Avoiding liquidity demands
The five third-generation owners and operators of New England Coffee were so successful at growing their company that they had a tough time buying out the previous generation. In 1996, the second generation stepped back from day-to-day management of the Malden, Mass., company, which was founded in 1916 and has annual sales of $90 million. But the second generation still owned the lion's share of the business until a 2003 buyout.
“We were just building [the second generation's] equity,” explains Jim Kaloyanides, the president and COO. “We decided if we kept growing the equity, we'd never be able to afford the business. We had a plan that when they passed away, we'd inherit it. But they're still here.”
So, five years ago Kaloyanides, 58 —along with his brother, Michael, 54, vice president of business and product development, and three cousins (John, 58, vice president of operations and human resources, Stephen, 53, vice president of purchasing, and Jamie Dostou, 50, vice president of finance)—negotiated an ownership transfer that makes them equal owners and allows them to pay off the notes over the next several years.
“When you get into the third and fourth generations, it gets harder and harder to buy someone out without outside capital. We've been able to do it all internally,” Kaloyanides says.
The 250-employee company is New England's largest family-owned coffee roaster. Kaloyonides says his father and uncles resisted the temptation to pay themselves dividends. “It's not that they were having hard times,” he says. “They just reinvested to make [the company] grow, and it kept growing.”
The third generation has found a simple way to avoid liquidity demands from inactive shareholders. “It's against our rules to have inactive shareholders,” says Kaloyanides. “Any owner has to work. If one decides to leave, by shareholder agreement he'll be bought out, so there's nobody that's not on the payroll that's looking for a dividend.”
Once the five owners finish paying off their notes, they might turn on the liquidity spigot, Kaloyanides says. In the meantime, he says, “It's hard to take a dividend when you owe someone else. But at least in our family business it hasn't been all about the money.”
Preparing for a transition
Because the Paul Hemmer Company is a Subchapter S corporation, profits are taxed at the individual level. To reduce the burden on the company's 21 shareholders, the company distributes dividends in excess of their income tax liability.
“We've committed to always making the tax payments, and based on cash availability, we'd make distributions in addition to the tax,” says Paul Hemmer Jr., third-generation president and CEO of the Fort Mitchell, Ky., construction company, which generated revenues of $176 million in 2006.
Currently Hemmer, 58, owns 58% of the company; two of his brothers—Michael, 51, who heads the construction group, and Jon, 47, who leads the asset management group—together own 15%. Three sisters and two other brothers, who are inactive, collectively own 20%, but the company has begun to dilute their ownership via a gradual redemption.
Thirteen non-family executives together own the remaining 7%. “When I begin my transition, that number will change dramatically,” Hemmer says. “But it'll take quite a few years for me to cash out, so I need them to continue to successfully—profitably—run the business. I've tried to think, what kind of company do we want to have in the future? Rather than a family legacy business, I want to make it an executive-owned business.”
Why? “Many times family businesses fail in the second or third generation because no one in the family can run [the companies] with ambition,” Hemmer says. None of his five children, ages 11 to 31, works for the company, nor do any of his nieces or nephews. Even so, he notes, he can pass on to them “the concept of ownership.”
The active shareholders have different goals from the inactives, Hemmer notes. “The inactive shareholders are interested that the company operate profitably, that the value of their shares increase and that they don't incur any liability,” he says. “We've been growing quite a bit, so we've had retainer capital. We need to reinvest it. But that puts you at odds if you have someone looking for a distribution.”
The non-family owners “are looking more at compensation,” Hemmer says. “Incentive compensation is very important. The challenge is to create the sense of ownership with these executives. That's when they start looking at the value and profitability of the company as opposed to their expectation for compensation.”
Last December, the company adopted a plan that would issue stock grants to executives based on company profit, plus their level of responsibility and performance. “I'm hoping over the next ten years they'll start to understand and appreciate the value of this,” Hemmer says. “It's an opportunity to create income through dividends and, more importantly, to create wealth through the value of the shares. It only works if the company is profitable.”
However, the company's performance over last few years has been a roller-coaster ride. “Outside forces, such as the economy and wars, have a dramatic impact on the business we're in,” Hemmer says. Sharing financial information with the non-family executives helps them understand and be patient, he adds.
So does their stake in a parallel company, Paul Hemmer Development Co. (PHDC), created in 2000, which manages facilities the operating company has built for clients. While PHDC accounts for only about 5% of total revenue, it is more insulated from economic swings than the construction company is. PHDC is owned by the 13 non-family executives and three active family members. “The purpose is to build deferred wealth through real estate holdings,” and to further inspire the non-family executives to think and act as owners, Hemmer says.
Back-and-forth loans
Officially, the Halton Company is a Caterpillar dealer for northwest Oregon and southwest Washington. Unofficially, the more than 400-employee company, with more than $150 million in annual revenues, acts like a bank. Marketing manager Kathryn Rebagliati, 35, says her grandfather, who founded the firm in 1940, set up a system that enables the company to lend money to shareholders as well as to borrow from them. For the most part, that has worked to the shareholders' advantage, she says.
Some notes have been passed down to the second and third generations and provide liquidity and cash flow to those shareholders. “Principal is available to take out,” she notes, “but then obviously you're not getting interest on it anymore.”
Currently the second generation—Rebagliati's uncle Ted Halton, the company president, and her mother, Sue Halton, vice president of strategic services—are majority owners. Rebagliati; her brother, John Findlay, 29; and two cousins each own less than 5% of the dealership. Ted's son, Tanner Halton, 29, is vice president of product support; his daughter, Sarah Halton, 26, has been involved in some company projects but is currently not active in the company.
Shareholders may borrow from the company by leveraging their stock. Rebagliati says that has an upside and a downside. For instance, her brother, who once worked in the company's information technology department but is currently not active in the family business, took advantage of the loans to launch a number of companies. “He ended up losing some of his stock because he couldn't pay back the loan,” she says. “Now he doesn't have as much stock in the company.”
After the company took the stock back, there were fewer shares outstanding. Although that increased the percentage held by each shareholder, it changed the dynamic between the two branches of family. Rebagliati, her mother and brother now collectively own a smaller percentage of the stock than her uncle and cousins do. That not only affects voting but also has tax and other financial implications for her uncle. “There are benefits of owning less than 50%,” Rebagliati explains. “So when this happened, it pushed him over 50% and affected how much insurance he needs to have.”
So far, none of this has eroded shareholder harmony, she says. But the dealership is navigating other issues on the horizon to ward off conflict. Shareholder meetings keep everyone informed.
The owners are considering offering compensation and travel reimbursement to the two inactive shareholders, who must miss work to attend. Scrapping plans
Instead of paying dividends, Maine Plastics Inc. of Zion, Ill. (which takes its name from Illinois' Maine Township, where the company originally recycled metals) continues to provide a salary and benefits to its two semi-active shareholders.
The two active family members in the plastics recycler —Robert Render, 53, who is president and owns 26.66% of the company, and his brother-in-law David Kaplan, 50, who owns the same amount and is vice president—have adopted this policy to keep their semi-active partners happy and dampen their desire to sell their stake.
The semi-actives—Robert's father, Henry Render, 78, who owns 20% of the company and non-family member Gene Cohen, 65, Henry's co-founder, who owns 26.66% —are itching to sell. “They can't force a sale, but they'd want to sell at market price,” says Robert Render. Their buy-sell agreements specify a formula for stock valuation that would be somewhat lower than the market price.
“They could find an outside investor with a bona fide offer and we can say yes or no,” Render says. “Which is unlikely. Why would anyone pay market price for a minority stake?” He and his brother-in-law would thus be obligated to either match the offer or sell to their partners' suitor.
Neither option—taking on new partners or taking out a substantial bank loan to buy back the semi-actives' shares—is palatable, Render says. He notes, however, that his father is not likely to seek an outside partner.
Henry Render officially retired when Robert took the reins in 1996 but still spends most days acting as an adviser and continuing to market recycled metal for the company, which generates $30 million in annual revenue and has 150 employees.
Robert Render has suggested that his father sell 5% of the company. So far, Henry has not taken the bait. “So I have two semi-cranky partners who would probably like to see the company sold but don't have the votes to do it,” Render says. “My dad is sympathetic to us, so he's not pressing us. He's actually a very positive force.”
The senior Render's insurance policy is not enough to cover the purchase of the shares, “but we have eight to ten years to pay his estate off, so we're protected if, God forbid, he should pass away,” his son says.
Render acknowledges he's thought of selling the business, but “we're nowhere ready” for due diligence. “A big part is the psychological part of it,” he says. “We four [shareholders] may have different goals. One may want to stay; others may not. All that complicates the transaction. That's one more thing on the tipping scale not wanting to do anything in that regard. We try to balance compensation and the premise of one day there being more money at the end of the rainbow.”
Buying out inactives
Two years ago Bob Jung looked back at the history of Trico Corporation, the lubrication-machine reliability manufacturer and service company his grandfather founded in 1917, and felt daunted. “Our family did a terrific job of having a business that made it 90 years, but the family grew faster than the business could grow,” recalls Jung, CEO of the Pewaukee, Wis.-based company. “There just weren't jobs for everybody, and there weren't enough resources, particularly income and cash, to distribute.”
At the time, his aunt, uncle and cousin, plus his cousin's two children, were inactive shareholders. Jung's son, Jim, 25, joined the company about two years ago and works as a production supervisor at Trico, which employs 46 people and rakes in less than $20 million in sales.
Jung is quick to point out that the company was not in dire need of ownership changes. For the most part, everyone got along. But there were six fourth-generation children, and the company “just wasn't going to be able to sustain supporting six more people,” he explains. More important, he says, “The business needed resources to grow.”
With the help of a covey of consultants, the family spent 22 months carving out and implementing a plan to reorganize ownership. Jung, 53, says he had a hard time rallying support from the inactive shareholders. “I was the guy who brought up the topic that no one ever wanted to talk about in the family,” he recalls.
Part of the plan had Jung become the sole owner as of last November, but he is paying for the shares he bought back over four years, financed by a bank loan. He had already bought out his sister's 25% stake in the non-voting shares over a seven-year period in the 1990s, and his father, Don, had gifted his voting and non-voting shares before he retired in 2001. (Don passed away early this year.)
But Jung's uncle, who had retired from his position as vice president in the 1990s, and his aunt, who had never worked for the company, were still on the board and owned stock. So did the husband of Jung's cousin, who retired at the end of 2007 as the company's administrator of process improvement. “So that was one less salary,” Jung says. “That's going towards funding the debt.”
Another part of Jung's plan was to buy back the shares of Trico Building Company, a sister company Trico created decades ago to hold the company's real estate. It was owned by various family members who leased the property to Trico Corporation as a way to provide inactive owners with a tax-deductible (to the company) cash flow stream for the shareholders. “When it comes to distributions, it would defeat the purpose at this stage to take that extra money out,” says Jung. As of last November, Jung, his sister Karen Fredrickson, 48, and their mother, Carol, 74, became the sole owners in Trico Building Company.
“There were contentious moments,” Jung admits. “Whenever you suggest change, people naturally are skepticalâ¦. What everyone wanted to be happy was far bigger than the pie was. So we had to go through discussions and iterations. If there were a real simple solution, it wouldn't have taken 22 months.”
Jayne A. Pearl, a freelance writer, editor and speaker (www.jaynepearl.com), is the author of Kids and Money: Giving Them the Savvy to Succeed Financially and a workbook based on her seminar, How to Gimme-Proof Your Kids.