasonably affordable monthly stipend to compensate for their risk in cosigning the loan. They also agreed that they needed to rewrite their buy – sell agreement and begin planning for Mark and John to buy out Paul and Mary over time beginning at a point where the company was, once again, headed in a positive direction.
What Say You?
How about giving us your feedback on this scenario? What other solutions might there be?