Is Equal Always Fair? The Importance of Thoughtful Business Succession Planning

Originally submitted by Dan Waters, Attorney & Sean Minahan, Attorneys  Lamson, Dugan and Murray, LLP; Proud members of C2C in the LICA Contractor.  The issues and discussions addressed in the following apply equally to family farm succession planning as they do for succession planning of family owned contracting companies.

 

Christmas Dinner, 2042:

Steve: Mike, pass the sweet potatoes. . . . Mike, I said pass the sweet potatoes!

Mike:  Maybe I would pass the sweet potatoes if you carried your weight around here!

Steve:  Come on, I didn’t ask to be a part of the family business, ok?  Mom and Dad’s estate plan made us equal owners, that wasn’t my choice!  I’m a fitness instructor, not a land developer!

Kelsey: Still Steve, that doesn’t mean you get to take your third of the profits and do nothing to contribute.  Mike is right, you need to start taking your role seriously and . . .

Mike:   How about this for serious, I’m quitting! *stands up* I’ll be taking my third of the business in cash, then you’ll never hear from me again!  *storms out.*

Fast forward several months, or years, and a substantial portion of the family business has been drained paying legal fees.  Disagreements in valuing Mike’s share of the business and resulting litigation continue to put financial and emotional pressure on all the parties involved.  Worse yet, the children and their respective families refuse to speak to one another.  The holidays will never be the same.  What could have led to such a disaster?  A simple oversight on the part of the parents, granting an equal share of the family business to each child pursuant to their estate plan, without considering the children’s future roles within the company.

Most parents want the best for their children.  When it comes to succession planning, parents wish to transition the family business fairly.  To achieve this goal, parents may choose to divide the business among the children equally.  However, an equal division may not create the fair result desired by the parents.  While an equal division is often the easiest approach, it can lead to significant conflict, and even the demise of the business or family relationships, if the children are not equally invested in running the company.  Easy is not always right, and equal is not always fair.  For example, let’s wind back the clock and reconsider the above scenario, except with the parents still alive and running the family business, and try to avoid an unfortunate falling out:

  • Mike works full time for his parents and actively contributes time and effort to the company. He understands the equipment and other details of the business, is a natural manager, and builds great relationships with clients.  Mike shows consistent interest and knowledge regarding the land improvement industry.
  • Kelsey works part time for the business as the book keeper. She acts responsible in this role.  Kelsey prefers this limited position, being largely preoccupied by taking care of her three young children.  Kelsey’s understanding of the day-to-day operations of a land improvement contractor is limited.
  • Steve works for an unrelated business in a different industry. He shows little interest in the company, but is respectful towards his parents and is a good son.
  • The parents work with a team of advisors to develop a succession plan. At first, the parents consider an equal division of the company.  However, it is explained that a fair division of all assets can be achieved without dividing the company equally.  Instead, the parents designate the following ownership structure to take effect at their passing:
    • Mike will receive a 70% ownership interest in the company and become the controlling owner of the business.
    • Kelsey will receive a 20% ownership interest in return for her labor.
    • Steve will receive a 10% ownership interest so he can collect distributions from the company, but not have a controlling say in the direction of the business.
  • Understanding the potential for dissatisfaction and conflict based on this arrangement, and desiring a fair distribution of all assets in the estate, the parents designate that Kelsey and Steve will receive a greater percentage of other assets than Mike.
    • For example, Kelsey may receive the parent’s boat and certain investments while Steve receives the parent’s second home and his father’s classic car.
  • The end result is each child receiving a fair percentage of the estate, considering the total value of the business and all other assets owned by the parents at their passing.
  • Alternatively, the parents may wish to give Mike the entire business and more of the other assets to Kelsey and Steve. It is possible that the value received by each child in this scenario may not be nearly equal, but this could be considered fair given Mike’s contributions to the business and the parents’ objective to preserve the business and family relationships.  Granting Mike sole ownership and control may avoid any potential family dispute later on involving the business.  Mike has demonstrated himself to be capable of operating a successful land improvement contracting business.  However, owning the business is also a risk for Mike.  There is no guarantee the business will grow, while the value of other assets is more certain.

While considering one’s mortality is often uncomfortable, knowing that a tailored succession plan is in place which matches the business skills and future needs of the children is worth the extra effort.  Consider the following questions when beginning to form a succession plan prior to meeting with an advisory team:

  • What are the current and future prospects of the business and the land improvement industry as a whole? If the business is struggling or expecting difficulties, receiving an interest in the business may be more of a burden than a benefit.
  • What is the current and anticipated future role of each child within the business?
  • Which child has shown the greatest ability with regard to the operation and management of the company?
  • Which child has shown the greatest interest and knowledge regarding the land improvement industry?
  • Which child has the best vision for the company moving forward? How should the ownership interests in the company be valued? Is the valuation method established in the governing documents of the business?
  • Which child should have the greatest ownership percentage in the business?
  • Should one child receive a greater than 50% ownership interest in the business, granting authority to have the final say in cases of disagreement among the owners?
  • Should one child receive the entire business?
  • Are there certain individuals working for the business that should receive a percentage of ownership in the company other than the children?
  • Are there assets, such as certain construction equipment or supplies, outside the business which are important to the functioning of the business that need to be passed on to the child who will be the primary owner of the company?
  • Whose name(s) is on the deeds and titles of any machinery registered and used by the business or real estate belonging to the company?
  • What assets do we own that may be passed on to the children other than the business? Generally, how should these additional assets be valued and divided among the children to balance against children receiving different ownership percentages in the company?
  • What team of advisors should we work with in creating a succession plan?

Once a business succession plan is established, the children’s relationship with the company may change.  One child may choose a different career path, while another becomes more invested in the business.  The succession plan should be updated to account for such changes.  It is advisable to reexamine the succession plan in regularly scheduled intervals to ensure it matches the current and anticipated circumstances surrounding the business.  A thoughtful succession plan can protect a lifetime of effort channeled into your business, and create stability for future generations.  Give your family the gift of a more certain future this holiday season.

Disclaimer: The content of this article is for informational purposes only.  It is not legal advice, nor is it intended to create, and your receipt of it does not constitute, an attorney-client relationship.  This article may only be reproduced in its entirety (without modification) for the individual reader’s personal and/or educational use and must include this notice.  The content of this article is intended to be up-to-date, but may or may not reflect the most current legal developments.  The authors assume no liability or responsibility for any errors or omissions contained within this article.  You should not act or refrain from acting based upon this article without seeking professional legal counsel.  This article only provides a brief overview and an attorney should be consulted if you have questions regarding this topic in relation to your specific situation.

About the Author:

Sean Minahan
Sean Minahan is a partner of Lamson, Dugan and Murray and a member of the Litigation Department. Prior to joining Lamson, Dugan and Murray, Mr. Minahan independently contracted with the Iowa State Public Defender’s Office in handling juvenile and adult cases for indigent clients.

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