Many self-storage businesses are family-owned. They’ve been in the industry for decades, passed from one generation to the next. Real estate businesses are inherently perfect for multi-generational succession planning, if for no other reason than because unwinding the properties for sale—depending on how they’re structured and financed—may be more cumbersome than simply transferring ownership to family members.
However, the process of business succession isn’t necessarily easy. First and foremost, most people don’t want to talk about what happens when they retire, or worse, they die or become disabled. But those risks can’t be ignored. Once there are sufficient assets to a business and a hope for continuity, these plans must be considered and, most important, written down.
If your family wants to continue your self-storage business rather than sell it, it’s critical to involve all relevant stakeholders in the conversation early. Share honest considerations on what would be best for the continuity of the business and the family’s investment in it. It’s best to start now.
Once you identify the need for succession, the next step is to create a plan. This is imperative to avoid any drama and disputes that might arise if something happens to you. The inevitable strife that could result, not even including the potential loss in value to the business due to lack of clarity, could be significant. A clear plan benefits everyone involved and may, in fact, save the company from liquidation. Remember, you can always update your plan. The one you create now may not be the one you ultimately use.
Determining Company Value
There are four common ways to transfer a business:
- To an existing co-owner or co-owners
- To heirs or family members
- To an unrelated key employee or employees
- To an unrelated outside party
No matter where the business ends up, one of the most important aspects to succession planning is creating a proper valuation of the assets. Valuation methods in self-storage, as in any real estate business, could include:
- Cost approach: Based on the cost to rebuild
- Market approach: Based on comparable properties in similar market areas
- Capitalization-rate approach: Based on income from the property
- Gross-rent multiplier: Considers purchase price and gross rents
These measurements don’t include valuation for the company’s goodwill in the market or any valuation multiplier that may be based on earnings.
A good succession plan will include in its language a specific method of calculating the company’s value. Absent such an agreement, there are many ways to value the assets of a business; and the possible disparity in those valuations may, by itself, lead to challenges and dispute in the sale process. That’s why it’s so important, if possible, to decide the valuation method in advance and include it as a key element of the succession plan. Now, let’s talk about the four transfer methods.
Transferring to a Co-Owner
Probably the easiest method of succession is simply the transfer one member’s interests in the business to another member, typically through the use of a “buy-sell” agreement. That contract can outline the methodology to value the business and its assets to create a fair cost for the transfer of one member’s shares to another.
These purchases are typically financed through key-man insurance policies in a cross-purchase agreement. Each partner takes out insurance on the other so if one dies, the remaining party will have the funds necessary—via the life insurance paid out upon death—to purchase the partner’s shares or ownership. The insurance is directly used to pay for the other’s share of the business based on clear valuation terms identified in the buy-sell agreement.
Some buy-sell agreements contain a “shotgun” clause. If one owner offers to buy the shares of another, the owner to whom the offer is made has the option to accept and sell, or he can buy out the offering party at the same price. The concept of this provision is to balance the offer with potential acceptance. So, if one member makes an offer to buy the company at a certain value, he accepts the risk that his ownership could also be purchased at the same price. For many, this option suggests fairness in pricing. Such a clause is also considered a positive way to resolve disputes between partners who may have a disagreement about the future of the business or its claimed value.
Transferring to a Family Member
Without a written plan, the transfer of a business to an heir or heirs can cause conflict and dispute, especially if other heirs are excluded or one is given more authority than others. A succession plan can clarify these issues in advance. Undoubtedly there’s more emotion involved in passing a business to a family member than to other owners or outside parties. Expectations of legacy and success may be involved with the transfer of a business from one generation to the next, which may be hard to accomplish.
Therefore, it’s often said that transferring a business to a family member might not be the best approach to succession planning. Many businesses have failed during the later generations.
Based on the involvement of the heirs and the business climate and valuations at the time, it might be better to sell to a third party than to keep the business. But if the decision is to transfer within the family, it’s important the designated heirs have some experience and training in the company before that time comes.
For family members who aren’t involved with the business, the transfer can include ownership but not management. Sometimes it’s important to share the wealth between heirs but designate only a few for management positions. Typically, those decisions are based on the members already involved in the business or who’ve shown an interest in the company. In these instances, any heirs who aren’t already involved are given the opportunity to sell their inherited ownership to others at a predetermined value.
Transferring to a Key Employee
Sometimes an owner doesn’t have any heirs. In lieu of selling in an open market, it may be the true continuity of the business is based on the employees who run it. In such a case, it may be the best plan for succession is to transfer it to one or more key employees who are able to obtain the financing (often through the seller) to purchase the business and its assets.
If the decision is to sell to key employees, you must feel confident they’ll be able to manage the business without your leadership and control. No one wants to sell to his employees, especially with seller financing, only to recoup the business a few years later after a default.
Transferring to an Outside Company
Selling to an outside company, especially to someone who’s in the same industry and may have even been a competitor, is often the hardest option. Commonly, outside offers are less than the valuation created for an inside sale or transfer. Further, by selling to a third party, the longevity of the business is at risk. Assets might be sold, employees replaced and the intangible “goodwill” of the past business obliterated. Then again, when selling to an outside company, the owner can truly separate himself from the business he sells.
Whatever method of business transfer you choose, plan for succession early. Not everyone likes to think about unpleasant “what ifs.” Instead, think of it as planning for your golden years, when you can sit back and enjoy the rewards of your many years of hard work.
Scott I. Zucker is a founding partner in the Atlanta law firm of Weissmann Zucker Euster Morochnik & Garber P.C. and has been practicing law since 1987. He represents self-storage owners and managers throughout the country on legal matters including property development, facility construction, lease preparation, employment policies and tenant-claims defense. He also provides, on a consulting basis, advice to self-storage companies in the areas of foreclosure and lien sales, premises liability, and loss-control safeguards. To reach him, call 404.364.4626; e-mail firstname.lastname@example.org.