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4.23.99  
The Family Business: What to Do If Some Heirs Aren't Hands-On
Selections from Sustaining the Family Business

How we plan to pass on our company stock affects our estate value and can help resolve issues that cause conflict. As my car-wash company, ScrubaDub grew and my income accordingly, my accountant suggested that I consider giving away stock to my children every year to take advantage of the $20,000-per-year tax-free exclusion ($10,000 from each spouse). But this would reduce the total value of the stock I held while transferring future appreciation in the stock I gave away to someone else. In addition, I was concerned about giving away control of my business prematurely; I was reluctant to do this because I'd heard horror stories about families in which children who worked outside the business owned stock. All these stories seemed to end the same way: The children who worked outside the business successfully forced the sale of the business.

In addition, it seemed to me that giving stock to all family members created a system guaranteed to inhibit growth because those who received dividends from the stock would have a disincentive to reinvest earnings in the company's development. Looking for a solution, I discussed the problem with many experts on succession and read pretty much everything written on the subject. This is when I hit on the solution of reissuing our stock in voting and nonvoting shares. But this didn't solve the problem of how to treat my daughter fairly (as a nonbusiness member of the family). If I was giving her brothers an advance on their inheritance, shouldn't I do the same for her? But more and more stories came to my attention of the ill-advised policy of giving stock to family members not in the business. It wasn't that I didn't trust my daughter's judgment or thought she didn't understand what the company meant to me. I simply became convinced that the interests of any family member not working in the business differed fundamentally from the best interests of those who did work in the business.

FAMILY FEUDS. I considered giving company real estate to my daughter, but then I heard stories of families fighting over rental payments on business property. In most of these stories, parents had given the operating-company stock to their children in the business and left the business real estate to those not in the business. At some point, the children collecting the rental income would be advised by a lawyer or accountant that the rental income was not enough, given the market value of the property. Their attempts to increase the rent would provoke a feud. The children in the business would claim that Dad never intended the real estate to be priced at market value, and in any case, the company couldn't afford it. The accountant would tell the land owners that value follows the property and that if their siblings can't afford the rent maybe they should move. You can guess the rest.

I saw this scene played out in what had been a very close family. The father, wanting to protect his daughter financially, left her the building that housed his business at his death. When someone suggested that the rent was too low, the mother sided with her daughter in raising it. The two brothers who ran the business were so upset with their mother and sister that they negotiated to purchase the building at higher than market value in order to get out of the rental agreement. From that day on, neither brother has spoken to his mother or sister. What was intended by well-meaning professional advisers as a sound plan to protect one child destroyed the family.

All these stories persuaded me that to prevent future family conflicts, all ScrubaDub business assets should remain in the hands of those running the business. I purchased life insurance to ensure a distribution of liquid assets as my daughter's share of our estate. This way, after my death, each of my children will have received gifts of equal monetary value from us, although my daughter will be getting cash while my sons will be getting the company. In addition, my wife and I gave public securities to our daughter to make up for some of the benefits the boys were getting from the business while we were still alive. This done, I sat down to figure out the best way to pass the stock on to my sons. Convinced that the pyramid form of passing stock down had destroyed too many family businesses, I was determined to find an alternative.

In the pyramid system, the first generation -- the sole originating stockholder -- forms the peak of the pyramid. Once the second generation begins giving stock to its children, the pyramid starts expanding rapidly. Now a broad range of stockholders own stock, and many of them do not work in the business. Even if the company is extremely successful, produces ample dividends, and continues to grow, problems will still probably arise as a result of the number of personalities involved.

COLUMN STOCK DISTRIBUTION. My solution was to work with experts in the estate-planning field to develop what I call a "column" system for passing on stock. This involved creating family trusts representing the number of family working partners (in our case, two -- one for each of my sons). All of the voting and nonvoting stock that I have given away or sold has gone into these trusts, which I call family columns. These column trusts stipulate that stock will be available only to family members working in the business through these family voting trusts. Owners of the stock in the trusts are given certificates for the number of shares they own. (This makes it possible for them to give stock in the trust to their own children when they enter the business). Holding the stock in the trusts simply provides a means to vote the stock. The owners of the underlying certificates retain all other incidents of ownership. The vote of each trust must be cast as a block. Therefore, if the family partnership is set up with two voting trusts representing the two family members who enter the business after the founder (as in my family), each family member serves as a trustee of the other's trust but votes only on behalf of his or her own trust. Each trust has only one vote. With two trusts, we have a fifty/fifty partnership.

When members of the third generation have entered the business, and have convinced their parents by their commitment and competence to begin giving them stock, the members of the third generation will receive certificates representing their share of the stock held by their family column trusts. That means, of course, that after the first generation, for a long time parents and children will hold certificates for stock in the same trust. Since the trust has only one vote, the holder of the most certificates--the parent, in the beginning--will decide for that trust. Since the trust holds both voting and nonvoting certificates, while the parents remain active they only give nonvoting shares to their children in the business. This prevents the children from "ganging up" on the parent once they as a group hold a larger block of shares than he or she does, and also prevents a "votes for sale" scenario in which family members try to recruit a majority of other family members to their point of view, with the usual relationship-damaging consequences. As the parents retire, they sell or give the voting shares in the trust to their children, who then must agree on a way to vote their one vote.

Keeping the family business stock in trust also provides some protection against divorce by ensuring that a spouse leaving the family cannot be compensated out of family business holdings. I find this setup far preferable to prenuptial agreements, which are frequently used to ensure that stock given to a young couple will not become the property of the nonfamily partner if the couple splits. I think prenuptial agreements put a great burden on a young married couple and hold such negative connotations that they invariably leave the spouse who has married into the family with bad feelings even if he or she remains happily married to a member of the family and dividing the stock never becomes an issue.

IMMUTABLE SYSTEM. It is important to note that once family column trusts have been established, no matter how many children subsequently enter the company, the structure remains the same: New columns should not be added, and each trust should never be granted more than one vote. If a voting member should die before his or her children are old enough to enter the business or take over his or her voting rights, the other trustee of the family trust (if there are only two participants, as is currently the case in my family) would vote the stock until the surviving children or grandchildren enter the business. If there are more than two column trusts, then the voting trustee of each column should indicate in a will which of the other participants he or she wants to vote the trust if he or she dies before the children reach maturity.

It must be a provision of the column trusts that the stock they hold can only be given to other family members who work in the business. Children who elect not to join the business and go on to other careers should be compensated by other nonbusiness assets in the family estate, such as cash gifts, residential real estate, stocks from a diversified portfolio, and so on. This may sound heartless, but it is vital to keep the control of the business in the hands of those working it. Any child who chooses not to come into the business and receives compensation in the form of other assets in the estate holds no claim on the business asset.

Marshall B. Paisner is chairman of the board at ScrubaDub Auto Wash Centers Inc., one of the world's largest car-wash chains, an enterprise he founded in 1965. He is active in many family business organizations and forums.

Reprinted with permission from Sustaining the Family Business: An Insider's Guide to Managing Across Generations by Marshall B. Paisner.
Copyright 1999, by Marshall B. Paisner.
Published by Perseus Books, a member of the Perseus Books Group.
Adapted by permission of the author and Perseus Books.
May not be modified, reproduced, republished, uploaded, posted,
transmitted, or distributed in any manner.
Available on May 12, 1999, from bookstores nationwide, online
retailers, or by calling 800 386-5656.

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