Treating Children Fairly and Equitably
You love your children equally, even though you know they have different abilities and personalities. At Christmas, if you put a candy bar in one of their stockings, you did the same for all. If you bought a bicycle for one, you bought a bicycle for all. The same evenhanded treatment applied to their first car, college, and their first house. You want to treat your children fairly, and that usually means equally.
One of the most troubling estate planning decisions is how to divide your assets when you and your spouse are gone. It is one of the biggest reasons why family business owners don´t complete estate planning. You bring your "fair and equal" mindset into this process. When people in corporate America retire, they take their profit sharing or 401(k) funds and away they go. Heirs of wealthy investors can easily divide liquid assets, and the whole process is quick, neat and tidy. Not so in a family business. Three factors make this division difficult for family business owners.
First, between 60 and 80 percent of their total net worth is typically tied up in the business or business-related real estate. Available cash (profit) is plowed back into the business. Family business owners often awaken to the reality that they have built themselves traps by having such a large percentage of their total net worth tied up in their illiquid businesses.
The secondfactor is determining the value of the business. Business valuation experts go into great detail explaining the three most commonly utilized formulas for determining the value of a business, and there are situations where it is worth the expense to have a formal valuation done. But most owners have a rough idea what their businesses are worth, and their seat-of-the pants estimates are usually very accurate.
The thirdfactor arises when one (or more) of your children decides to work in the business and one (or more) doesn´t. If none works in the firm, your question is simply to whom will you sell it and when. We firmly believe that children who work in the business should own it, and those who do not work in the company should not own stock. Parents often expend great energy describing how well their children get along and how much they love each other. They are amazed to discover that sharing a closely held business that doesn´t pay dividends, doesn´t provide salaries and perks to non-employee children, and has no real value until sold creates conflicts, broken relationships, and lawsuits in even the closest of families.
Let´s assume your net worth is million, half of which is cash, publicly traded securities and real estate (passive assets) and the other half is stock in your closely held business. Let´s say you have two children - one working in the business and one who doesn´t. How would you divide these assets?
The typical answer is to give the child working in the business the stock in the company and the other child the more passive assets. Is this fair and equal? No way. How much work will be involved in keeping the company worth what it is now worth? How much work is involved in keeping cash, stocks, and real estate worth their present value? There is a vast difference in effort needed. How about risk? Owning a closely held business is far riskier than ownership in most publicly traded stocks, real estate, or cash. The child with the company must perform more work and assume a greater risk than the child who receives passive assets.
Even the IRS recognizes the fact that a dollar´s worth of stock in a closely held business is not worth the same as a dollar of cash. A minority owner of stock in a family business cannot control decision-making, and since there is no ready market of buyers willing to purchase this stock, the IRS allows discounts on the value. Your financial and legal advisors can help determine the amount of these discounts, but they are often 35 percent or more.
The biggest hurdle family business owners must jump is the mindset of treating children equally.In dividing family business assets there is rarely fairness in the equal division of assets. Instead, owners must consider being fair and equitable. These goals can be mutually achievable. The process is to realistically determine the value of assets and arrive at a formula whereby children who do not receive stock in the company will receive a percentage of that value in other assets. The methodology will vary from family to family depending on the nature of the business, the composition of assets, and the number of children involved.
Written by Wayne Rivers, President of The Family Business Institute, Inc. FBI´s mission is to provide complete solutions to help family businesses maximize their family and organizational success. Wayne can be reached at (919)783-1880 or at firstname.lastname@example.org.