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Division of the Family Business: Equal versus Equitable

Many business owners prefer to separate their business and personal interests. However, if you are like most business owners your business is your largest asset and indistinguishable from your overall estate. As owners approach the point in their personal life when they contemplate the eventual distribution of their estate, they will run into the inevitable question as to how to distribute their company to their children.

The majority of owners will split their company equally among their children. The equal distribution of this important asset can lead to family conflict and impairment or destruction of the business. If the business is divided equally, is it fair to assume that all siblings will take an equal share in the operational management of the company? Even if these siblings have no industry or company experience. Is this fair to the children who have made a career in the family business, helped to increase business value and, sometimes taken a discount in the form of lower wages to work in the family enterprise?

In most cases, neither of these outcomes is acceptable to any of the children. But according to a survey conducted by Mass Mutual in 2018, nearly 60% of business owners say they plan to divide ownership equally among their children. If the intent is to distribute assets equitably, there are several options that allow for family harmony and legacy preservation.

These distribution options are:

  1. Recapitalize the Company
  2. Shareholder Reorganization
  3. Life Insurance
  4. Distribute Personal Assets

Recapitalize the Company

In this situation, the company takes on additional debt or uses life insurance and distributes cash in the form of a stock buyback. Allowing the non-working children to get money and the working children to retain control of the business.

Shareholder Reorganization

A shareholder reorganization can be effective in family business situations where the children would like a financial interest in the company, but one or more children need to retain control to make effective management decisions with minimal outside interference. This can be structured in the form of voting and non-voting shares in the company.

Life Insurance

The family business owns an insurance policy on the business owner’s life. When the business owner dies, the business receives the life insurance proceeds and then per an agreement, the business purchases a portion of the business interest from the deceased’s estate. Then the estate distributes the proceeds according to a will or trust to the non-working children for equitable distribution.

Another option is for the business owner’s estate to purchase a life insurance policy on the owner. When the business owner dies, the owner’s estate receives the life insurance proceeds.  The estate then dispenses the proceeds to non-working children to maintain an equitable distribution of the estate.

Distribute Personal Assets

In this situation, the business owner can bequeath non-business assets to the non-working children such as retirement accounts (e.g. 401(k), IRA, ROTH), real estate, and collectibles. Allowing the working children to retain control and the economic interests and liabilities of the family business.

Your business plays a large role in supporting you and your family today. As you contemplate the future, you may run into questions about how to treat family members fairly. Just remember that equal is not equitable and this is especially true if you have children who work in the business and those who do not.

When planning for your business’s future success, you will likely need to address how you will eventually distribute your business. As you address this issue, you may realize that what you think is fair is quite different from what your children consider fair.