Last time, we discussed how to transfer your business to your children. We mentioned three of the five tasks we use at Obsidian during the family business transfer process. To recap, visit our previous blog.
Today, we conclude this discussion with the two final tasks:
Task 4. Address the issue of fairness to all children
Task 5. Draw up contingency plans for both parent(s) and child(ren).
Task 4: Address The Issue of Fairness To All Children
Let’s define terms. First, “equal” is not the same as “fair.” Second, fair is in the eye of the beholder. In family business transfers in Washington DC, the beholders are:
1) you, the parent/owner
2) your children–both business-active and non-business-active
Third, you love all of your children and are naturally inclined to distribute your assets equally. Fourth, there are three challenges to manage:
b) the efforts of the business-active child
How can you leave the business to your business-active child and make an equitable distribution of the balance of family assets to your inactive children (and perhaps to the business-active child as well)? Here’s where coordination with your estate plan is key.
As you make a judgment about “fair,” so too will your children. That’s why it is key for you to define fair before involving other family members.
One of our clients, “Donna,” told us that she shared ownership with her two siblings “Richard” and “Harry.” We asked how she had come into ownership and she told us that her father, “Stefan,” had successfully taken over the reins of the family business from his father. None of Stefan’s siblings had any involvement with the business. When Stefan designated Donna as his successor, he wanted to be “fair” to all his children. “So, he split the ownership of the company between my brothers and me.”
We asked, “What do your brothers do for the business?”
Donna replied, “Nothing, really. Well, every few months they call to draw some money out of the business.”
Wow. Donna was working owner hours to run a company and sharing the profits with her uninvolved brothers. How fair is that?
Like Stefan you probably offered all of your children an equal opportunity to become owners, yet only one child seized that opportunity. Why force your most ambitious, risk-oriented child—the one who chose to succeed you—to share the rewards with children who chose different careers? Would you have enjoyed sharing ownership with siblings who took on none of the load?
If dividing ownership among several children still seems like a good idea, know that giving your business-active child the controlling vote is not a solution. The child running the business will have a fiduciary duty of fairness to his or her sibling-owners.
Finally, value and risk are the reasons non-business-active children don’t want business ownership if you offer them other equivalent choices and let them know that they will receive their inheritance through your estate plan. As you well know, ownership interest in a closely held business is less liquid and more risky than most other assets. The only buyer for ownership will be their sibling who likely doesn’t have the money to purchase it. Second, without a controlling interest, a shareholder cannot make any business-related decisions. Third, if the value of your business rises, the inactive child’s heirs may face the not-insignificant estate tax consequences of owning a highly valued, but illiquid asset.
Task 5: Draw Up Contingency Plans For You And Your Children
Inevitably, circumstances can and do change. That’s why we include in your exit plan two Plan Bs that anticipate as many events as possible: one for you and one for your successor.
Your Contingency Plan
If you die or become incapacitated before you can complete the transfer of your business, your estate plan (wills and trusts) must direct the transfer to the child(ren) of your choice. If, however, your business is so valuable that your child cannot buy your company, and gifting it would trigger high taxes, we have other solutions.
What will happen if your designated successor loses the drive or the willingness to make the sacrifices necessary to run a successful business? What happens if you and your successor find that you cannot settle difference in management style? That’s where a comprehensive succession plan comes into play.
Contingency Plans For Your Children
If your transfer plan involves several children sharing ownership, what happens if it the children can’t get along? Once they receive ownership, children should have their own backup plans in case one leaves for whatever reason. Once again, here’s where succession planning is important. We have experience in creating succession plans for new owners that protect the business and minimize estate taxes for your children and their heirs.
Your Family Business Transition Planning Process Will Be…?
Being at the helm of your family business transition planning – in Washington DC or anywhere – can be one of the most rewarding things you’ll ever do. Making that transfer successful starts with a thoughtful conversation about you, your children and your business. Don’t skip that conversation! Obsidian is standing by, ready to guide you and your family to a strong future, together.