Building a successful business can take much of a lifetime; passing it along to the next generation should not consume all the rest. Succession planning, especially if the intended successors are family members, is essential both for purposes of estate planning and ensuring that the business legacy continues in capable hands. Numerous strategies are available. Here is one for a business founder with at least one child who seems a likely candidate to take over the business, though not yet.
Assume the founder is married with three adult children. The first child, the “leader,” works in the business, demonstrating drive and potential for leadership. The second child, the “follower,” also works in the business but exhibits less executive flair. The third child, the “poet,” works elsewhere as an unappreciated artist, expressing no interest in the founder’s business or any other. The founder, whose principal asset is the business, wants to benefit all the family upon his death while still rewarding the child who is likeliest to lead the business to the next generation. With that in mind, the founder does not want to pass all the value of the business upon his death to the leader and the follower because there will be too few other assets in the founder’s estate to make a roughly equal share for the poet. Yet it is the leader who must take control if the business is to carry on.
One approach to achieving these goals is for the founder to hold his stock in the business through a revocable trust established in his lifetime. The trust would specify successors to the founder’s interest, while ensuring that the entire family benefits from any eventual sale. What follows is the basic superstructure.
The founder would transfer all of his stock in the business to the trust, appointing himself as the initial trustee, thereby maintaining complete control over the stock. The trust is revocable by the founder at any time, becoming irrevocable only upon his death. As such, the transfer to the trust would not be taxable, and the stock would remain in the founder’s taxable estate because of the control retained during life.
The trust might provide that the founder be succeeded as trustee by the child working hardest in the business, the leader. The succession might occur when the trustee becomes incapacitated in some way or chooses to resign; or if not under those circumstances, then upon the death of the founder. If the leader does not survive to assume the role of trustee, the next successor might be the other child working in the business, the follower. If the follower is not able to serve either, the founder may prefer that a trusted executive of the business, rather than the poet, take charge as the successor trustee.
Death of the Founder
Upon the death of the founder, the leader or a successor to the leader becomes trustee, holding the voting power over the stock and thus control of the business. When this happens, however, the leader and the leader’s siblings do not necessarily succeed to beneficial ownership. This is because the founder wanted first to benefit his surviving spouse, who has pursued many other interests, just not in the business. For that reason, the leader as trustee holds the stock for the benefit of the founder’s surviving spouse.
Benefiting the Surviving Spouse
Any dividends or other distributions from the stock would be payable as income to the surviving spouse. If the leader as trustee votes the stock to sell the business during the life of the surviving spouse, the proceeds from the sale would continue to be held in trust for the benefit of the surviving spouse. As the beneficiary, the surviving spouse would have an absolute right to any income from the invested proceeds. The surviving spouse might receive further distributions of principal according to a standard of lifestyle maintenance, health and support, all as determined in the discretion of the trustee.
Death of the Surviving Spouse
After the death of the surviving spouse, if the business has not been sold, the leader trustee would continue running the business as trustee. The trust might provide further that the trust be terminated and its assets distributed upon any sale of the business or a decision by the trustee to terminate sooner.
Upon termination, the trustee would distribute trust assets as stated by the founder under terms of the trust instrument, whether equally or in some other proportion, to the leader, the follower and the poet; or, if any of these children of the founder has since died, to the descendants of that deceased child. If the business has been sold, the distribution would take the form of cash. If the business has not been sold, the distribution would take the form of stock, thus providing the trustee with discretion to decide whether the three siblings can work together in continuing to run the business. (Perhaps the poet has since given up writing and graduated from business school.)
The founder may provide in the trust for equal distribution among the three children upon termination, based on the assumption that the leader, and to a lesser extent the follower, will have been amply compensated for their contributions to the business through salary and bonuses. Of course, the founder could also provide for disproportionate shares upon final distribution, rewarding the leader and the follower with more than the poet, on the assumption that the first two children should receive a greater share of the appreciation of the business value that occurred under their leadership.
There are plenty of variations on the foregoing example. The point is the flexibility available to the business owner to plan the transfer of control and ultimate disposition of a business well beyond his lifetime.
For more information please contact Jay Merwin at (410) 583-2400 or firstname.lastname@example.org.