You have a successful manufacturing company, the ABC Manufacturing Co. Your spouse helped you start the business thirty-five years ago, but has not worked in the business for thirty years. However, he or she has helped you make many decisions for the business and you felt that advice was invaluable. It was always great to go home and discuss the business with him or her. Your son has been working with you for the past four years and some of the growth of the Company has been due to his efforts. Your daughter is coming to work for the Company next month. Your other two children are not interested in working for your Company and it is clear that as a result of their respective career paths, neither of them will ever be involved in the Company.
You recently met with your accountant and attorney and discussed your estate plan. At your meeting, you discussed the two major issues which were on your mind, probate and taxes. With respect to the first issue, your attorney told you about the benefits of putting all your property into living trusts. In this type of trust, you would retain complete control over all your assets and then, upon your death or disability, a successor trustee, whom you would name in the trust agreement, would administer your assets according to the instructions you provided in the agreement without any necessity of probate court proceedings. Also, you could modify the terms of this type of trust at any time. After resolving the probate issue, your advisors discussed the major planning opportunities available to you to reduce your estate tax burden. The first is the federal unified credit shelter equivalent which permits everyone to transfer assets having a value in the aggregate of $5,340,000 and not incur a federal estate or gift tax liability on the transfer. Thus, you and your spouse can transfer $10,680,000 free of federal estate and gift taxes. The other opportunity is the marital deduction which provides that whatever is transferred to your spouse will not be subject to federal estate or gift taxes but will be subject to estate tax when your spouse dies. Your attorney also pointed out to you that you can reduce the federal estate tax burden by giving away $28,000 per year to each of your children. After reviewing these planning opportunities, you stated that you wished to provide primarily for your spouse and upon your spouse’s death, you wanted your children to be treated equally and that they should split your assets into four equal shares.
Based on the foregoing, your attorney has prepared estate planning documents which provide that that upon your death, all your assets will be held for your spouse’s benefit and upon his or her death, the assets will be divided into equal shares and distributed to each of your children.
Your accountants have advised you that you currently have assets which, in the aggregate, have a total value of $15,000,000, included in that total is your Company, with a value of $8,000,000.
Well, you seem to have accomplished your estate planning desires. You have planned to avoid probate, you have planned for minimal estate taxes and you have provided for your spouse first and then left everything equally to your children. But something just does not seem right. Perhaps it would be a good idea to imagine what will happen after you and your spouse die. Did you transfer any of the Company stock to your spouse? If so, the surviving spouse may transfer it to anyone as he or she pleases. Did you transfer any assets to your children during your lifetime? If the assets were cash or other income producing assets, did you leave sufficient assets to take care of your spouse? In order to reduce estate taxes to zero upon the first spouse to die, did you take full advantage of the marital deduction, which may have required your trust to give stock in the Company to your spouse or hold it for his or her sole benefit? After both you and your spouse died, were all your assets to be divided equally among your children, so that the Company now has four equal shareholders? Are the two children still employed by the Company and producing income for all the shareholders? Did all children agree how the business should be operated?
A typical estate plan often deals with issues that arise as a result of the transfer of ownership. Most people, like you, do not want their assets to be dissipated as a result of the probate court process and estate taxes. Thus, planning is often directed at resolving these two major issues. More often than not, traditional estate planning does not address the complex issues presented by the transfer of ownership and management succession of any operating business.
Business succession planning has two major components, ownership and management succession and attempts to address the effects that the transfer of ownership and management will have on the business. The closely held business often constitutes a major part of the business owner’s estate. It is the machine that provides the wealth to the owner so that the owner can live as he or she desires and can support his or her family. Thus, it is important to plan as best you can to ensure that the machine will continue to produce money for you and your family, especially after you are no longer an integral part of the business. Proper planning may permit the owner to exert more control over the life of the business.
Ownership succession planning is often confused with estate planning, since both have to do with the transfer of ownership. However, ownership succession planning is only concerned with the transfer of the ownership of the business. Typically, the closely held business constitutes a substantial part of the value of the business owner’s estate. Since there are relatively few other assets in the owner’s estate, the owner therefore believes that in order to treat all the children equally, the business will have to be divided equally among all the children. Dividing the business among everyone could result in a disaster especially if only some of the children are employed in the business. Those who work in the business will have different agendas in the operation of the business. Those who work will desire to maximize their compensation, minimize distributions and provide for the long-term growth of the business. Those who are not in the business will want to maximize the dividends payable to them and may question the amounts paid as compensation to those who are employed in the business. Those who are in the business and devoting their entire energies may not appreciate working for only part of the long-term benefit.
How can you address the issue of treating your children equally when only some of them work in the business and the business constitutes a major portion of your estate? One way would be to distribute all your other assets to those not in the business and distribute the business only to those in the business. However, this might not seem “fair” if the value of the business far exceeds the value of all your other assets. You might desire that the children in the business “buy” the business from those who are not in the business so that when all the assets are divided, the amounts paid by those in the business will equalize the shares given to those who are not in the business.
Your son who has worked with you in the business for the past four years and who has contributed to the growth of the Company may feel that he is entitled to own some of the Company based upon his efforts. If you agree, you may wish to give some of the stock of the Company to him in the form of a gift. However, if you are like most business owners, you may not be ready to give anyone any voting rights in your business yet. If so, you might consider establishing nonvoting stock (which, if structured properly, will be permissible even if your corporation is an “S” corporation). If you decide to either sell or give away stock during your lifetime, you may wish to require that all shareholders sign a shareholder’s agreement so that you retain control over the disposition of the stock in the event that anyone desires to transfer his or her stock or becomes subject to a court order requiring the transfer of the stock. To better ensure continuity of ownership after you no longer own any portion of the Company, you may desire that your children enter into a shareholders’ agreement so as to “keep the business in the family”.
Once you have decided to whom you want to transfer ownership of your Company, you will have to decide who will be the best manager of the Company. It may be too early to tell and therefore, you may not be ready to make that decision. During your lifetime, you have been the owner and the manager of the Company. However, after you no longer contribute to the Company, someone will have to take your place in the management of the Company. Your choice as to who should succeed you as the manager of the Company should be guided, to the extent possible, by rational criteria. Who will be the “best” manager so that the Company will continue to produce money to support all those whose lives are dependent upon it? Maybe your son or your daughter is appropriate. If so, you may wish to arrange your plan so that one of them will be the manager of the Company. This could be done in a variety of ways. You could provide that the child who is to become the manager be given stock with greater voting rights. Thus, while the ownership could be equal, the one with the greater voting rights would be able to exert more control over the management. Perhaps neither of them is the best. Maybe your trusted administrator is the most capable of managing the Company. If so, you may wish to enter into a deferred compensation or other “golden handcuff” arrangement with the administrator.
If a family institutes a successful business succession plan, it may be on the way to a plan to create, preserve and grow wealth for the family and its future generations. The family can plan to invest the wealth generated by the business in opportunities outside the business. Families often find that it is “better” to continue to work within the family to invest their wealth together. It may be more preferable than investing in the publicly held stocks and bonds. Some families will form family councils, to perform various functions for the family, including providing a “bank” to which the family members can bring investment opportunities for the family. If the investment opportunities are appropriate, the family can choose to invest in it. In this way, wealth can be reinvested by the family and the success they attained with the original business might be attained in to a new business.
It should now be clear to you that traditional estate planning and business succession planning are often designed to accomplish separate goals. Traditional estate planning concerns itself with wealth preservation and transfer. Business succession planning is concerned with planning so that the life of your business will succeed when you are no longer involved with the business. Failure to plan properly may leave the success of your business to chance. Planning for ownership and management succession actually increases your ability to control your business and its (and your) future.