Industrial Strength Succession Planning


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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 [as the new owner(s)]. 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 that is described in the first paragraph comes up often. But rarely have we seen a solution to the how-to-transfer-the-business-to-the-business-kids-and-treat-the-nonbusines-kids-fairly problem. This article tells you the solution.

We’ve done it hundreds of times for family business owners and their business kids.

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 (the tax law and legal documents). It’s those human beings (with different agendas and opinions) that 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 nonbusiness child) when that nonbusiness 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 highly 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, sort of even sides, 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 out-of-business 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, now has become a thorn in their sides. First, together we (Joe, Mary and me) pinned down their specific goals as related to the business and all of their children. Here are their goals: 1) stop the business bickering; 2) 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 3) 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—really my insistence that only business kids own stock of Success Co. Here’s the plan we implemented:

  1. Success Co. was recapitalized (100 shares of voting stock and 10,000 shares of nonvoting stock). Everyone of the shareholders got their proportionate share (i.e. Joe got 52 voting shares and 5,200 nonvoting shares).
  2. Success Co. was professionally appraised with a specific fair market value (FMV) per voting share and nonvoting share.
  3. Success Co. redeemed (bought) all of the shares—voting and non voting—owned by the non-business kids (Sue and Ray). At what price?... exactly FMV.
    Note: At that point Joe owned 68% of Success Co., while Sam and Sol each owned 16% (rounded) of the stock.
  4. We used an intentionally defective trust (IDT) 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 nonvoting shares, which contained about 99% of the FMV 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. If you have kids (one or more) who will ultimately own your business, reread the above. Slowly! 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, we must admit we sometimes hit bumps in the road. Have not figured out how to change human nature. In Joe’s (and his family’s) case, 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: 1) maintain their lifestyle for as long as they live (lifetime stuff) and 2) an estate plan that will pass all of their wealth—every dime of it—to their kids, instead of losing it to the IRS.

Unfortunately, the right way to do a business succession plan and properly tie it into a comprehensive estate plan seems to remain a mystery to almost all closely held business owners and their professionals. What to do?

So, here are two choices: 1) Go to my web site to learn more about the subject matter of this article; or 2) join our annual succession/estate plan test. (We want variety: you can be single or married; do or don’t have kids in the business; are or are not insurable; or have some problem(s) that no other professional can seem to solve). To participate in this year’s test, please send the following information:

a. For your business. Your last-year end financial statement (all pages).

b. Personal. A current personal financial statement for you and your spouse.

c. A family tree. Your name and birthday. Same for your spouse, children, their spouses and your grandchildren.

d. All phone numbers—business, home and cell.

Send to Irv Blackman, SUCCESSION/ESTATE PLAN TEST, Blackman Kallick Bartelstein, LLP, 10 South Riverside Plaza, 9th Floor, Chicago, Illinois 60606. What’s our job? To create the right plan for you, your family, and your business and to coordinate and work with your professionals.