Family Business Transition Series - Beware the golden handcuffs

April 06, 2017

BTS_Article_GoldenHandcuffs_06Apr17_LandingBanner_679x220.jpg

The success and longevity of any family business is dependent upon a well-thought-out succession plan. Our Family Business Transition Series is intended to provide the information and advice you need to find a solution that works best for your family and your business. 

From the day they are born, our parental instinct is to give the same amount of love and attention to each child. Whether it is putting the same number of marshmallows in their hot chocolate or ensuring that each receives a gift when we return from a business trip, it is inherent in us to treat our children fairly. And to the recipients, fair usually means equal. (If you doubt that, just ask the child who got fewer marshmallows!)

But the fair and equal mantra isn't as easy when the children are grown. While an equal division of liquid assets is reasonably straightforward and perhaps considered fair in the eyes of most parents, it can be deemed unjust by the son or daughter who believes he or she has contributed more time and effort in support of the aging relative.

Similarly, when it comes time to hand off the ownership of your family business, it isn't such a wise strategy. It is extremely difficult to achieve fairness through an equal gifting of the shares. Typically, not all siblings are involved in the day‐to‐day operation of the business so the perception often exists that they do not have the same entitlement to the rewards. The alternative, forcing siblings into an equal partnership they would not otherwise have chosen themselves can be a recipe for disaster. This is what we call ‘golden handcuffs’: sibling teams find themselves locked in what is often a financially‐rewarding but conflictual situation with no easy way out. In a worst‐case scenario, it can destroy family unity and the profitability of the business.

So when planning for the transition of physical assets such as the shares of the business, the goal should be to treat offspring fairly and equitably rather than equally.

Read more: Why You Need a Compensation Policy

What is considered fair and equitable?

Is it fair that the child who works in the business inherits the shares while the remaining family assets are split among the other children, regardless of any disparity in value? What message does this deliver to the non‐involved siblings? Does that preclude the children of these non‐involved siblings from involvement in the ownership or management of the business at a later date?

Or is it considered more acceptable to gift one child the shares of the business while ensuring the others inherit an equal value in other assets? While it is possible to equalize the monetary value of the gifts using insurance and other investment strategies, how do you equalize the levels of risk and opportunity in managing an operating business versus managing the more liquid assets?

And who decides what is fair and equitable? As many families have discovered, one sibling making major decisions that impact their brothers and sisters is rarely seen as objective or fair! Ultimately the decision as to how to split the assets lies with the exiting business owner(s) or the parents of the heirs.

Read more: Don’t Put the Cart Before the Horse

The BDO SuccessCare Communication Vehicle™ is designed to help you find a solution that will reflect your personal principles and philosophy ‐ i.e. what is important to you. We use a process that opens a dialogue around your legacy plan for the family unit and your goals for the future ownership and management of the business.

Clarify your philosophy

  1. The first step in our process is to help you define your philosophy around ten key considerations. It is important to think about how each of the ten relates to your long‐term goals for the family unit, the management of the physical assets, and the sustainability of the business entity.
  2. The next step is to develop a Family Participation Plan that reflects your criteria for involvement in the business both at the ownership level and the day‐to‐day management of the business.
  3. You are now ready to draft what we call your “transition principles,” incorporating the most important elements from steps one and two above. These transition principles are your “rules” for the distribution or transfer of physical capital to the next generation.
  4. We recommend you then schedule a meeting with the next generation to discuss their aspirations around participating in the future ownership and/or management of the business and wealth and share your transition principles and the thoughts that led your conclusions. Be open to input and/or modifications from the next generation so you can arrive at an agreement to uphold these principles.
  5. Finally, ask your lawyer to draft an agreement that embeds these transition principles in the rules for entering or exiting ownership, determining owners’ return on investment and compensation, and for shareholders making decisions together. The ultimate goal of this agreement is to uphold a fair and equitable distribution of the shares of the business without the need for a shotgun clause.

Clarify your wishes

All too often, a business owner's succession plan is a will that divides the estate equally among his or her heirs, and a shareholder agreement that inadequately attempts to settle a potential dispute amongst siblings.  Our approach is to put away the shotgun and instead use the process outlined above. This not only ensures an agreement is based on the family’s specific transition principles, but is essentially an internal stock market when it comes to the disposition of shares of the privately‐owned company.

Read more: Considering a family council? Here’s what you need to know

For more information on how the BDO Communication Vehicle™ can guide you through this approach to avoiding the golden handcuffs, contact Daphne McGuffin or any member of The BDO SuccessCare team at 1.800.598.6400.