“Family first.” – Michael Bluth from “Arrested Development”
Brinen & Associates has advised many family-run businesses. We’ve often found that children who are actively employed in the business are not clearly identified as successors for a variety of reasons – intentional or not.
Appointing the child who shall ascend to the throne can be a difficult decision. Emotions can run high, and it’s possible not everyone will be happy with the outcome. Some succession strategies will ensure owners make the most responsible decisions for businesses and their families.
Consider a scenario where Mario’s Restaurant is a popular neighborhood pizzeria solely owned by its namesake. Mario is also the father of two children, Charlie and Anne, who double as employees.
Charlie is the head chef, handling the operations that everyone sees – he’s at the counter taking orders, making the pizza and is responsible for the menu. Anne is more than just a waitress at the pizzeria – she manages the wait staff, handles most of the hiring and is also the on-site bookkeeper. Both are indispensable to the business. Fast-forward to the present: Both are over 21 years old and want to carry on their father’s legacy as he readies for retirement.
Which child can Mario name as his successor?
It’s a trick question: He can name both. No matter what type of business entity he operates, such as an limited liability company or corporation, he can maintain its structure and change the pecking order by recapitalizing the business. For example, Charlie could become chief operating officer, while Anne could become chief financial officer, and both would be co-executive officers. Shareholder and operating agreements will need to be drafted or amended to reflect the changes under this restructuring.
Ownership shifts can be accomplished through recapitalization. The recapitalization process involves the exchange of one form of financing or equity for another, such as removing preferred shares from the company’s capital structure and replacing them with bonds. Recapitalizing will require a tax lawyer, because Mario will want to try to dodge – I mean avoid, not evade – as many tax laws as possible during this transition. Taking this route will probably alleviate a lot of tension and if the kids can get along during business hours, and then the local favorite could live on for another generation.
Note: Recapitalization gets tricky with S-Corps, since you do not want to violate the “one class of stock” rule.
We’re just scratching the surface of succession and estate planning as it pertains to closely held and family-run businesses. All succession and estate plans, especially those involving succession call for legal, accounting and financial planning expertise. Brinen & Associates has particular experience in these areas and we invite you to contact us to create or amend your business succession plans.