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Succession Planning: Splitting Up the Pie

Often, the senior generation of a family business goes through the process of choosing one of its offspring as the successor to lead the company in the future. Usually, the chosen successor is given the title of president or CEO. For a period of time, he or she will work under the supervision of the senior family member, who may have founded the business. Eventually, the successor takes over complete operating control of the business.

This means that the fate of the future operation of the business is in the chosen sibling’s hands.

Do Other Siblings Own Part of the Business?

Whether or not the business is successful is up to that individual’s efforts. To the extent that the other siblings also own a portion of the business, their financial fate is also in the chosen sibling’s hands. A number of problems can arise unless you have some consideration of these issues when planning the division of the estate of the older generation family members.

In some cases, members of the senior generation may want to give each of their children part of the family business. It’s a natural reaction to think: I want my children to have a piece of the business that I helped to start. However, if the ownership in the family business is parceled out to all of the siblings without investing a controlling interest in the sibling chosen as CEO, the future operations of the business could be severely hampered.

The other siblings might not like the direction the new CEO is taking the business. They might feel there are not sufficient distributions of profits being paid to the shareholders. In other words, there might be a true dichotomy in thinking about how to run the family business. Such differences of opinion can paralyze companies.

The most obvious solution to the above problems (and others that could arise) is to make sure that the CEO sibling has control of the business either through ownership of an outright controlling interest or through a voting control of their business.

However, while either of these solutions can resolve the issues noted above by giving the CEO the ability to make all the important decisions regarding the operations of the business, it puts the non-control siblings at the mercy of the control CEO sibling. This could result in a situation where a non-control sibling ends up receiving a non-earning asset that is also a non-liquid asset (an interest in the family business).

If the controlling owner does not want to make distributions, the asset will be non-earning to non-control siblings. In addition, in most family businesses, the stock may not be sold without a right of first refusal to the business or to the other shareholders. This makes the interests owned by the non-control holders virtually illiquid.

The control CEO, on the other hand, might feel that it is unfair that there is an increased value of the whole business without being able to enjoy the full value of that increase because the ownership is divided among him or herself and other siblings.

Equalizing the Estate

So how to resolve the problem? One common-sense approach is to either gift-or gift and sell- the entire business to the control CEO sibling. If more than one sibling continues to work in the business, then some ownership provided to them would make sense, but only if they are required to sell their interest back to the company (or the control CEO and other siblings working in the business) if they leave employment.

The objective is to not put the business in a situation where the control CEO doesn’t have complete operational control of the business. In order to properly equalize the estate for all of the siblings, the senior generation should gift (or leave in a will) other non-business assets in the estate to the siblings who are not active in the business. You might also consider gifting or leaving family business real estate to the non-business active siblings. This should be done in a manner that won’t impede the business operations and will truly provide valuable assets to the siblings who are not active in the business.

If there are not sufficient non-business assets to equalize the estate to the beneficiaries, then at least a portion of the business could be sold to the CEO sibling in order to provide the assets (from the proceeds of the sale portion)> That way, the estate can be equalized for all of the siblings.

On the surface, this might sound or even not worth the trouble, but be assured it is generally worth the effort and planning. If these matters are not dealt with, the consequences could be disastrous. Consult with your CPA and attorney to ensure the issues are handled correctly and are properly explained to all involved.

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