Planning for the inactive family member

In the last few decades, people have changed their views of family businesses. Once thought of as small, unsophisticated and unchallenging, a family business is now seen as a path to independence -- both financial and emotional.

Time was when business school graduates wanted to be hired by large corporations and to work their way to the top. But many of today's top graduates now view running family businesses as challenging and rewarding.

One question that should be asked is whether the business produces enough income to support more than one top manager and his family. If several children take over the business, will it support all of them? Can it expand to meet the need? And can the founder's estate treat fairly those children who do not want to join the family business?

Fair treatment for all

One way to achieve equitable treatment is to equalize inheritances using other assets. With a trust or will, the founder may transfer the family business to offspring who want to run it while still giving equal value to the other children.

If the founder gives the business to some of the children before his death, the others must wait for their shares until the founder dies. Making qualified gifts to all children before death will probably entail owing gift tax immediately. A founder can equalize the estate upon death by giving an interest factor to the nonactive children to adjust for the fact that they have had to wait to receive their inheritances.

When successor children buy the business and pay full value, theoretically the estate need not adjust for the nonactive children. But some founders will want to give the other children something to make up for the successor children having gained a livelihood. A founder lacking nonbusiness assets may buy insurance to provide for the inactive children.

Sometimes, to equalize the inheritances, the founder will give inactive children real estate that is rented to the business. However, this may prove problematic if the successors want to move the business or dispute the fairness of the rent.

Giving inactive owners nonvoting interests

A founder with insufficient nonbusiness assets or wanting to give the inactive children options of joining the business in the future, may give nonvoting ownership rights in the family business to inactive family members.

This may solve the issue of running the business day-to-day and give the active members control of most issues. But inactive family members may still raise questions about the payment of dividends or why the active members drive nicer cars and have more benefits.

Inactive family members may want their shares as soon as possible and may push to sell the business right away. Active family members with their livelihoods at stake are less likely to want to sell. These dynamics make it preferable to keep inactive family members out of the ownership of the family business if possible. If this is not possible, the best solution is to put buy-sell and corporate governance agreements into place.

Equal interest for all

Some founders will want -- or will be forced by circumstances -- to give everyone an equal interest in the business. This should not be done without giving the active family members the right to buy out their siblings at a fair price.

Active family members should be able to choose whether they want to stay in business with their inactive family members. While this solution may not be preferred, it is sometimes used when sensitive family dynamics would cause friction otherwise.

The founder usually does not want to have any of his children think they were not loved by their parents, so the problems that may be created are left to the children to work out. This could be the demise of the business if the children are not able to reach some agreement.

Inactive family members, particularly in families with more than two children, can create sticky problems for the founder who wants to be fair but may not have the flexibility to do so while maintaining the viability of the family business. Sometimes the founder will simply let the children work it out.

Founders who want the family business to prosper should plan carefully before turning the business over to the next generation. Careful planning will not only affect the future of the business, but will also set the tone for the children's relationships going forward -- and the involvement of their children when the time comes to again turn over the reins.

Melvin J. Van de Ven, CPA, CVA is a partner in the certified public accounting firm of Schott & Van de Ven, 1020 N. Kingshighway, Suite D, Cape Girardeau. He can be reached by email at mvandeven@schottvandeven.com