Succession Planning

There are many corporate/business law planning alternatives that can serve as the “frame” upon which to build and execute a successful family business succession structure. The following is a brief explanation of some of the “tools” that can be used to create the frame that will best suit the structure of each business succession.

• Voting and Non-Voting Stock. Children not involved in the business can be given non-voting stock so that the active owners can control the business operations. Certain actions taken by the active owners (and controlling board members or managers) could require a “super majority” vote. The non-active owners can control key decisions by being able to participate in a “super majority” vote on such matters as: 1) salaries of key employees (family members particularly); 2) issuance of additional ownership interests; 3) encumbrance of a significant portion of company assets; 4) material asset acquisitions; and 5) sale of a material portion of the company or its assets. Family harmony can be threatened if one group of heirs feels they have too little say in what is being done with their “patient capital.”
• Ownership Preferences. In the case of a corporation, preferred stock may be used, and in the case of an LLC or partnership, preferences can be built into the operating or partnership agreement. These preferences can provide passive owners with priority returns from operations and a first priority upon liquidation or sale. These rights will give the inactive owner(s) security that the interest they started with upon transfer to their generation will not diminish in value and, if it does, the active owners will not get anything more than they will receive. There are many variations of how these preferences can work. These techniques can be referred to as “risk/reward locks.” The key is to incentivize management to run the business day-to-day in the best interest of all owners without undue interference by inactive owners.
• Separating the Business or its Assets. If the business can be separated into two or more operating units (and meet the IRS requirements for doing so without triggering onerous tax obligations), one or more separate operating units can be put into the hands of specified children and/or sold to an unrelated third party. It may also be possible to spin out some of the assets from the business that can then either be given directly to nonparticipating children or sold for the benefit of those children. There are a number of reorganization techniques that can be used to accomplish the family’s goals. A partial sale and succession plan may help solve any liquidity problem by generating cash that can be given to the parents, thereby reducing the risk that they will not be paid completely for all of their interest in the business sold to their heirs.

Care must be taken not to exacerbate or encourage family conflict with such structures.For instance, if one set of heirs has the voting control over an operating business and another group has voting control over the buildings, land, and other assets needed to operate the business, vastly different priorities may emerge over time. One group may depend upon a salary income from continued operation of the business, while others may want to sell underlying real estate or other assets so that the proceeds are available for use or reinvestment. There is also the almost certain principal that “equal” businesses operations, once separated, will not perform equally due to many factors outside of management’s control. This can leave one group of heirs significantly wealthier than the other over time and may result in a perceived lack of fairness.

Buy-sell agreementsare very good tools to control ownership of a company between unrelated parties.  There can be some concerns, however, in family business succession planning. A buy-sell agreement is designed to keep ownership out of the hands of either someone you do not know, or someone you know and who you do not want to have as a co-owner/partner. Using a standard buy-sell agreement with family members will almost always result in unintended consequences, since a buy-sell agreement will typically not address the other 90 percent of the issues that should be addressed when transferring a business to family members. Careful analysis should be undertaken before providing rights and obligations to family members who, regardless of their current relationships, may not see eye to eye in the future. Forced redemptions of stock could cause business cash flow problems and the inability to sell could cause significant family financial conflicts and even litigation.