Case Study: Navigating Family in Business

The Miller family came to Tier 1 Capital in the fall of 2019 in the midst of a complex business situation. Five of their family members (four siblings and a cousin) had successfully opened a retail business together years earlier. However, one of the founding five had since become disabled and unable to contribute to the family business, and others were nearing retirement age. With no succession or buyout plan in place, the situation had become complex and very sensitive.

The family business was also actively managing several debts. They had initially borrowed capital from a bank to start the company but were able to pay off the 20-year loan in only 8 years. After the business took off, they took out another loan to open a second location, and then other loans for new investments and other real estate opportunities. In total, they had four outstanding debts they were actively paying off—a total of nearly $2 million in debt. Each month, they were paying over $45,000 in debt payments alone.

The Millers were at a loss for what to do next. They knew they needed a way to buy out the disabled founder’s shares as well as create an exit strategy for the remaining four partners, but they believed they didn’t have the cash flow (an extra $25,000 per month) to do it. Succession planning had become a huge elephant in the room. Indeed, the Millers had been putting off the inevitable conversation for 10 years now, simply paying the disabled founder’s salary while everyone was unwilling to do what needed to be done.

In all, the Miller’s had three financial goals facing looming obstacles:

1. Buy out the disabled founder’s equity.

• • Obstacle: No one wanted to risk the conversation.

2. Ensure salary continuation for the remaining founders.

• • Obstacle: Drafting a fair agreement for everyone.

3. Guarantee funding for equity buy-outs for retiring founders.

• • Obstacle: Finding the funds for buy-outs and salary continuation.

While the specifics of the Millers’ situation may be unique, the pressures they face are nearly universal for family-owned companies and small businesses in general. Family-owned businesses currently account for 64% of US GDP, employing some 62% of the US workforce. However, a 2019 study found 61% of small businesses struggle with cash flow, leading 69% of business owners to lose sleep over ongoing cash concerns.

Rising inflation is also adding to small business owners’ stress with additional strains on supplies, inventory, and labor. For the first time in decades, interest rates on small business loans are threatening to hit the double-digit threshold, leading many owners to doubt whether their monthly cash flow is enough to cover their debt repayments.

Finally, the Millers aren’t alone in their difficulties with succession planning. Only 34% of family-owned businesses say they have a robust, documented, and communicated succession plan in place—despite 72% of owners wanting to ensure the business stays in the family.

The issue of succession is a complex and precarious one, and waiting to create a succession plan can negatively affect the business in myriad ways. Uncertainty can lower employee morale and inadvertently encourage key employees to leave for increased job security. Not to mention, considering compound interest, the longer you wait to save up for exit strategies, the more you’ll end up needing to put away to accomplish the same goal.

With the Millers’ situation, avoiding the necessary financial conversations about their business had created a situation where their cash flow seemed like it wasn’t enough to meet their goals. For everything to work out as they wanted, they needed an intermediary to help them facilitate the tough succession conversations and create a plan that would leave everyone happy.

 

When the Millers came to Tier 1 Capital, the first thing we did was reframe their mindset about where their cash flow was actually headed between their various loan payments. We asked, “When you went to the same bank to take out additional loans after paying off your first loan, whose money did they give you?” They were completely silent. Then it hit them—the bank was loaning their own money back to them.

By believing conventional wisdom, they were caught up in the debt cycle—forced to borrow money to capitalize on, use their profits to repay their debts, then borrow again the next time they needed capital. We know from experience that conventional wisdom benefits the system more than it benefits individuals. In a system built by and for banks, corporate leaders, and the government, small businesses need to step outside this game if they’re to win.

The truth of the matter was that the Millers had the necessary cash flow to meet their succession planning goals, but their existing cash was either going into the wrong hands or stuck in an illiquid state in the form of business equity. We immediately knew that all they had to do was use their money more efficiently.

We told the Millers, “Someone is going to control your money. Whether it’s you or the bank is your decision. And if you make the decision to be in control, you’ll never be at someone else’s mercy again.”

After 10 years of stagnation, they were ready to apply the Tier 1 Capital Growth Process™ to take back control of their cash flow and pay themselves first. Our process included refinancing larger debt first, eliminating smaller debts second, and then using mutual whole life insurance policies as a method to borrow money in the future so interest payments would be reinvested rather than wasted. Here’s how it played out:

• • Refinance Large Debt: By restructuring their debt for a longer period, the Millers reduced their monthly payments by almost $20,000.

• • Repay Smaller Debts With Cash Reserves: After their refinance was processed, paying off small debts freed up an additional monthly cash flow of around $8,500.

• • Take Out Whole Life Insurance Policies on Founders: By borrowing against their own life insurance rather than from the bank, they guaranteed buy-out funding and salary continuation for the remaining founders.

• • Start Building Cash: With an additional cash flow of nearly $350,000 per year, the Millers could set aside money for future buyouts, retirement, and succession planning for their families.

By owning and controlling their cash flow and not being in a race to pay off debt, the Millers were able to achieve their goals sooner and without pinching their cash flow. By embracing the Tier 1 Capital Growth Process™ rather than what the system had trained them to believe, they were able to pay off their debt, buy out business partners, and fund a succession plan within their family successfully.

Once the Millers were ready to embrace a new way of thinking about their finances, their decision suddenly became more clear—and it was amazing how quickly cash started to build.

• • Tier 1 Capital’s team successfully facilitated the difficult conversations about finances between the founding partners, providing a buffer for each of the five founders to communicate and create a plan that would work best for everyone.

  
  

  • By applying our process, they freed up an additional $30,000 a month in cash flow, helping them buy out their disabled partner and create fair retirement and succession plans for everyone else.

  
  

  • After a few years, they went from a position of having no money saved to having a cash reserve of almost $8 million.

  
  

  • The stress of never discussing finances was lifted, and they are in the process of bringing in the next generation of their family to ensure the longevity of their business.

  
  

  • They have access to all of their financial assets, even with specific amounts set aside for business succession or financial security.

In short, by changing the way they thought about finances and using Tier 1 Capital as a bridge to finally get everything on the table, the Millers were able to ensure each founder ended up with what they had worked so hard to achieve. The future of their family business was finally secure.

 

Reframing the Millers’ mindset about their cash flow and how to take back control changed the trajectory of their small family business. Broaching the subject had become too painful on their own, and they didn’t know how to build a cash reserve without relying on the system that was failing them.

At Tier 1 Capital, we believe that whoever controls your money controls your life. Focusing on being in control of your money will get you much farther than focusing on getting out of debt or getting a higher rate of return. We show business owners how to free up their cash flow and unlock their equity to fund exit, succession, and key person planning.

Whether you’re a family business or not, you don’t have to have the difficult conversations alone. At Tier 1 Capital, we’ll make your cash flow work for you as efficiently as possible so you can ensure the health and longevity of your legacy. Learn more about who we are and what we do, or schedule a call with us today.