When transferring ownership and management responsibilities to the second generation, owners of family businesses struggle to determine what is fair. To many founders passing on the company to the kids, “equal” is the same as “fair.”

However, the incoming generation rarely considers equal distribution of ownership to be fair.

Olivia is the CEO, majority owner, and matriarch of LivCo (not the company’s real name), a family business in the Peabody area. Henry, Olivia’s husband, is a retired minority owner of the logistics and supply-chain management company. Olivia is an only child; she inherited the whole of LivCo when her widowed father passed away in 2015.

At the time of inheritance, Olivia and Henry were near retirement age. Instead of trying to sell the company, Olivia took over her father’s CEO role and held onto the company until her three adult children, Andrew, Ben, and Cathy, would be ready to take over.

Nearly a decade later, Olivia still does not feel the kids are “up to speed” on how to manage the company. However, Andrew and Ben both feel they are ready to take the top position. Although they love both their parents, they quietly long for Olivia and Henry to step aside. Cathy, meanwhile, is less interested in the family business.

Succession brings tough choices for business owners

Olivia and Henry met with their financial advisor to discuss inheritances — who should get what when they pass away. They felt it would be “fair” to give each child an “equal” share of their estate, including one-third each of LivCo. However, equality is not always to the benefit of the company’s continuation and family harmony.

Andrew and Ben have both worked at LivCo for about 20 years. Olivia sees Andrew as the heir apparent for the CEO role. He is a manager in title but more like a defacto COO, while Ben is a hands-on unit supervisor, more often than not performing the tasks of the employees who directly report to him. The youngest, Cathy, works at LivCo in spurts, but never for long. However, Olivia makes sure Cathy’s payroll checks do not stop.

Do your heirs see equal distribution as fair?

Olivia believed that she had a thoughtful succession plan. However, she was wrong on two counts. First, even if each child received an equal third of the company, Ben would not find it fair if Andrew took the helm. And neither Andrew nor Ben would find it appropriate to give ownership to Cathy.

Andrew and Ben want their mother to consider their “sweat equity.” To them, “equal” means giving each child the same share, while “fair” could mean distributing shares based on involvement, contribution, and interest in the business.

Second, Olivia needs to communicate her intent. Olivia may have a plan in her head, but it was not articulated to the family and non-family key executives much less put on paper.

Your employees want a share of the business

Outside the family, some of Olivia’s executives want the opportunity to acquire ownership of LivCo. They have unique skillsets and devotion to the company, and the business would be worth less and put at risk if they left. But those executives don’t have the capital to buy the company; they would expect seller financing (which is synonymous with a “gift”). While that may seem like an unreasonable expectation from non-family employees, it’s a real consideration by the non-family executives. Olivia can decrease the risk of employee attrition by acknowledging their contribution and aligning compensation to a successful transition.

How one business owner created a family succession plan that is fair, not equal

Olivia’s financial advisor began by facilitating a family meeting. That meeting was followed by confidential one-on-one meetings with the advisor and individual family members, spouses, and key employees. The financial advisor then came back with specific recommendations based on those conversations.

For brevity, the possible solutions listed below will focus on the business, not the entire estate or the suite of recommended tax avoidance strategies the financial advisor discovered:

• LivCo underwent a professional valuation. (Most business owners think they know their company’s value; most of them are wrong.) The company was worth $45 million.
• Olivia drew up a will that would give equal ownership of her shares to sons Andrew and Ben if she pre-deceased her husband, Henry. In that case, all three children would have the opportunity to purchase Henry’s shares at fair value if the other parties did not wish to buy the shares. Otherwise, there would be an open bid for designated critical employees with the proceeds going to Henry’s trust. If there were no bidders, Henry’s shares would remain his.
• Upon Henry’s passing, Henry’s shares would be transferred to a trust, with Olivia’s daughter, Cathy, acting as the trustee. Andrew and Ben would still have the opportunity to buy or bid for the shares as would vital employees.
• To provide for Cathy, Olivia purchased $15 million in life insurance, making her the beneficiary.
• Post-nuptial agreements were drawn up; spouses would have to sign the contracts for the children to receive their inheritances.
• Olivia drew up what the corporate hierarchical structure would look like after her passing, including non-family employees. The titles and responsibilities of owners and executives were documented. Incentives were designed to keep key employees in place and to reward them for hitting specific targets.
• The financial advisor assembled an advisory board for Andrew and Ben to report to. The board would advise on compensation and termination decisions.
• To protect the future of the family business and the family, LivCo created a buy-sell agreement between Andrew and Ben and for any potential additional owners. A buy-sell agreement is a legally binding contract between business partners that outlines how business interests will be handled if the other partner leaves the firm.
• Olivia worked with her financial advisor to explore potential tax avoidance strategies and potential liabilities to her children, such as requiring liquidity to pay inheritance taxes.

Communication is essential to your business succession plan

Olivia continues to refuse to relinquish control, which will create its own set of issues. Collaboration works better than control when bolstering intergenerational solidarity and preparing management for challenges. A transition plan that is not co-designed can create havoc.

Olivia should explain why she’s not passing on ownership and responsibilities now. She may find that she’s holding on for the wrong reasons. Olivia should also speak directly to Andrew and Ben about her decision to make Andrew the CEO and communicate to the family about how Cathy’s insurance proceeds are meant to even out inheritance amounts.

A well-developed succession plan is essential for the longevity of a family business. But no matter how well-written it may be, clearly communicating the plan to all stakeholders is critical to its success.

This article first appeared in the Berkshire Eagle on December 5, 2023.