Parents love all their children, but also know that each is a unique individual with their own characteristics, strengths and weaknesses. A well-thought-out estate plan takes this into account, as does a well-thought-out succession plan. When it comes time to consider the future ownership and management of your business, careful consideration about who should receive an ownership stake, how much they should receive and the form in which it should be received is critical. In the context of the family business, those important considerations are overlaid with the unique — and often complicated — dynamics of the family.
Competing Interests
There can be many different constituencies associated with the family business, and each can have different goals and priorities. Consider the different priorities of family members who manage the business, as opposed to those who are employees without management responsibilities. Everyone has a skill set, and that skill set likely differs from that of others. For example, not every family member should work in the executive suite. Similarly, not every family member can generate sales or work on the factory floor. Yet, the family member serving as CEO must manage family members who work in other capacities. Further, family members who own and work in the business may have different objectives than family members who own but do not work in the business. Family members who are employed by the business receive salaries and perquisites, and may wish to reinvest profits back into the business. Conversely, owners who are not employed by the business may want to receive distributions on equity rather than reinvesting profits.
The potential conflicts described above are but two that can arise among the owners of a family business. Even still, the possibility of conflict increases as family dynamics are included in the mix. Consider the conflicts that can arise when junior generation family members and senior generation family members own interests in the business and junior generation family members exercise ownership rights contrary to the “way we have always done it before.” Then, toss into that mix the hurts and slights of childhood (whether real or imagined) that intrude into relationships among owners and the potential conflicts only multiply.
The multiplicity of business and family relationships, interactions, goals and objectives can lead to family discord, conflict among business owners and, ultimately, a weaker or failed business. Accordingly, choosing the proper family members to receive interests in the family business following the owner’s death, and how they should receive those interests, is an important way to mitigate conflict and avoid weakening the business.
Ensuring Equal Value Through Life Insurance
Following an owner’s death, families often transfer interests in the business to some, but not all, family members. Yet, in many cases, much of the business owner’s wealth is locked up in the business. Given the value of the business compared to other assets, those family members who do not receive an interest may feel shortchanged.
The question arises: Is there a way to ensure family members who do not receive an interest in the business still receive an appropriate portion of the family’s wealth? The answer is yes. A business owner can augment assets with a life insurance death benefit. Using life insurance can allow a business owner to leave business interests to family members employed by the business and other assets, and cash from the insurance policy death benefit to family members not employed by the business.
Consider the following example: Assume a business owner’s business is worth $10 million, along with other assets worth $2 million. Further assume the business owner has four children — two who work in the business and two who do not. Finally, assume the business owner would like to leave assets having equal value to each of the four children. Without an additional source of funds, an equal division of value would require the children not employed by the business to receive interests in the business, setting the new business owners up for conflict as described above.
This potential problem could be avoided if the owner were to purchase a life insurance policy insuring the owner’s life with a death benefit of $10 million. In that case, business interests and $1 million of other assets could be distributed to (or for the benefit of) the children employed by the business, and the life insurance death benefit and $1 million of other assets could be distributed to (or for the benefit of) the children not employed by the business. In this way, the potential for conflict, with respect to the ownership and operation of the business, can be avoided and each child can receive equal value.
The Tax Benefits of Life Insurance
Life insurance has other uses in the business succession context as well. The federal government and many states impose estate and inheritance taxes. Generally, such taxes are due within nine months of death (state deadlines may vary, consult an attorney in your state for your local deadlines). When a business owner’s wealth is concentrated in the business, it may be difficult to raise the cash necessary to pay the tax on time. Options to raise cash can range from borrowing to selling the business. Here, too, a life insurance death benefit can help, as a death benefit can provide liquidity immediately following an owner’s death to help pay estate and inheritance tax. Even better, a life insurance death benefit is a tax-favored asset. If a life insurance policy is owned by a properly constructed and administered life insurance trust, the death benefit is not subject to income tax or estate tax.
Careful and ongoing planning is crucial to the success of any estate and business succession plan. Using life insurance in your plan is just one way to help ensure your goals and objectives for the future of your business — and family — are met.