With each installment of our Video Blog Friday’s Series, Paul Karofsky reflects on influential lessons learned from his career working with family businesses. Each Friday, we will provide a new story with a unique topic – so stay tuned! We hope you enjoy the eighth feature in our series, When Equal May not be Fair…, where Karofsky illustrates the importance of thoughtful compensation for children of a family business – both children working in the business and children who do not work in the business…

 

Mom (upon leaving their attorney’s office): This estate planning is driving me crazy! I know we’re trying to reduce taxes but it’s important to me that we treat all the children fairly. How else can we do that without giving each one an equal interest in the business?

Dad: But why would we do that? Only two are working in the company and the other two are professionals with their own careers.

Mom: Shouldn’t we treat them all equally? We both agreed that “fairness” was our goal. Isn’t that the fair thing to do? It has been your business, after all. Isn’t it the results of your efforts that we would be dividing up?

Dad: For the first twenty years, maybe, but not so today. I may still control the stock, but we’re more a like a partnership. I think the family members who work in the company deserve the rewards. It seems unfair to for the two who are in the business to have to share the results of their efforts with their sister and brother who don’t work in the business. They could have come in, but they chose law and teaching instead. Should they share part of their legal and teaching revenues with the two in the business?

As they continue walking to their car, Mom reflects to herself. “What would we do for our two children who don’t work in the business? Almost everything we have, beside the vacation house, is tied up in the company. I need to know that all our children are treated equally in order for me to be satisfied. And we haven’t even talked about our own needs yet. Does a transfer of the business ownership to our children to save them estate taxes mean we could be dependent on our children?”

Dad reflects, “Why should those who work in the business every day have to share their rewards with a brother and sister who have their own careers? It would be a real burden on those in the business to have to support those who don’t work in it. I understand that my wife wants ‘fairness.’ But ‘equal’ would be more than fair for those outside the business and less than fair to those within.

What’s going on…

It is not an uncommon experience in family businesses for Mom and Dad to have differing opinions nor for family and business values to be somewhat disparate. Family values typically say “equal is fair.” But enter the business setting and the issues and the values can become more complex. Both Mom and Dad have valid points. Let’s look at their perspectives.

From Mom’s standpoint, fair means equal. When there are four cookies on the plate and four kids at the family table, each child might reasonably expect one cookie. She reasons that since Dad built the business and still has ownership control that its worth and value should be shared evenly among all their children. Mom has an emotional attachment to “equality” consistent with what “family” is all about and her concern about her own future is prudent indeed.

Dad believes that since the children working in the business have been major contributors to its success, they should share in its rewards. Dad is looking at a different criterion. For him, fairness represents a return on investment to those who invest.

What should the family do…

1.Agree on criteria. While Mom and Dad are on the road to decision making, having agreed that fairness is their chief goal, they now need to define what that means. Does fairness mean one cookie for each child, or does fairness mean the hungriest gets more, or that the most able to earn for her or himself gets less?

2.Call on the pros. Top notch legal, accounting, and insurance advice can often make the difference between a good plan and a great one. Family business principals are known to be private, but an open sharing with trusted advisors will pay handsome dividends. Call a team together, treat them like your “board for a day,” state your shared goals and criteria, and wrestle with the options.

3.Separate the parts. There are three components to a change in ownership in a family business: changes in control, income and retained earnings. Depending upon the goals and needs of both the family members and the business, these three components can be addressed separately. One group can have “control” while the same or another receives “income” and another accumulates “retained earnings.” It is possible, for example, for Mom and Dad to retain voting “control” while having retained earnings accrue to the children who work in the business. This can save estate taxes and reward those who work in the business. Likewise, it is possible for children who don’t work in the business to be gifted a “fair share” of the previously retained earnings at a predetermined value prior to the significant contributions of their siblings.

4.Consider all assets. Most of Mom and Dad’s assets appear to be tied up in the business. But what about real estate, savings and investments and life insurance?

5.Put yourself first. Mom and Dad’s first obligation is to protect themselves, to ensure that their future is provided for so they can maintain their own independence. That may even be worth a trade-off in estate taxes.

6.Explore all options. Talk with other family business owners. See what they are doing. Attend seminars and workshops. Read. A paperweight on my desk says, “No one can take the ultimate weight of decision-making off your shoulders. But the more you know about how things really are, the lighter the burden will be.”

Paul Karofsky is Founder/CEO of Transition Consulting Group, Ltd.  He was third generation CEO of his family’s business and is a former monthly columnist for BusinessWeek Online and former case study editor of Nation’s Business and Families in Business. The recipient of multiple awards and honors, Paul holds a certificate in Family Business Advising from FFI with Fellow Status and has been consulting to family enterprises for over 25 years.  Paul can be reached at [email protected] or 561.626.1110