Part One of the Dynasty Family Business covered necessary characteristics a family business needs to become a Dynasty Family Business, and was posted on May 24, 2017. In this second part, the passage of ownership will be explained.
The “live forever plan” has not yet been shown to be successful. For a family business to be dynastic, there must be a successful transition of ownership or a passage of ownership. A lifetime transfer of ownership allows a donor to “see” how the transferee acts as an owner. This causes the family member who becomes an owner to have some “skin in the game”, which can impact their actions and perceptions.
When the time comes to sell the business their are important factors to keep in mind. If a shareholder sells stock or membership units, the sale can create a taxable event for the seller. If a shareholder sells stock or membership units at a discount, the sale can create a gift to the buyer. The purchase of newly issued stock at a discount may create compensation for the Buyer. In regards to the purchases and sales of the business, there is no need to transfer the whole company at once. You could create a series of Options, an installment sale, or you could transfer part of the business during your lifetime and the other part after passing. These payments could be made over time creating a retirement income. All sales among family members or sales by the company of newly issued stock/membership units to a family member should be memorialized in a stock purchase agreement. By doing this, it will provide representations and warranties on which the buyer can rely. This is critical when the Buyer is paying over a period of time and/or the Buyer has rights to acquire more in the future. This can be used to refute allegations of a gift, provides evidence of basis for the buyer, and this can promote family harmony by providing evidence of a “real” transaction rather than favoritism. Until the transferee owns ALL the stock/membership units, there should be a Buy/Sell Agreement whereby the Seller (which could be the Company) can reclaim the stock/membership units in case the transferee dies, becomes disabled, quits or is terminated. Gifting the company can remove assets from a donor’s taxable estate at a discounted value, could create a future tax problem for the transferee (they take the donor’s basis), and could cause disproportionate gifting (or perceived disproportionate gifting) which could create family discord.
Some choose to transfer ownership post mortem. An agreement like this may be made during a lifetime and can take effect after passing. It is important that plans such as this be in writing and in a way to fully express all of the terms of the transaction. This could be funded in whole or in part by insurance, it can provide liquidity for an estate, and this could “equalize” the estate if there are multiple beneficiaries. A Will or Revocable Trust can contain provisions to sell the stock/membership units.
When bequests are made, the recipient takes fair market value as “basis” for tax purposes. Disproportionate bequests can create family discord: “fair” is not always “equal”; and “equal” is not always “fair”.
Absence of a Will or Trust can create problems. It can lead to a discounted sale or closure of the business, which in turn can cause valuable employees and clients to leave the business, and can cause the termination of a franchise agreement. When there is no Trust or Will, the Executor/Trustee runs the business until distribution of the stock/membership interest. In the absence of a family agreement, the Spouse gets 50 – 100{7643a07be85def2dedbecc56bad3bab67e83a7c22b809f3c7a47a1fa73b8911c} and any share that does not go to the Spouse is divided between the children equally. All beneficiaries are entitled to their pro-rata share of ALL assets of the deceased, including the stock/membership units. Recipients may not be qualified to make necessary business decisions.
Dynasty Family Business does not just happen. They have certain characteristics which set them apart form those family businesses which close or pass outside of the family. To successfully establish a Dynasty Family Business, documentation of the transfer of the ownership of your business within your family is critical.
Please contact our office at 515-727-0900, or at info@kreamerlaw.com when you are ready to form your business to become a Dynasty Family Business.
