Do not go gentle into that good night, Old age should burn and rave at the close of the day; Rage, rage against the dying of the light. Dylan Thomas The senior generation's desire to maintain voting control over the family business is a common obstacle to effective family business estate and succession planning. Family business owners tend to fall into one of two categories when it comes to control.
Do not go gentle into that good night,
Old age should burn and rave at the close of the day;
Rage, rage against the dying of the light.
— Dylan Thomas
The senior generation's desire to maintain voting control over the family business is a common obstacle to effective family business estate and succession planning. Family business owners tend to fall into one of two categories when it comes to control. The “monarch” seeks to maintain control even at the expense of a successful succession plan. The less common “steward” seeks to nurture the business and willingly cedes control to the next generation. Unfortunately, there are far more monarchs out in the family business world than stewards, and it's relatively rare to find a business owner who's willing to “go gentle into that good night” to ensure a smooth and orderly transition to the next generation. Particularly, if the senior generation founded the business, there's a tendency to want to maintain control even to the grave (and sometimes beyond).
We've found that even monarchs can effectively plan ownership succession if we recapitalize the business into voting and non-voting ownership interests. We can do this for partnerships, limited liability companies and corporations. Even S corporations can have voting and non-voting stocks without violating the rule that S corporations aren't permitted to have two classes of stock.
For example, assume that a monarch-style business owner owns 100 percent of an S corporation and is willing to start planning for succession as long as he doesn't have to give up any voting control. Further assume that we recapitalize the corporation into voting shares equal to 10 percent of the corporation's value and non-voting shares equal to 90 percent of the corporation's value. The business owner keeps all of the voting shares, maintaining complete control of the corporation. But he's willing to use most of the non-voting shares (which now represent 90 percent of the total value of the corporation) for planning to reduce the taxable estate. If the business owner gifts the non-voting shares to his children, either outright or in some type of tax-efficient irrevocable trust, he'll freeze the value of the shares for gift tax purposes and any income and appreciation on the gifted non-voting shares won't be included in his estate. He may even get a valuation discount on the transfer for gift tax purposes. If the business owner leaves the voting shares to the children active in the business at his death, he's done effective ownership succession planning.
If, however, children who are active in the business inherit the voting shares and non-active children only own non-voting shares, we're setting up a possible conflict. The children with non-voting shares who aren't active in the business will typically seek distributions, while the active children would prefer to reinvest in the business or take distributions in the form of compensation that doesn't have to be shared with the non-active children. In this case, we would recommend structuring the estate plan (perhaps through a shareholders agreement) so that the non-active children could be bought out by the active children at a fair value, payable over a period of years that wouldn't cripple the business.
Recapitalizing the family business into voting and non-voting interests, with the voting interests remaining in the senior generation, can often break the control log jam that stands in the way of effective ownership succession and the reduction of estate taxes. Unfortunately, the desire to retain voting control often goes along with the desire to control the management of the company. Even if ownership succession succeeds, the family business will likely fail, or have to be sold, if the business owner hasn't engaged in the more important process of management succession. Management succession and ownership succession are inextricably linked. Completing the hard emotional work necessary to have a successful management and ownership succession should ensure that the family business won't have to “rage against the dying of the light.”