Equitable Is Fair

Most parents want to treat each of their children fairly when dividing up their wealth. Often, they equate fairness with an equal distribution of their property among their children. Providing an equal distribution of property to each child may be difficult to achieve when the bulk of their estate consists of a farm or closely-held business. Moreover, not all children have the same needs, abilities, or career goals. Even if an owner could give each child an equal share in the farm or business, that asset may not be appropriate for all the children. An individual who is uninterested in, or unskilled at, the business may prefer a different asset.

Frequently, an owner will have one or more children who work in the family business (active children) and one or more children who are uninvolved in the family business (inactive children). In my opinion, a succession plan is most likely to succeed if the owner can treat all children fairly while transferring control of the business to the active children only. This approach helps ensure that the active children can operate the business without interference from inactive siblings. Many owners, however, lack sufficient assets to transfer the business to the active children and an equitable amount of property to the inactive children. So, they are often faced with the competing goals of providing the active children control of the business and dividing their estate equitably among all their children.

Active and Inactive Children Have Competing Goals and Interests

Many business owners attempt to treat children fairly by leaving equal shares of the family business to each child—both those active in the business and those who are not. This often creates conflicts in the family after the owner’s death because of the competing goals and interests of the active and inactive children. If the owner leaves equal shares of the business to all of the children in a family, the active child is put in the awkward position of having his business decisions second-guessed, and sometimes overruled by his inactive siblings. If they collectively own a controlling interest, inactive children can force distributions that reduce the company’s working capital to unacceptable levels or force a sale of the business—perhaps even a bargain sale—to generate cash. In such situations, the active child may resent the interference of the inactive children.

Conversely, if the owner leaves a controlling interest in the business to the active children, the inactive children may have to wait decades before realizing any value from their inheritance—or they may never realize that value. First, the inactive children often cannot sell their interests because of sales restrictions or lack of a market. Second, the controlling active children are under no obligation to make distributions (in fact, closely-held businesses often do not) or sell the business. The active children can take money out of the business in salary and bonuses without making distributions to the inactive children. If the active children mismanage the business, the inactive children may never receive any of the owner’s assets, much less their fair share.

Even if an owner believes the children can be fair to each other, the influence of a child’s current (or future) spouse cannot be overlooked. Whether or not they work in the business, the spouses of the owner’s children have strong roles in family businesses. Including the spouses in planning for transferring ownership in the family business helps ensure that they understand and support the decisions made. If the spouses are not supportive of the plan, they are likely to exert their influence to try to change or disrupt it. Similarly, the changing needs of each child’s family may affect his or her ability to cooperate with his or her siblings regarding business decisions.

The timing of the transfers may also create resentment among the owner’s children. The goal of many business succession plans is to provide for the orderly transition of the business at the owner’s retirement. Accordingly, the successor often receives the ownership interest during the owner’s life. If the owner requires the remainder of his assets to fund his retirement, the children who are not active in the business may not receive their share of the owner’s wealth until he dies. Since this may not occur for several years, these children may resent the fact that their siblings who are active in the business have already received their share of the owner’s wealth.

Equitable Instead of Equal

Treating each child fairly does not necessarily mean an equal distribution of the wealth. Due to each child’s unique situation, it is often unwise to assume that an equal distribution of the property is the best way to achieve fairness. As discussed above, transferring the business to both active and inactive children may result in each child receiving an equal interest, but can create tension between the active and the inactive children. Consequently, a more realistic goal may be to divide the property equitably, rather than equally.

It is recommended that equity requires the owner to consider each child’s contributions to the business when determining how interests in it will be divided. Instead of transferring equal ownership to each child, those who have contributed to the business’s success should be rewarded with a greater allocation of business rights (e.g., voting interest) or dollar value. Although there are mitigating factors, in most cases there should be some reward for children who make a greater contribution to the business. Not rewarding contributions can be counterproductive. Contributing children who see their siblings receive the same interest in the business even though they have done nothing may lose their motivation. They almost certainly will resent the siblings who do less.

Although many families are uncomfortable discussing the topic, owners must determine whether their children would like to be involved in the business in the future, either as owners or active workers. It is not safe to assume that a child who is not currently active wants no interest in the family business, or that one who is active has no desire to try a different career. Even though inactive, the child may have a very strong desire to own and be associated with the company. On the other hand, a child may be working in the business because he or she feels that is what the parent wants and would welcome an opportunity to explore opportunities outside the family business.

Trying to divide wealth equitably among children is not an issue unique to business owners. However, business owners have the additional problem of balancing the children’s needs and wants with what is best for the business. Also, unlike assets that each recipient can freely manage or spend (e.g., an investment portfolio), the recipients of a business interest are tied together. Their ability to work together directly impacts both their own welfare and that of the business.