Tax & Business Insights

Business Succession Ė Part III

Volume 15 Issue 2 --  March/April 2003

In the past two issues we have looked at some ways that NEB, a business owner, could transfer his business to his son, STUD, a next-generation owner.  This time, we will review one more method and then consider some general problems that commonly arise.

ESOP

If there are no children or family members to which the founder of the business wants the business to pass, an Employee Stock Ownership Plan, ďESOP,Ē is an option. ESOPís are complex and require good, and often expensive, planning and implementation.  ESOPís, like 401(k)ís, often lead employees to lack diversification in their retirement investments.

Transfer at Death

There are, unfortunately, quite a few people who literally do nothing.  If NEB died without a Will or Trust, the stock of Studco would pass through NEBís estate and be distributed according to the rules of intestacy (state law decides who gets what).  In contrast, even a simple Will or Trust may direct to whom NEB ís stock is distributed.

Often when business owners like NEB die, the spouse may end up with all or a portion of the stock of Studco.  What STUDís Mother, Luwilla, ďLU,Ē does with her stock will control who ends up with control of Studco.  If siblings or others who receive Studco stock, either by Will or intestacy, do not work for the business or live in the immediate area of operations of the business, they may be quite bitter because the surviving spouse gives the stock to the children who stay and work in the business.  The pros and cons of this approach and the ensuing family fights are a frequent problem for businesses and practitioners.

Management Control

Depending upon how NEB wants to structure succession, he can keep management control until his death or phase STUD into the control of Studco gradually.  When and how management control is phased out is of critical importance. 

For example, letís say NEB and LU have three children: STUD, MUD, and CRUD, all of whom work in the business. NEB and LU may decide that one child, STUD, should get slightly more stock than MUD or CRUD, maybe more than 51% of the stock of Studco, in order that there not be control and voting deadlocks among the children.  How parents or the older generation structure ownership among the younger generation can be critically important to future harmony in small businesses.

Buy-Sell

In most situations, consideration also needs to be given to what happens if there is a premature death of STUD.  If STUD unexpectedly falls into a vat of stucco and dies, who gets his stock in Studco?  Suppose itís STUDís wife, FANNY, who still performs in a topless bar?   STUDís stock is now an asset of his estate.  If STUD has a common ďI love my wifeĒ Will giving everything to FANNY, then she will become a stockholder, perhaps the controlling stockholder, of Studco.  If FANNY expects dividends or other compensation, it may be difficult for the business to continue and provide the income FANNY wants or demands. 

These problems can be avoided by having a Buy-Sell Agreement so that in the event of STUDís death, his interest in Studco must be offered back to Studco for redemption.  Alternatively, NEB may have the right to buy the Studco stock in STUDís estate.  By having a buy-sell arrangement in place, family control of Studco can be maintained.

Which of the many alternatives is the best?  It is impossible to say in the abstract that any one of the methods of business succession is better than another. Ultimately, the circumstances of the particular business, the desires of the older generation, and the economics associated with financing the plan will dictate which approaches are better in that situation. Whatever method of succession is chosen, it is imperative that it be incorporated in NEB and LUís estate planning.

It should be clear to anyone reading these newsletters that there is not one correct answer, except the need for planning.  Unless sound planning is done at the right time, it is very possible that there will be disputes among family members at the death of the older generation rather than a harmonious continuation of a business.  



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