Many family-owned businesses have had to scramble to maintain ownership, when owners or heirs were struck by COVID-19. Lacking a succession plan may have led to disastrous results, or at best, less than optimal corporate structures and large tax bills. This difficult lesson is a wake-up call, says the article “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’” from Bloomberg Tax.

Another factor putting family-owned businesses at risk is divorce. Contemplating the best way to transfer ownership to the next generation requires a candid examination of family dynamics and acknowledgment of outsiders (i.e., in-laws) and the possibility of divorce.

Before documents can be created, a number of issues need to be discussed:

Transfer timing. When will the ownership of the business transfer to the next generation? There are some who use life-events as prompts: births, marriages and/or the death of the owners.

How will the transfer take place? Corporate structures and estate planning tools provide many options limited only by the tax liabilities and wishes of the family. Be wary, since each decision for the structure may have unintended consequences. Short and long-term strategic planning is needed.

To whom will the business be transferred? Who will receive an ownership interest and what will be the rights of ownership? Will there be different levels of ownership, and will those levels depend upon the level of activity in the business? Will percentages be used, or shares, or another form?

In drafting a succession plan, it is wise to assume that the future owners will either marry or divorce—perhaps multiple times. The succession plan should address these issues to prevent an ex-spouse from becoming a shareholder, whose interest in the business needs to be bought out.

The operating agreement/partnership agreement should require all future owners to enter into a prenuptial agreement before marriage specifically excluding their interest in the family business from being distributed, valued, or deemed marital property subject to distribution, if there is a divorce.

An owner may even exact a penalty for a subsequent owner who fails to enter into a prenup prior to a marriage. The same corporate document should specifically bar an owner’s spouse from receiving an ownership interest under any circumstance.

A prenup is intended to remove the future value of the owner’s interest from the marital asset pool. This typically requires the owner to buy-out the future spouse’s legal claim to future value. This could be a costly issue, since the value of the future ownership interest cannot be predicted at the time of the marriage.

Many different strategies can be used to develop a succession plan that ideally works alongside the business owner’s estate plan. These are used to ensure that the business remains in the family and the family interests are protected.

Reference: Bloomberg Tax (April 5,2021) “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys