To Plan For Succession
by Dave Donelson
When—not if—you no longer run your gallery for some reason, what will happen to it? How will that major development affect your lifestyle? Those are questions more and more gallery owners face as they contemplate retirement, unforeseen illness, or the many other twists and turns on the road to the future.
“We’ve been thinking about it,” says Kerry Wilson, manager of Windrush Gallery in Fairfax, Virginia. She owns the gallery with her mother, Sylvia, and her sister, Candi. “It’s been on our minds, but we haven’t done anything about it.” That pretty much sums up most gallery owners’ approach to the situation.
The simplest and easiest (sort of) solution is to sell the gallery to an outsider or just liquidate the assets and walk away when the time comes. Given the intensely personal nature of the gallery business, however, selling to an outsider is no slam dunk and liquidation can yield a pittance when stacked against the financial demands of retirement. Long, detailed conversations with your attorney, accountant, and financial planner should begin literally years before you decide on either step.
Ellwood Jones, President of Capital Regional Financial Planning Group in Sacramento, California, observes, “In my experience, small businesses sell to inside people more often than they sell to outsiders.” Those insiders can be family members, key employees, or even collectors with extremely strong ties to the gallery. Selling to one of them isn’t something to be undertaken lightly either, considering the consequences. “The business may be the biggest asset they have,” Jones says, which means its successful disposition can have a huge impact on the gallery owner’s lifestyle in retirement.
Show of Hands Gallery in Denver, Colorado, started as a cooperative of sixteen artists in 1983. Debbie Kneale, co-owner, is the last of the original members. “In essence, I’ve been through this fifteen times,” she says. “Our accountant wrote up an agreement that gives the business first option to buy out—at book value—the shares of the person who wants to leave. We really wanted to protect the entity of the business.”
“If the remaining partners couldn’t or didn’t want to exercise the option, they still had the right to approve any outsider who might buy the shares of the departing partner,” Kneale explains. “That way they couldn’t sell their shares to their obnoxious cousin.” When it came time for her to buy out the last original partner seven years ago, she didn’t want to be the sole proprietor, so those shares were sold instead to current partner Douglas Brugger. “We still operate under the same agreement,” she says.
What happens next? Kneale is 54, partner Brugger is 43, and they’re actively thinking about that question now. Neither partner has family to take over the gallery and they recognize that selling to employees is far from an ideal solution. “Those folks may not have the capital, so there is the question of whether you want to remain tied to the lease, carry a note, and so on,” Kneale points out.
Attorney Roger Hurwitz, partner in Slagle, Bernard & Gorman in Kansas City, Missouri, is a Fellow of the American College of Trust and Estate Counsel and has practiced law in this area for fifty years. He says, “The first issue is the competence of the successor, whether it’s a child, a friend, or whatever. Is that person competent to manage the business?” Gallery owners may hope to teach their successor the ins and outs of their business, but that takes time, too. “Business owners are not good teachers,” in Hurwitz’s experience. “It takes effort to teach. The successor can learn a lot by watching, but it takes a lot of active teaching, too.”
Kneale agrees. “Unless they intend to employ you to do some extensive training, go to the shows with them, and help with the buying, it could be difficult to just hand them the keys and walk away,” she says.
Looming over the entire situation, of course, are the financial implications of transferring the gallery business to another owner, regardless of whether that person is your offspring, a partner, a key employee, or a complete stranger. “When it comes to taxes and inheritance, I don’t want to be penalized,” Wilson says succinctly.
“What’s the annual after-tax income they want in retirement?” Jones says. “Everything flows from that number. They also need to know what the current value of their business is. If the value is large enough, they can sell it and retire. Quite candidly, most owners have no idea what they need for retirement or what the value of their business is.”
Again, the sooner you start planning for succession, the better off you will be. “You can’t start planning too early,” Jones adds. “Once you’ve survived the five-year startup period, you need to start looking at your ultimate goals. If we can get at least a ten year run, that’s good. You can budget it in, and if you have a bad year you can make it up, all of those things. Three to four years is minimum.”
Jones poses other questions that can be answered and problems that can be addressed if there is enough advance planning: Is the cash flow large enough to support a buyout while leaving the buyer enough to live on until it’s completed? Are there key managers who need to be retained and/or trained? Is there a business plan that needs to be updated? Lease to be negotiated? Relationships between artists and the prospective owner that need to be developed?
It may seem like something you can always deal with later, but succession planning is best done far in advance for a number of reasons. Prime among them is your own financial security and peace of mind, but your partners, employees, customers, and artists all have a stake in your decisions as well. So does your Uncle Sam and several other interested tax collectors. Scarlett O’Hara’s immortal words, “I’ll think about that tomorrow” should have no place in your vocabulary.
Some Key Succession Questions For You, Your Attorney, and Your Accountant
- Do you expect the new owner to be an insider or an outsider?
- When will the transfer take place?
- How will the price be determined?
- How will the purchase be financed?
- How much training will the new owner need?
- How will management retain key employees? Artists?
- Will a sale impact your financial future?
- Can you maximize gallery-supported retirement funds?
- How can income and transfer taxes best be minimized?