Authors Note: Although the text of this article is geared toward family-owned businesses, several of these concepts and legal issues would apply in all small-business settings.
It is given that a court reporting agency should be operated in a business-like manner, even when the owners are all members of the same family. This becomes especially important when management determines family-related issues such as succession.
The following is a working outline of some (but not all) important succession issues. These issues involve management transition, resolving existing conflicts, taxation and wealth transfer problems, generating continued income to founders, and retaining non-family employees.
POINT ONE
The family business and its owners(s) need to create a thoughtful succession plan. A smooth succession in the ownership of business cannot occur unless management is first shared, and then shifted, to other persons.
Select future leaders. Identify family members who may become the future leaders of the business. These potential leaders should be trained and mentored to take over the management of the business. These potential leaders should be trained and mentored to take over the management of the business. During this training period, the senior management should objectively assess whether next generation members have the talents to successfully take over the business. Are the family members competent to take over the key leadership roles? Often, non-family personnel can bolster areas where family talent is limited. In other cases, more dramatic measures must be considered; e.g., selling the business while strong management is in place; turning over control of key positions and management responsibilities to non-family executives.
Corporate officers and board of directors. At appropriate times, certain of the key "next generation" persons need to placed into corporate offices and onto the corporate board of directors. In addition, outsiders can bring objectivity and special expertise to the board (often, an outside "advisory board" is created for this purpose). More importantly, in the succession process, they may facilitate the resolution of management conflict among family members.
Chairman/President. Some sort of co-presidency may be advisable during a transition period, with the parent as chairman of the board, and the next leader as president.
Introducing the next generation to the outside. Present ownership should introduce the next generation to key business relationships and gradually turn over the responsibility of managing these relationships to the next generation. This includes financial institutions, suppliers, customers, etc., who should be accustomed to dealing with the succeeding generation. It is critical to show management depth and succession planning to those key relationships who have long term interests in the business. Introducing these key relationships to a thoughtful succession plan that is ongoing may provide assurance to outsiders that the business will remain stable through generational changes. This will help the business to solidify its long term relationships with its creditors, customers, etc.
Qualifications of family members of employment. Before bringing family members into the family business environments is the basis or philosophy regarding the compensation of the succeeding generation family members. From a family perspective, parents may wish to treat all children equally -- regardless of merit, position or contribution in the business. Though it may be an admirable goal for all family members to earn their way toward roughly equal compensation in the business, talents and contributions are rarely equal. More often, compensation systems should be based on merit. High achievers should understand that they will be rewarded for their efforts.
POINT TWO
If succession is to proceed successfully, present areas of conflict should be identified and addressed; they will not go away by themselves. At times, close advisors can assist in addressing and resolving these conflicts. Other times, an outside board creates an excellent forum within which some of these matters can be addressed. It is often advisable to involve family and/or business counselling -- the business may need the assistance of a family business psychologist to resolve family problems that are affecting the business. The problems may include:
Sibling rivalry - some may fell that other siblings are getting an economic benefit from their efforts: "outside" siblings may feel excluded; parents may be perceived as having "favorites."
Parental control - older generation business founders may not be able to acknowledge the maturity and abilities of the younger generation. One of the most difficult family business problems may be getting the older generation to let go.
Separating family and business issues - some family problems shouldn't be allowed to interfere with the business. Family members may need assistance in keeping these problems out of the work place. For example, a divorce may separate a key business player (an in-law) from the family, even though that person continues to be involved in (and needs to be involved in) the business.
Irreconcilable differences - some problems among family members may be beyond resolution. If so, this should be acknowledged and alternatives considered.
POINT THREE
Develop a plan to transfer ownership of the family business to the appropriate family members. Lifetime transfers of the business will almost always be better, from both an estate tax and a business perspective, than transfers at death. The tax advantages of gifts include:
Subsequent appreciation not taxed. The gift tax value is the value on the date of the gift. Appreciation from the date of the gift until the date of death of the donor will escape tax.
Annual gift tax exclusion. Gifts of less than $10,000 per donee will not be subject to tax and need not be reported. There is no such corresponding exclusion for estate tax purposes.
Tax exclusive. If the gift generates gift tax, the basis for calculating the tax is the value of the gift (exclusive of any gift tax paid). In contrast, if the same asset is bequeathed by will and generates estate tax, the estate will pay tax on the amount of the bequest an the amount of estate tax attributable to it (tax inclusive).
Audit exposure. Gift tax returns are not audited as frequently by the IRS as estate tax returns.
Utilizing available discounts. Transfer of "non-voting" interests in closely held businesses are valued at significant discounts (often 25-60%). By transferring a business to the next generation in phases (e.g., 49% [gift] 2% [gift] 49% [bequest]), all transfers are eligible for these meaningful discounts.
Techniques available for lifetime transfers:
Transfer in trust can defer the time at which beneficiaries receive outright control of stock. Gifts in trust can also protect the stock from the claims of beneficiaries' creditors and avoid having the stock distributed to an ex-spouse in the event of divorce.
Grantor retained annuity trusts ("GRAT"). Stock could be transferred to a trust which would pay an annuity to the grantor for a specified period. At the end of the specified period, the stock would be distributed to, or held in further trust for, the next generation. A taxable gift occurs at the time that trust is created, but the gift is reduced by the value of the annuity interest. For example, if $1,000,000 of closely held stock is transferred to a GRAT which pays a $75,000 annuity to the grantor for 10 years, the value of the gift would only be about $500,000 (based upon current interest rate assumptions). The grantor can be the trustee of the trust, so he/she can still effectively control the stock in the trust. If the grantor dies before the annuity term expires, all or part of the trust will be included in his/her gross estate, but any unified credit consumed, or gift tax paid, is restored.
Generation-skipping transfers in trust can allow the next generation to control the stock (as trustees) as enjoy the fruits of the stock (dividends or S corporation distributions can be paid to the children) while providing for the ultimate in the parents' and the child's estates. In addition to the tax benefits (the property in the trust would be excluded from the children's estates), these trusts can help facilitate the transition to yet another generation. Care should be taken, however, to make sure that tax considerations don't drive a plan in a manner which is inconsistent with important business succession goals (e.g., should non-working children and grandchildren own shares of stock in the family
Lifetime installments sales. A sale of stock to the next generation effectively "freezes" the stock at its present value insofar as the older generation is concerned. An installment sale has obvious cash flow chase price is paid over time.
Consider corporate recapitalization prior to transfers. The corporation can be recapitalized so that the bulk of its equity lies in non-voting stock (this is permissible in an S corporation so long as the only difference is in voting rights). The donor can then give away substantially all of the equity without relinquishing the vote. Gifts of non-voting interests will generally be eligible for substantial valuation discounts.
POINT FOUR
Providing income and security to the older generation is usually a prerequisite to transferring control to the next generation.
Employment and consulting agreements. As a part of the transition, the older generation can be retained as employees and consultants, and be compensated accordingly.
Deferred compensation arrangements. In addition to qualified retirement benefits (pension, profit-sharing 401(k), etc.), the older generation might also receive non-qualified deferred compensation. These arrangements can be put into place well in advance of retirement and as a part of a long-term succession plan (or they might be put into place as a part of a comprehensive retirement and buyout package).
Income stream for surviving spouse. The foregoing arrangements should also be constructed to take into account the surviving spouse's needs. Deferred compensation arrangements might provide for some manner of payment over both spouses' lifetimes. An employment or consulting arrangement for both spouses, or for a surviving spouse, may also be indicated. The financial arrangements which are put into place as a result of the buyout and retirement of the older generation should always consider the consequences if the spouse who has been involved in the business is the first to die.
Bequests of stock to or for the benefit of surviving spouse. In finalizing a plan for the transfer of stock to the next generation, the family must consider whether to transfer final ownership at the first or second death of husband and wife. Benefits to be gained by ultimately transferring remaining shares to the next generation at the death of the active parent (by bequest or sale) include:
appreciation attributable to next generation efforts need not be paid for (by estate taxes, if bequest; or increased purchase price, if sale);
keeping uninvolved spouse out of business matters;
At times, it is more advisable to wait until the second death to transfer final ownership to the next generation. Benefits to be gained from delay include the following:
More time available to address estate tax liquidity (e.g., use of survivorship insurance);
More time to assess competence of next generation and implement management succession matters (e.g., selecting the future leaders, who's in the business and who's out etc.). Mandatory death buy-outs of the business owner may deprive the spouse of necessary cash flow which, prior to the death, the couple was enjoying from the business. It may be advisable, in lieu of a mandatory sale at the first death, to allow the surviving spouse to inherit the stock, or to allow the stock to be held in a marital trust (probably a qualified terminable interest trust or "QTIP") for his or her lifetime.
POINT FIVE
Key non-family employees must not feel threatened by management and ownership succession. They should be involved in and made part of the process, as mentors. In addition, other more formal measures might be considered to retain essential non-family employees.
Long-term employment agreements/deferred compensation agreements. Employment security can be critical to non-family members. These agreements can be especially important during times of transition - these people need to know that their jobs will remain secure with the next generation. These agreements should, if appropriate, include non-competition, non-solicitation and non-disclosure provisions to protect the corporation in the event the employee leaves.
"Phantom" stock. Unrelated employees can be given bonuses or other wise compensated based - upon the performance of the corporation. These arrangements are designed to give these employees something which is economically equivalent to dividends and a share of the appreciation in value of the corporation. The arrangements need to be carefully constructed, nevertheless, so that these employees do not become "de facto" shareholders with shareholder rights as a matter or corporate law.
