Walt has spent the last thirty years building a successful manufacturing business. During that time, he married his beautiful wife, Victoria, and they had two children. Victoria has finally convinced Walt that it is time to take a day off to meet with an estate planning attorney to create simple wills. According to the initial consultation questionnaire, Walt and Victoria’s estate, comprising their business ($2 million), their home ($600,000), and their brokerage account ($400,000), is currently worth $3 million.

Although Walt and Victoria want to keep things simple, their attorney has persuaded them to consider a comprehensive plan that addresses business succession. But Walt and Victoria do not know where to start. In this situation, a knowledgeable practitioner must use legal and counseling skills together to position the family and their business for the best chance of success. Wearing both hats is the only way practitioners can help clients achieve the parallel goals of keeping family relationships intact while establishing plans designed to enable their business to continue to thrive. As knowledgeable practitioners, it is our job to encourage our clients to work on the business by planning for its long-term needs, including who will take over when they are unable to continue operating it, while they work in the business handling its day-to-day and short-term needs.

Take a Few Steps Back

Before you can move forward, you may need to take a few steps back. Regardless of how a business owner ultimately transitions their company, practitioners need to ensure that business clients have foundational documents in place. The following questions can help the client think through their needs and goals:

• Is the company using the appropriate legal structure and tax classification?
• If the business owns real estate and equipment, should those assets go into a separate entity from its operations?
• Is there an operating agreement or bylaws?
• What happens if circumstances change and the client cannot participate in the business?
• Does the client have disability insurance?
• Does the business need key person insurance?
• Do the owners need insurance to equalize inheritances for heirs who are not interested in the family business?
• Has the client identified others (not necessarily family members) who are integral to keeping the business running if the client is unexpectedly out of commission?
• Is there an incentive plan for retaining employees?

In addition to determining whether the foundational documents are in place, practitioners should review the documents’ content. This review is what distinguishes the services we provide from the generic forms available on websites such as LegalZoom. Despite Wyoming’s excellent statutory protections for limited liability companies (LLCs), experienced practitioners often encounter companies using generic documents. Wyoming’s statute affords LLC members protection against creditors who may attempt to pierce the limited liability veil even if traditional company formalities have not been observed, but many generic operating agreements impose a duty on members to comply with certain company formalities. If someone sues a company that used such a generic operating agreement, limited liability protection is unlikely to be available if the document imposes company formality requirements and the LLC members have breached those self-imposed duties.

Family Values

Before drafting a client’s ideal plan, practitioners need to flex their counselor-at-law muscles to gain an understanding of the family’s values, why the business was created, and the client’s vision for the future. This process may be the heaviest lifting for some practitioners.

Your clients may not have considered these matters and may have difficulty articulating their goals. Accordingly, it is crucial to take the time necessary to help your clients identify their goals. Otherwise, you will find that you are trying to hit a moving target, which sets both you and the client up for failure. Furthermore, if the client allows the next generation (G2) to assist in creating a shared vision for the business, they should consider a family constitution that memorializes their values. This constitution’s creation can be a collaborative effort that not only clarifies the interested parties’ goals but also yields buy-in from G2.

Practitioners commonly encounter the following goals when they are assisting clients with planning the family business’s transition to G2:

• The founder does not want to give up control (although they will rarely admit it).
• Parents want to provide an equal inheritance for their children, some of whom may not be interested in the business.
• The business owner wants to create a source of income for the surviving spouse.

This initial stage is an appropriate time to meet with the client’s advisory team (certified public accountant, financial advisor, insurance agent, etc.) without the client present. I have found that, if the client is present for the team’s first brainstorming meeting, there is inevitably a lot of posturing, because clients who are professionals may be unwilling to admit that they do not understand a concept. Business succession planning is a team sport, and the client’s advisors must be able to work together to use the best strategies available to benefit the client and the business.

Stay in Control and Do Not Exit Too Soon

In an ideal world, Walt will consult his attorney years before he wants to transition the family business to the next generation. Although Walt wants to ultimately die with his boots on, Victoria wants to be able to take month-long vacations with her husband to visit their grandchildren. A strategy that includes time intentionally carved out for Walt to teach his children the subtleties of running the family business will help them succeed while also allowing Walt to remain in control and become comfortable with his kids’ abilities.

Clients who have been at the helm for decades have built relationships with financial institutions, vendors, and customers who may be uncomfortable with a drastic change in company leadership. Therefore, a transition period is essential to allow G2 to cultivate the skills and network they will need when they do take over the company.

On the technical side, practitioners must work with the client’s financial professionals to determine whether gifting or selling a current interest in the family business to G2 is the optimal strategy to foster ownership and create valuation discounts. In addition, if the child lives in a community property state and is currently married or may get married in the future, the client will need to consider the potential for a divorce or other division of assets. Regardless of the technique integrated into the business succession plan, practitioners must consider the current income, gift, and estate tax environment along with changes that could occur in the near future.

Mixing Family and Business

Frequently, family business owners struggle with separating their interests and treating the company as a business and family as family. The client may need to recognize that some (or all) of G2 may not be interested in taking over or working in the business. Walt understands that his daughter wants to follow in her father’s footsteps. His son, on the other hand, is in culinary school in New York City and is not likely to return soon.

Many clients want their children to inherit equally. This wish can be especially problematic when the family business represents the bulk of the client’s estate. In this scenario, a fairly common business succession technique is to recapitalize the company, allowing the child who will continue the business operations to inherit the voting interests and the remaining heirs to inherit nonvoting interests.

Most heirs who receive nonvoting interests do not believe their business interests are equivalent to their siblings’ voting interests. This classic equity division inevitably causes turmoil among G2. The members who own the nonvoting interests will speculate about why distributions are not being made or dividends are not being paid. The members who own the voting interests may become resentful about shouldering the full burden of increasing the value of the family business, which benefits all of the members.

If time and health allow, the client may want to consider life insurance as a way to provide liquidity to the estate. Life insurance can be used to equalize the children’s inheritances when some members of the next generation are not interested in taking over the family business. If life insurance is not an option, the next best plan may be to allow the heir who will operate the business to purchase the other heirs’ interests. In this scenario, it is likely that the heir vested in the company will lack the ability to purchase outright the interests owned by the other heirs. Therefore, because there is no single method for determining the fair market value of the interests of a closely held company, the client will need a thoughtful plan for ascertaining how the business will be valued at their death. The client will also need to establish the parameters of the buyout.

Source of Income for the Surviving Spouse

Family businesses are often the client’s primary source of income because the client is also the operator. Accordingly, a surviving spouse will probably continue to depend on cash flow from the company. When collaborating with the client’s financial professional, the various ways to accomplish this goal will become apparent. For example, the surviving spouse may choose to sell their interests to G2. Another option is for the company to redeem the founder’s stock. In addition, if the equipment and real estate are owned by a separate company, the surviving spouse could own the interests in that company and receive rental income.

Clients Don’t Know What They Don’t Know

It is important to ensure that a basic estate plan is in place prior to the founder’s death. Many clients do not understand that business interests are subject to the probate process and that, when assets pass via a last will and testament, the estate is squarely under the jurisdiction of a probate court. When business interests are tied up in probate court, several common problems arise, including the following:

• Operations cease until disputes regarding who will operate the business are resolved.
• The court requires a business valuation.
• A fire sale of the business’s assets occurs because the personal representative lacks the knowledge needed to properly operate or sell the company.

Nevertheless, practitioners should use caution when funding business interests to a revocable living trust (RLT) in an effort to avoid such concerns. In 2018, the Bipartisan Budget Act was amended to set forth the new audit rules. Although a company may opt out of the new regime if it meets certain requirements, the new rules state that members of a company taxed as a partnership must be “an individual, C corporation, foreign entity that would be a C corporation under U.S. law, S corporation, or the estate of a deceased partner.”^[1] This list of eligible members does not include RLTs. Furthermore, if the company is taxed as an S corporation, the RLT should include provisions enabling it to qualify as a qualified subchapter S trust (QSST) or an electing small business trust (ESBT), and the company should file a formal election with the IRS. This situation is another reminder of the importance of collaborating with the client’s financial professionals even when creating a basic estate plan.