According to the U.S. Small Business Administration, “[i]n 2021, over a quarter (27.3 percent) of all firms were family-owned businesses.”[1] “According to most financial advisors, an owner’s business wealth is usually 80-90% of their overall net worth.”[2] Because much of a business owner’s wealth is comprised of their ownership interest in the (illiquid) business, integrating the business succession plan into an overall estate plan that preserves family harmony can be a delicate undertaking.

No One-Size-Fits-All Plan

Although many estate plans contain similar broad brush strokes with respect to things like the apportionment of estate tax, allocation of generation-skipping transfer tax exemption and fiduciary powers, the details of property division and distribution, especially when the property includes a closely held business, are unique and uniquely challenging to each family.

A Unique Asset: The Family Business

A family can own many unique assets, such as the family residence, a vacation home, items of jewelry, fine art and collectibles. The family business is also a unique asset.

Any unique asset can be difficult to dispose of in an estate plan. A particular asset may be:

  • Illiquid, perhaps with a value that results in an estate tax liability without an easy means of payment;
  • Difficult to divide among multiple family members;
  • Desired by multiple family members, possibly resulting in discord over who actually receives it; or
  • Received by the wrong family member, sold out of the family or wasted.

With the ownership interest in a family business typically being a large portion of an owner’s estate, these issues can complicate the estate plan, and impact the family dynamic.

Children and Other Family Members are Unique

Parents love their offspring all the same, but also know that each is a unique individual with their own characteristics, traits, strengths and weaknesses. A well thought-out estate plan takes this into account. For example, not everyone is able to effectively manage money, so leaving an inheritance for a spendthrift beneficiary in a trust and naming a trustee to manage it may be more appropriate than an outright gift.

When it comes time to plan for the future ownership and management of a business, careful consideration about who should receive an ownership stake, how much they should receive and the form in which it is received is critical.

People have different skill sets. Not every family member should work in the executive suite. It can also be said, not every family member is capable of being a sales leader or working on the factory floor. Also, family members who own and work in the business may have different goals and objectives than family members who own but do not work in the business. For example, family members who work in the business, receive salaries and perquisites, and may desire to reinvest profits back into the business. Conversely, family members outside of the business do not receive benefits from working for the family firm. They may want to receive a distribution on equity rather than allowing the company to reinvest its profits. These disparate goals can lead to family discord, conflict among business owners and, ultimately, a weaker or failed business.

Fair Does Not Necessarily Mean Equal

We all wish to be treated “fairly.” But what does that mean? “Fair” is qualitative or subjective, and can’t be measured, as everyone has a different idea of what is fair. “Equal,” on the other hand, is quantitative or objective, and can be measured. Nevertheless, in the context of an estate plan, not being treated fairly (by a person’s subjective standard) can disrupt family harmony and can cause pain, grief, guilt and other negative emotions.

Perhaps, consider a family with 2 children that has an estate valued at $8 million: a family business worth $5 million and a municipal bond portfolio worth $3 million. One of their children manages the business, the other child works elsewhere. This gives the business worth $5 million to the child who manages the business and gives the municipal bond portfolio worth $3 million to the other child, who is not working in the business. Those gifts are not equal in value, but are they fair? Well, that depends upon one’s perspective. To the child who received the business, it is a gift that might produce significant value but depends on the child’s hard work and is subject to many risks. Perhaps, in the eyes of the child who received the business, the sibling who received the bond portfolio got the better gift, because the bonds carry little investment risk, and a lot less work. Of course, the child who received the bonds might have a different view, as the business received by the other child could have tremendous growth potential, while the bonds probably don’t.

Dividing Equally

Let’s say the business owner instead decides to divide the value of the estate equally among children. In the previous example with $8 million of assets to divide, to create an equal division, one child could receive $4 million worth of business ownership and the other child could receive $3 million of bonds and $1 million of business ownership. Alternatively, each could receive $2.5 million of business interests and $1.5 million of bonds. In either event, although the child who is not working in the business will not control the business, depending on the equity structure of the business, that child will either have a small, if any, voting interest in the business or, if both children have equal voting interests, the potential for deadlock exists, which could hinder the profitability of the business. As described above, this a formula for family difficulty. 

However, there is a way to avoid this result. The senior family member can purchase life insurance with a death benefit sufficient to provide the child not working in the business with equal value when compared to the child who received the business. Assume that the value of the business will cause the parents estate(s) to be subject to estate tax. Life insurance should be considered to provide for liquidity to assist with paying estate taxes and paying other expenses of estate administration. An Irrevocable Life Insurance Trust (ILIT) will help ensure that life insurance proceeds are excluded from the taxable estate and provide liquidity for an estate comprised largely of illiquid assets.

PNC Can Help

PNC Private Bank® has the resources to work with you and your advisors to create an estate plan and business succession plan that can accomplish your and your family’s goals, including maintaining family harmony. To learn more, contact any member of your PNC team.