Industrial Strength Succession Planning

RAISE YOUR HAND if you are the owner (or part owner) of a successful family business and someday you want your kids to step into your shoes. Let's be specific about the word "kids." We mean only those kids who are now in the business and who will someday run the business. Kids who are not in the business should not share ownership with the business kids. Of course, the non-business kids will receive

RAISE YOUR HAND if you are the owner (or part owner) of a successful family business and someday you want your kids to step into your shoes. Let's be specific about the word "kids." We mean only those kids who are now in the business and who will someday run the business. Kids who are not in the business should not share ownership with the business kids. Of course, the non-business kids will receive other assets, usually of equal value to the amount (value of the business) received by the business kids.

Yes, the situation described above comes up often. But rarely have we seen a good solution to the problem. This column tells you the solution.

We have nicknamed the process "Industrial Strength Succession Planning" because when the transaction is properly done, it holds together and successfully survives the test of time. Interesting, when there is a problem, it is never caused by the technical aspects, such as the tax law and legal documents. It's those human beings with different agendas and opinions who make up normal American families. Rarely, very rarely, are problems caused by the immediate family. Who creates the friction? You guessed it — typically a brother-in-law or sister-in-law married to a non-business child when that non-business child owns a piece of the business.

Let's take a look at a real-life example, where the roof — because of family squabbling — almost caved in on a successful family business (Success Co. owned by dad Joe). Success Co.'s stock was owned 52% by Joe and 48% by his four adult children, 12% each. Three of the kids (Sam, Sol and Sue) work full time for Success Co. The fourth kid (Ray) is a successful professional and has no interest in the business.

Sue had a baby and told the family she would not return to work until her daughter went to college. The squabbling started with Joe and the now only two business kids, Sam and Sol, on one side and Sue, her husband (Roy), and Ray's wife (Roz) on the opposing side.

The most minuscule business issues created a flurry of hot-tempered conferences that rarely resolved anything. Success Co.'s profits turned down. Joe, a smart businessman and a fair-minded type of guy, was frustrated. The family called me for help, yet Joe assured me that, except for the divisive confrontations concerning Success Co., everyone in the family got along fine. Mary, Joe's wife, agreed, but she asserted that the nasty business stuff was sometimes creeping into their everyday personal life. Sadly, Joe nodded his agreement.

The business, which after the early years of a struggle to become successful, had always been a source of pleasure for Joe and Mary but had become a thorn in their sides. First, together we (Joe, Mary and I) pinned down their specific goals as related to the business and all their children. Here are their goals: Stop the business bickering; treat the kids equally (after much discussion "equally" was redefined to mean the business to the business kids and other assets, of equal value, to the non-business kids); and transfer Success Co., in a tax-effective manner, to the business kids, but allow Joe to maintain control for as long as he lives.

My advice was tough love: I insisted that only business kids own Success Co. stock. Here's what we implemented:

  • Success Co. was recapitalized (100 shares of voting stock and 10,000 shares of non-voting stock). Every one of the shareholders got his proportionate share (i.e., Joe got 52 voting shares and 5,200 non-voting shares).
  • Success Co. was professionally appraised with a fair-market value per voting share and non-voting share.
  • Success Co. bought back all the shares — voting and non-voting — owned by the non-business kids, Sue and Ray, for the fair-market value established by the appraiser.

    Note: At that point Joe owned 68% of Success Co., while Sam and Sol each owned 16% (rounded) of the stock.

  • We used an intentionally defective trust to transfer — tax free — the nonvoting shares (5,200) to Sam and Sol (2,600 shares each). The IDT saved Joe and his two sons about $2.7 million in income and capital gains taxes.

Since, the non-voting shares, which contained about 99% of the fair-market value of Success Co., were no longer owned by Joe, the shares were out of his estate for estate-tax purposes. Sam and Sol will receive the voting shares (half each) when Joe goes to the big business in the sky.

That's it. It's the basic plan, with slight variations as necessary to accommodate each family's unique circumstances, we have used for years. From a tax standpoint, it always works perfectly. From a human standpoint, I must admit we sometimes hit bumps in the road. In the case of Joe's family, the plan eliminated the constant turmoil. Even Roz, to everyone's surprise, bought into the plan.

As readers of this column know, solving just a portion of a client's estate tax problem is not our style. Always, but always, the comprehensive plan includes a complete lifetime plan (here, the succession plan was a part of the lifetime plan) and a complete estate plan that dovetails with the life plan. The overall plan for Joe and Mary is built around two basic concepts: Maintain their lifestyle for as long as they live (lifetime stuff) and an estate plan that will pass all their wealth to their kids, instead of losing it to the IRS. Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; tel. 312/207-1040, or via e-mail at wealthy@ blackmankallick.com.