By Eddie W. Kramer, CFP®, EA
Highly driven children often have a desire to own their own business, especially when they have grown up in a family of successful business owners. Well-meaning parents often desire to help their children get started in business ownership, especially if they, themselves, have run a business for many years. These parents know that personal business ownership can have many benefits beyond what their children may ever achieve as an employee to someone else.
To start a new business requires a grass-roots effort, a good-sized network, and a strong business plan to succeed. The hurdles and time needed to grow this network and customer base may take years to overcome. An alternative option is to purchase an existing business doing similar work, i.e., the product or service is already being offered by and existing business. Purchasing a business presents a great opportunity for children to build skills and create a healthy decision-making process.
Where do I begin to help my child purchase a business?
Some guidelines to follow as you decide to purchase a business for your child include the following: price of the business and its future cash flow potential, cautions to be aware of, best people to purchase a business from, and how to finalize a sale.
What is the right price to pay for a prospective business?
The net present value of the business is the discounted value of its future cash flows. Learn how the business currently generates its earnings. Do not focus on “hope” or “business potential.”
Always use caution before jumping into a sale of an existing business. Ask tough due-diligence questions early in the process. Below is an example of questions to consider with a seller:
- Can you determine where cash flow is derived?
- Which factors in the business create the cash flow?
- Will those factors remain consistent in the next 3-5 years?
During this phase of questions and negotiations, it is always prudent to ask an expert to look over the financials of the prospective business for the last 3-5 years. Your goal is to find a reason not to do this deal as quickly as possible. Otherwise, you can find yourself wasting a lot of time and money by skipping the “deal breaker” questions in the beginning. Look for danger in any of these answers and honestly assess how these potential problems will be overcome.
When is the best time to walk away from a deal?
Every business has skeletons in the closet. If you have not found any skeletons, you may not have not looked hard enough! For example, if the seller tells a story about unreported cash flow, pay attention! You don’t want to purchase a business that does not report cash to authorities. Find the skeletons, talk about them with the seller, and if you believe they can be strategically overcome, use them as negotiating power to get a better deal.
Be relentless in identifying the cash flow creators in the prospective business. You want the deal to focus on protecting the future cash flows since, other than assets, cash flow potential is all you are buying with an existing business.
Who are the ideal business sellers?
While not always true, older business sellers are often the best choice. They are more motivated to close and less likely to change their minds at the closing table. Should you prefer to have the business financed, they are also more likely to structure the deal with owner financing as they may want to create monthly income in retirement. Beware of desperate sellers. For example, a seller wants to close the deal within a very short time frame, and they balk at your request to move slowly and go through a methodical analysis. A desperate seller should cause you to double down on due diligence, cash flow viability, and searching for “skeletons in the closet” that would not be seen without a thorough review of company financials and understanding of company culture.
When do I get the attorneys involved?
Include an attorney into the conversation to help structure the deal terms and draft the closing documents; however, do not bring the attorney into the process too early. Attorneys are important to protect you and the deal, but they can also get in the way of you and the seller creating a healthy relationship. The seller can be helpful, especially when skeletons are identified to share the company story and discuss business dynamics and relationships that have led to success. Bringing in an attorney too early may cause the seller to shut down this invaluable knowledge sharing between buyer and seller.
What if I get cold feet?
Finally, recognize that “cold feet” at the closing table is normal for both the buyer and seller. Anticipate cold feet and prepare to take appropriate communication, negotiation, and contractual steps to protect yourself. By this time, you have spent many hours of due diligence to arrive at the closing table. The buyer should write the reasons they are making this decision to serve as a reminder when the inevitable nerves and emotions kick in before large sums of money change hands. The contract should have a clause addressing what will take place if the seller chooses not to proceed at the closing table, so the buyer has not wasted much valuable time and energy. Will money be held in escrow to compensate the other party in the event of cold feet after an agreement is made?
Okay, the contract is signed, now what?
After a deal is signed and closed, more work is to be done to move the business into your child’s name and direction. The negotiation is over, the contract is signed. Follow the agreement and take the next steps to move into your newly purchased business. Read the letter you wrote yourself about why you purchased this business and get to work implementing your business plan. Finally, you are ready to implement your business plan, and you can begin generating the cash flow you worked so hard to identify and protect.
In conclusion, your eager, ambitious, and entrepreneurial child is likely ready to find a company to purchase. This is your chance, though stressful as it may seem, to show wisdom through patience, proper due diligence, and shrewd negotiation. Remember stress is a combination of both danger and opportunity. As the parent, your job is to be the voice of reason for your child and help grow these important skills. This can be a rewarding experience as you watch your child become a business owner with great opportunity.
Eddie Kramer, MBA, CFP®, EA serves a dual role as Financial Advisor and Director of Business Development at Abacus Planning Group, Inc., a financial advisory and investment counsel firm managing over $1,200,000,000 in assets for 225 families. In addition, Eddie is an adjunct professor at California Lutheran University where he teaches Retirement Income Planning, Social Psychology of Leading Clients, and Retirement Planning and Employee Benefits. Eddie was named “10 Young Advisors to Watch” in May 2015 by Financial Advisor magazine and Investment News honored Eddie by including him in the 2016 “40 Under 40” Class (the same class as the esteemed Dr. Harness). Eddie facilitated Financial Planning Association NexGen Conference in 2017.