Understanding the difference between equal and equitable asset distribution is essential to developing a strong business succession plan and building business value. Working exclusively with successful business owners on their succession plans for more than a decade, one of the questions that I am frequently asked is: “How should I divide my estate?” This can be a perplexing question for business owners who have multiple children some of whom are active in the business and others who are not active in the business.
Generally speaking, most business owners love all of their children equally and therefore wish to treat them equally in their estate plan, whether they are active in the business or not. With the help of their advisors they develop and implement wills and trusts that leave all of their assets equally to their children. While the estate documentation can be technically correct and the “love” appears to be equal, it may not be practical. Frankly, there is an unequal emotional impact many people fail to realize such as:
- Often times, children become partners with their siblings with unrealistic expectations (income, distributions, benefits, perks, etc.).
- Children who make a career commitment to the business sometimes resent the fact that they are sharing the fruits of their labor with inactive siblings.
- Inactive children’s inheritance is subject to business risks they cannot control.
- Inactive children who wish to be bought out can cause financial strain on the business especially during a transition where profitability can be volatile.
In the majority of cases, the business owner’s net worth consists of closely held stock and real estate associated with the business. They have reinvested their profits back into the business to increase working capital and to grow the business. After all, their business is something they know, understand and feel they receive their highest return on investment. As a result, they have not accumulated significant wealth outside of the business. So when it comes to dividing their estate among their children, they often struggle with how to divide the estate.
The bottom line is: succession planning is achieved most effectively through an equitable asset distribution rather than an equal asset distribution. The goal is to treat your children as fairly as possible financially while minimizing the possibility of intra-family war. Developing an equitable asset distribution is most effective when the unique circumstances of each family member are considered.
Achieving an equitable asset distribution can be accomplished in a number of ways but the key is to leave meaningful assets to each child. This should significantly minimize the opportunity for resentment, jealousy and or disharmony among family members.
For example, it would be prudent to leave business interests to children who have taken an active role in the business and have proven that they have the capability, commitment and competency to be successors or contributors to the business’ future success. On the other hand, it would be prudent to leave non-business related assets such as real estate, securities, retirement accounts, etc. to children who are not actively involved in the business. In some instances the value of the non-business related assets is minimal relative to the value of the overall estate. Many clients will utilize existing life insurance polices to level the playing field and in some cases acquire additional life insurance to assist if need be.
In addition to reviewing your assets and determining which assets would be most meaningful to each child, it is also beneficial to take into consideration prior gifts or asset transfers that have been made and if necessary, make appropriate adjustments to your plan.
Recently I was involved in a situation involving three children where assets were transferred several years earlier to one child who was active in the business. The child who received prior gifts benefited immensely from the appreciation of stock as well as received handsome distributions along the way. Fortunately, the parents recognized the potential for conflict and have since modified their estate plan through specific bequests in an effort to achieve an equitable estate distribution.
Depending upon the age and maturity of your children, endeavor to communicate your intentions to avoid surprises or misinterpretation. The good news is: there is way!
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