Some of our clients will tell you there was nothing more satisfying than to start and grow a successful business and see their children (and sometimes grandchildren) assume its management.
In fact, multigenerational family businesses are the oldest and most common form of financial organization globally and include not just small mom and pop corner shops but also over 40% of public companies like Walmart and Samsung.
We have also heard stories of family members who left the farm to “make it big” or had no interest in learning the family trade. Often, those who left had valid reasons and were successful — not at all like in the parable of the prodigal son. What should you do if not all of your kids are on board to run the family business? To continue to be successful, you must sometimes prioritize business concerns over individual family members’ feelings, but, as a parent, you want to be fair to all of your children.
Suppose you want to leave stock in the business only to those who will continue to run it, but you want to be fair to your other children. In that case, the easiest solution is to leave the “non-business” children other assets from your estate.
What’s it all worth?
You should know how much your business and your other assets are worth. Intriguingly, most new clients are wildly uninformed about their business’s value. They either have a grossly inflated or an extremely low “fire sale” estimate of what they think their company is worth.
Ask your business attorney, business broker, or valuation specialist how to make a “rule of thumb” calculation to get a rough idea of the value for pre-planning. (A formal valuation report will be required later.)
What is a buy-sell agreement?
Once you have estimated your business and other assets’ values and have met with your succession planning team, you might decide that there are better options for leaving a legacy to all of the children.
For example, two brothers own a successful construction company. Some of their many children wanted to work in the business and some did not. Since the family homes were not paid off and the biggest asset was the business, the brothers decided to use a buy-sell agreement and life insurance to compensate their surviving spouses and “non-business” children for their share of the estate upon the brothers’ deaths.
A buy-sell (or buyout) agreement is a contract that states how a partner’s share of a business may be reassigned if that partner dies or otherwise leaves the company. In the event of a death of a partner, the proceeds from a life insurance policy can be used to purchase the deceased’s business interest.
You will find that once you start succession planning, like with our brother-partners above, other essential family management considerations come to light. One issue facing this construction company: Is it profitable enough to support so many family members?
Focus on growth
As CPAs, we often work with the family business to “make the pie bigger,” anticipating there could be potential management conflicts between the second generation if there are not enough profits to support everyone. We also want to make sure family members will not be stepping (physically and managerially) over each other to control the company. We most often accomplish this by expanding the operations geographically and by separating management responsibilities.
In this case, the family purchased a similar construction company in another part of the state for some of the adult children to operate. In another example, a winery owner put one daughter in charge of production and another in charge of marketing. One daughter works at the vineyard, and the other works at the tasting room. The family peace that can be achieved when you give family member managers their own domain and physical space is impressive.
Using a rental LLC
For some very profitable family businesses, there are sufficient profits to share, but management would like to limit the involvement of family members to those who are actively involved in the business and who are sufficiently qualified to participate.
One client wanted the children not involved in management to have a stable income from the business. The company had significant property, plant, and equipment (PPE) in LLCs (limited liability companies) that were rented to the family business. We suggested the parents gift the LLC ownership in the rental business to the “non-business” children and company stock to the children who managed the company.
Voting and non-voting stock
A large manufacturer, now celebrating four generations of successful family management, instituted stock agreements early on for voting and non-voting shares. Children can inherit non-voting shares of company stock from their parents. If they are not interested in working for the company, they can receive dividends as passive investors during their lives and pass on their non-voting stock to their children.
However, if the descendent wants a seat at the board, they must work several years for the company to be eligible to trade their non-voting shares for voting shares. The benefit of this system is that talented and driven future descendants are encouraged to pursue a career with the company, thereby maintaining family management as the company grows.
Implementing the plan
Of course, none of these great ideas can be put in place until you physically (or virtually) meet with your estate attorney, draft, and sign your will and trust agreements, and until the assets are actually transferred to the trusts. Up until that point, all of this planning is just in your head. (We have also found many excellent plans sketched on note pads but never formalized.) I have witnessed several families and businesses disintegrate into years of litigation and bankruptcy because all the grand and just succession planning was never put into place. So, please talk with a qualified estate attorney as soon as possible.
Congratulations on being part of the only 30% of businesses that survive long enough to be passed down. Now let’s find out how much your business is worth and formalize the transition.
Michelle C. Herting, CPA, ABV, AEP, specializes in estate, trust and gift taxes, and business valuations. She has three offices in Southern California and is president of the Charitable Gift Planners of Inland Southern California.
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