Estate Planning For A Family Business Balances Three Roles

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Estate planning is important for every family, but for those with a family business it becomes more complex. Consequently, the attrition between generations is significant. Only 34% of family businesses successfully pass to the second generation and only 13% make it to the third generation. The successful succession of the family business is dependent on anticipating the dynamic integration of estate planning with the different roles in the family business.

Now for “the rest of the story”: Many years after Disney’s Beauty and the Beast, Belle and her Beast of a prince built a widely successful family business. They also had two sons – Hartless and Vermin, and a daughter named Sophia. Beast, who was as smart as he was handsome, assumed that a simple inexpensive estate plan was all that was needed. So he left the management and control of the family business to his sons with one third of the profit for his beloved Belle, and the balance in equal shares to his children, Hartless, Vermin, and Sophia.

Beast died of feline leukemia the next year.

Five years later Hartless and Vermin were collecting piles of gold in salary. Their lavish “business” expenses left only a meager profit to be shared with the others. Belle and Sophia struggled to make ends meet on the leftovers. Dividing ownership of a family business is the easy part. Insuring equitable provisions for the entire family is more difficult.

Family business successions are most successful when preceded by the wise integrated planning of three roles: family, business and ownership — each of which have different goals and objectives as well as rules of behavior. Behavior that is appropriate or tolerated at home may be inappropriate in the business environment. And while many families avoid discussions where there is disagreement, encouraging the expression of disagreement is critical in the business realm, especially the “family business” realm.

The Family Role

For most family businesses, the family role is the most important. The emotional issues of unconditional acceptance and equality are both the friction and the glue in many families. Family dynamics resist change. Families are naturally inwardly focused, seeking to nurture and develop the next generation.

The challenge of the family is for the older generation to pass on not simply the acumen of the family’s finances but also the strength of the family’s values. Each generation has to be actively raised to the level of peer by the actions and attitudes of the generation before them. Beast’s first mistake was failing to provide that type of mentoring for Hartless and Vermin (or maybe his choice of names). Proven family character must be required for leadership in the family business, and a board of directors with at least two outsiders would help keep family values intact. (Mrs. Potts, Lumiere, and Cogsworth would be excellent candidates for Belle & Beast’s Board of Directors.)

The Business Role

It is best to keep a boundary around the realm of the business. For a business to be successful, it has to be able to change quickly. Businesses have to generate profits, and therefore have to be outwardly focused. As a result, family members can’t be treated equally. If one family member works part time, while another chooses to work nights and weekends the monetary incentive needs to be in proportion to the profit each brings into the business.

If a business is passed from one member of the older generation to a single member of the next generation many issues can be postponed or ignored. But if the business moves from a single owner to a partnership of siblings and then to a set of cousins who are shareholders the business must continue to run like a business while simultaneously coping with a potentially sensitive matrix of relationships. Careful thought must be given to leader selection, the role of non-employees, conflict resolution, and the shared control of different family branches.

Those running the business must also be trained in the fiduciary responsibility of management, preferably before the change of ownership. There will need to be policies for fair dividend distribution for those not employed. Again, outside governance by a carefully selected Board of Directors can provide wise stability.

The Ownership Role

Ownership concerns become critical as the family business is divided among cousins, spouses, and extended family. As soon as a family business is divided into shares there will be those working in the business and those who merely own shares in the business. Plans must be made for buy-outs, professionalized management, mentoring, and family council meetings.

Transfer of ownership is the least complex of the three roles for estate planning, but it won’t achieve your succession goals without a solid family structure and healthy business structure in place.

Family businesses are complex, needing to address multiple roles. Wise estate planning for the family businesses accepts, mentors and integrates others (family role); makes a profit and demonstrates objective professionalism in its decisions (business role); and plans for the inevitable – a successful transfer of ownership to the next generation (ownership role).

Photo used here under Flickr Creative Commons.

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.