This blog follows up our last blog regarding families and their transitions of assets and businesses. Sometimes those families are famously like the J. Paul Getty family or the Biltmore Estate Cecil family. Sometimes it is the family down the street with the dry cleaning store on the corner.
In this blog we explore how many family businesses are in the US, how are they structured and what kind of unique issues may arise in their unique Estate Plan.
US Family Businesses by the Numbers
In our last election presidential candidate Bernie Sanders often talked about “The Big Corporations”. In reality there are not that many “Big Corporations” in the United States.
- 99% of U.S. businesses have less than 500 employees.
- 90% of U.S. businesses have less than 20 employees.
- Also 90% of the businesses in the United States are family business.
Statistics for Survival
- Statistic show that only 1 out of 7 businesses succeed initially.
- They show that 70% of businesses do not survive when the business is run by the 2nd generation.
- The statistics show that 15% or less of businesses survive to the 3rd generation.
Family Business Internal Structure
As we discussed previously, families and family businesses each bring their unique character and issues to Estate Planning. The uniqueness of a business owner can include:
- The business may be the primary asset of the family;
- The family may be very involved in running the business or not at all;
- Each business is very unique and may be very unique in operation, style, family involvement, accountability, and marketability;
- The business may be more of a self-operating business, where the systems are up and running and the product or services are provided without a lot of oversight from the business owner or the business owner may be very involved and have their finger in every aspect of the business daily; and
- It may be a business where the services provided are provided by the owner themselves, i.e. an independent Financial Services office, Accounting services, independent Insurance Professional, Attorney, Dentist, Doctor, Architect, etc.
Family Business Legal Structures
The family can operate in a number of different business structures. They include:
- Sole Proprietorship. This is taxed with the individual owners personal 1040 tax return. It is often a smaller more informal operation.
- C Corporations. This is a more formal and larger operation. Often this is a business entity that offers benefits and retirement plans to people who are working within the business. There are normally a large number of people working for the business.
- S Corporations. This is the most common corporate business form you will see. This is often a small business with fewer employees. This is a “flow through” tax entity and can offer better tax advantages for a small business owner.
- Limited Liability Company. These have only been in operation for a few decades. They are less formal and are now how most new small businesses are structured. The structure is setup with less formalities than a Corporation with the idea of limiting the liability of the owners of the business.
- Limited Partnerships. May have one or few general partners and many limited partners.
- General Partnerships. Normally have several general partners and no limited partners.
- Professional Association, Professional Corporation, or Professional LLC. These are structures that are normally owned by a licensed professional and ownership may be limited to those that are professionals that hold specific professional licenses. These are often used for Architects, Accountants, Insurance Professionals, Financial Advisors, Dentists, Medical Doctors, Lawyers, etc. When their entity is marketed or sold when the owner passes on or is retiring, the business must be sold to someone who holds the same professional license in that professional field.
Unique Estate Planning Issues in Family Businesses
The family members (adult children) may anticipate that they will own and operate the family business, although they have had little or no part in creating the business. This sense of “entitlement” can be a difficult emotional issue to deal with when one is looking at the transition of a business in Estate Planning.
Some adult children may think that the business will run as smoothly as it does without the founder being there to operate it. For example, I had one small business that had a middle-aged, “often vacationing” daughter who said that she could run and operate the business by herself just as well without her dad. Her dad did the sales, installations, and service of a unique product that he sold, installed and serviced. He took few vacations. When I asked the “often vacationing” daughter, “How would the business run without your dad?” She had a blank look in her eyes. I asked, “Doesn’t he do both the sales and the installation?” It was only then that there was recognition in her eyes that it would not run the same way. She had been working in the family business for over a decade and somehow assumed that it would “magically” operate well without her father, including during the many times she planned to be away on vacation in the future.
A spouse may expect the business to go to one or more children as a “legacy”. You will often see that one of the spouses will say, “Our child deserves this business”. That child may have no ability under any form or circumstance to be able to operate the business and would quickly run it into the ground. Remember the statistics regarding the feasibility of an ongoing business. 70% of businesses fail when they went go the 2nd generation and only 15% of businesses survive when they go to the 3rd generation.
Buy Sell Agreements.
Family members should have Buy Sell Agreements between them as to how the members ownership interest is purchased if they become disabled or pass on. We will go into more detail on this later.
Sudden Illness or Death.
If the founder is suddenly sick or passes away everything fast forwards in the transition of the business. If the founder is the only one who knows how to run the business, that can be very difficult. We were working with a client who had an insurance agency where he was primarily a broker between the insurance companies and individual independent insurance agencies. There were a number of ongoing renewal contracts that would continue to bring money into the business. That founder was not only the only one who operated the business, but also he was the only one who really knew what the assets were. In spite of the fact that the owner had cancer, that he was sick, and that his time was limited, he still did not pass on the needed business information to his family prior to his passing.
Inside and Outside the Business.
There may be adult children who are helping to operate the family business and adult children who are outside the business in that they do not work there. The adult child working inside the business may have been compensated for “sweat equity” and the adult children outside the business may be jealous.. For example if you give the business equally to the adult children working the business and those adult children not working the business, you can have serious problems. The adult children doing the “sweat equity” running the business will resent their siblings receiving the benefits of the business when those siblings are not working for the business. The adult children outside of the business are resentful that the adult children working inside and for the business have all of the knowledge and control of the business.
You do not want to setup a fight between your children.
A solution may be to leave the business to those family members working in the business and leave other assets, including Life Insurance proceeds, to those family members who are not working in the business.
At the Law Firm of Steven Andrew Jackson, Attorney and Counsellor at Law, we have helped hundreds of families protect themselves and their loved ones, avoid Estate Taxes and Probate Costs, and keep their Estate Plans current with the law through The Customized Protective Estate Planning Solution™.