Legal Tip: How Do I Divide the Family Business between My Children?

As an entrepreneur I always keep my ear to the ground for valuable information that experts are willing to share, and today I was introduced to a great article on how to divide the family business between your children.

This may or may not apply directly to you and your business, but the information is still extremely valuable.  Pass this along to anyone that you know that runs a family-owned business that might benefit from this…

Kenny Childs is an attorney with Kyler, Kohler, Ostermiller & Sorensen, LLP (“KKO Lawyers”), who regularly helps his clients with estate planning issues.  He has written this article to share some advice with us on how to handle and “pass-on” the family business.

Is fairness between your children important to you and your family?  How do you divide your estate between your children who have worked and been involved in the family business all their lives and those children who haven’t?  Should the children in the business buy the business on sweetheart terms and still share equally in the estate?  This is a major issue for those families operating their own businesses.  The biggest mistake you can make is failing to address this issue in your estate plan.  Failing to make these sorts of decisions before you pass away can cause years of contention and pain for your surviving family members.

Generally speaking, we believe that if you have children involved in the family business and both you and the children want to keep the business after you pass on, it is critical that the children who are in the business buy or inherit all of the business interests and if possible, the business real estate.  Otherwise, the family is left in a state where they have serious conflicts of interest.  We have seen relationships between family members destroyed because a parent thought it wise to leave a child not involved in the business his or her “share” of the business so he or she could receive an income stream and not feel left out.

The problem with this is that most family owned businesses do not pay significant dividends; the child not working in the business owns a valuable asset but it is useless to him or her unless the business is sold.  On the other hand, if there is a significant dividend or distribution out to the child not working in the business, the children in the business feel as if the non-working child receives significant dollars while doing nothing.  Also, children in the business will also have different investment and cash flow goals for the business than the outside child.  This does not mean that all of the children cannot inherit equal values; it just means that the children outside of the business should inherit other assets, not the business.

In dealing with dividing the business real estate, we usually recommend that the children in the business either buy or inherit the property.  When this isn’t possible, consider putting in place a lease that can only be terminated by the company and that sets a fair market value for rents based on an appraisal done every few years or a lease involving automatic increases.   The children in the business can also be given an option to purchase the real estate within a certain time period for its fair market value.  This allows them to buy some time after the parents have passed on to prepare to purchase the real estate from the estate.

In order to accomplish the goal of having a clean break between the children involved in the business with those that aren’t, there needs to be liquidity within the estate in order to “pay off” the children that won’t be involved in the business. Other assets that may pass to children not involved in the family business include the personal residence, retirement plans, savings or investment accounts, rental or other investment property and life insurance proceeds.  If your estate is lacking in other assets to pass to children not involved in the family business, then life insurance is almost always the best route to take to give liquidity to the estate.

As we have discussed in previous newsletters, in order to avoid estate taxes on life insurance, we use an Irrevocable Life Insurance Trust that effectively gets the life insurance out of the estate before you pass away in order to avoid the insurance proceeds from being added to the value of your estate.  Beware however, that this strategy is not one to implement on your death bed as you would obviously be uninsurable at such a time and if you do pass away within three (3) years after an existing policy is assigned to an Irrevocable Trust, the full value of the policy is subject to estate taxes.

Another way to give liquidity to your estate is to begin investing now outside of the business.  So many times our clients are focused exclusively on re-investing inside the business, which is obviously very important, however this creates all of the wealth to be passed on limited to the business itself, which fails to provide liquidity for those children outside the business.  Consider not paying off all of the business debts immediately and consider making investments apart from the business.  A 401(k) or other retirement plan may be a good start.  Obviously there is a delicate balance to be struck here and decisions regarding where and when to make such investments should not be taken lightly.

The biggest mistake you could make is failing to implement a plan long before you pass away.  The older you get the more limited your options become in implementing different strategies to both minimize estate taxes and to ensure fairness in dividing the family business between your children.  Furthermore, providing all of the children a plan in advance gives the children time to come to terms with the division of the estate and do their own planning for the future based on the division.  Allow a way for your family to avoid the grief and pain caused by failing to properly plan for a division of the family business long before you pass away.

If you feel this is an issue your family needs to address, please call the offices of KKO Lawyers to make an appointment with Kenny Childs and tailor an Estate Plan to your situation.  If you have any questions or feedback, feel free to comment :)

Check out these similar articles:

1. Review of Spin Selling by Neil Rackham – A great book for real estate investors and sales professionals… Neil Rackham, in this classic book shows how classic sales techniques such as closing and objection-handling can actually reduce your...
2. 7 Tax Strategies Every Real Estate Agent Should Know! My personal lawyer, Mark Kohler, specializes in helping Realtors and Entrepreneurs with Tax and Legal Strategies to help them KEEP...
3. Merry Christmas 2009 from ChrisRecord.com! I wanted to take a moment and thank all of my friends and followers for the wonderful support that you...
4. Digital Business Cards have 50x the response rate! Answer this question seriously. If you pass out 100 business cards, how many responses do you end up getting? 1%?...
5. The Ultimate Business Card System For Entrepreneurs I received a great question from one of my readers today and I figured I would take a moment to...