Division of a Company Among a Family

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The question of how to divide an estate among siblings becomes even more complex when you own a family business. According to research by PriceWaterhouseCoopers, while 62% of entrepreneurs plan for the next generation to inherit the family business, only 18% have a solid succession plan. Forbes projects that over the next few years, family-owned companies collectively worth $3 trillion will transition to the next generation.

What is a division of a company? The answer depends on your family’s objectives, values, abilities, and plans. Fair splitting of business assets does not necessarily mean each of your children has to play the same role in the company’s future. These considerations can help you plan the division of a company with a succession plan that fulfills your vision for the business in a way that unites the family.

Aptitude and desire to run the business

Often, confusion about a division of a company arises when only one of your children participates in its daily operations. After all, inheriting a business doesn’t automatically result in an MBA. Before making a decision, you need to conduct a transparent assessment about which of your children, if any, has the necessary knowledge and skills to manage the business. You also need to talk honestly with them about whether they actually plan to take on an operational role. 

Inheriting a family business doesn’t necessarily mean all the siblings have to work at the company or contribute in the same way. You can recapitalize the business to pay a fair share of its assets to non-participating members of the family while the participating members continue operating the company. You could also set up different stock classes to weigh each family member’s vote depending on his or her level of participation.

Vision for the company’s purpose

Delving into your reasons for passing down the business to your children can help you define your next steps. Do you want to make sure that each of your children has an equal share of the business profits? Does that necessarily equate to a say in the company’s future? Do you plan for your children to inherit the family business whether or not they will participate and contribute to its success? Answers to these questions can help you understand what exactly “fair” means to your family.

An article in Family Business magazine cites the work of psychologist Morton Deutsch, who suggests defining the company’s primary values based on how they can help you reach the goals you defined above. Most often, in the succession context, business owners define these values as need, equity, and equality.

For example, if you want to make sure the business continues to succeed through future generations, you must consider equity in your succession plan. With an equity framework, each family member receives a share of the business in proportion to his or her contribution to its output. When family unity drives your decisions, you may instead consider an equality framework. In this situation, each family member would receive the same share of the business regardless of input. 

Deutsch’s third example assumes the primary business objective is the family’s ongoing welfare. In the need-based model for how to divide ownership of a company, each family member’s share depends on his or her needs. With this framework, the division of resources varies by established criteria such as family size or financial obligations without consideration of contribution to the company.

You should know how much your business and your other assets are worth. Intriguingly, most new clients are wildly uninformed about their business’s value. They either have a grossly inflated or an extremely low “fire sale” estimate of what they think their company is worth.

Ask your business attorney, business broker, or valuation specialist how to make a “rule of thumb” calculation to get a rough idea of the value for pre-planning. (A formal valuation report will be required later.)

Valid valuation

If you haven’t had a professional valuation in recent years, you may not have an accurate idea of your company’s worth. Before moving forward with any type of succession plan, consider an appraisal by a specialist in this area, such as a business broker. The question of whether your business can survive after you retire or sell may depend on its true market value, which is completely separate from the emotional attachment you have to your family enterprise.

When you value the company, don’t forget to account for benefits and other costs of inheriting a business. At the same time, you should consider how much income you plan to draw from the company during your retirement. 

Real talk about retirement

Even if you plan to stay on in your current business role for some time, your retirement plans are a vital part of your succession plans. You want to make sure that you can fund your own future even as you strive to provide your children the benefits of an inherited business. If you don’t have separate retirement investments, you can strategize about ways to achieve both objectives.

Some owners remain in a paid advisory role, which creates ongoing income along with the ability to continue as a guide and mentor once you decide to step away from active operations. This type of succession structure can help you prevent the emotional impact of retirement that may arise after a lifetime of hard work and innovation. It also bolsters the chances that the company will survive and thrive under the next generation.

You could also stay on as an investor in the company. While you still have some say in its future as a board member, you will have the time and freedom to engage in new pursuits as well as the ability to fund your retirement with dividends and other passive income. Some business owners take advantage of the tax benefits that come from gifting the business to your heirs in exchange for drawing a lifetime income from the firm. 

If your company’s assets include real estate, consider renting these holdings to the new owners when you retire. This provides an income stream without the need to take part in day-to-day operations, which could be a benefit if your children decide not to manage the company when you step aside.

The succession transition

When you decide on a structure for succession, the next step is a plan to guide the transition. A successful succession plan should detail the following elements:

• The operational training required for the next generation
• The complete timeline for the transition
• The older generation’s exit strategy and conditions
• The terms of your new role if you plan to stay on as an advisor or board member
• Details about staff needed to manage the transition if applicable, such as outside operations managers
• What portion of the business each of your heirs will receive and whether these are liquid or illiquid assets

It’s never too soon to start thinking about a transition that honors your life’s work. Even if you are several years from retirement, you can set the stage now for your business to have a prosperous future in perpetuity.