The Effect of Divorce on a Family Business

The Effect of Divorce on a Family Business

By Edward D. Tarlow

Family businesses face many challenges as they strive to survive and thrive. Among the most difficult to overcome is one that is unique to a closely held business: divorce.

A divorce can be financially and emotionally devastating to a family business. We have all overheard a business owner referring to his or her company as being “like a child.” The custody battle for the business can be expensive, contentious and, without proper planning in advance, potentially fatal.

This is particularly true if a company has been jointly owned and its growth has been a labor of love for both spouses. Even when one spouse is a non-owner who does not work actively in the business, the company is frequently a couple’s largest asset; thus its value becomes a point of contention in divorce proceedings.

For a family business to survive a divorce, the possibility of divorce must be anticipated and planned for well in advance. While nobody wants to imagine a time when a marriage is dissolved, it is inexcusable to ignore the possibility.

The incorporation documents of every closely held business should include an agreement about ownership rights and stakeholder value in the event of an owner’s divorce. Succession planning documents should also include provisions for the dissolution of the marriage of one or more of the next generation of owners.

Disposition of the business can be addressed in a premarital or post-marital agreement, carefully structured and negotiated to provide certainty in the event of a divorce. Every possible permutation of what might occur should be considered and addressed, such as spouses who are joint owners, a non-owning spouse who acquires a share in the business as marital property, and stakeholders who are not party to the divorce but whose ownership is affected, among others.

A variety of options exist to resolve the issues of ownership and control of a closely held business upon the divorce of one or more owners. It is generally in the best interests of both parties to the divorce if a business remains a viable operation, although this is not always possible.

Buyout of a Spouse’s Share

One solution to settle control of a business in a divorce is for one spouse to buy the other spouse’s ownership interest, or for the spouse who is an owner to compensate the non-owning spouse for the value of the owner spouse’s interest in the business. A typical hurdle is finding a valuation method and pinpointing a number on which both parties can agree. The services of an independent certified value analyst (CVA) may be required.

Transfer or Redemption of Shares

If a non-owner spouse receives ownership shares in the business as part of a divorce settlement, it may be in his or her best interest to “cash in” by transferring the shares back to the company in return for cash. This may put a financial strain on the business (and the owning spouse), but can also create a clean break that leaves control of the business with the active spouse.

Sell the Company

If the divorcing couple does not have a binding agreement in place and cannot come to terms on how to divide their interest in the business, it may come down to selling the business to a third party. The downside is that the income stream from the business is eliminated, and the forced sale of a distressed business may lower the sale price.

Continue Co-Ownership

In some cases a business may be in a financial position that precludes buying back shares, the company may not fetch an acceptable price if sold, or both spouses may simply wish to see the business continue, and therefore come to an agreement to remain co-owners. Some even keep their business partnerships in place for the sake of any children who may be employed in the family business.

Divide the Business

If both divorcing spouses desire to continue in the business, one option is to split the business into two separate companies, each owned by one of the divorcing spouses. This works well when a business has multiple divisions or business units that can be run separately, or when a company’s real estate assets can be split off from the operating business.

All of the possible resolutions cited above carry important – often overriding – tax implications. Decisions about how shares are transferred, redeemed, purchased or otherwise shifted from one spouse to another should always be made with the goal of minimizing the tax burden for all parties.

According to federal statistics, the divorce rate in the U.S. is 50 percent, so it is almost inevitable that divorce will affect closely held business owners. Accepting this possibility and creating a well considered plan ahead of time can help reduce uncertainty at a time of great stress and disharmony.

Edward D. Tarlow is a founder and shareholder at Tarlow Breed Hart & Rodgers, a Boston law firm that specializes in family businesses, and a founder and president of the Family Business Association of Massachusetts. He can be reached at (617) 218-2011, or via email at etarlow@tbhr-law.com.

 

Additional Resources

  • “Divorce and the Family Business – What are the Options?” by William Long and Scott Sissel, Business Entities, March/April 2007
  •  “Marriage, Divorce and the Family Business,” by Charles A. Redd, University of Miami Law Center’s Philip E. Heckerling Institute on Estate Planning, Volume 42, Chapter 4, “Business Succession or Business Cessation? Passing the Torch Without Dousing the Flame.”
How Protected is Your Family Business from Creditors?

How Protected is Your Family Business from Creditors?

By Alexander A. Bove Jr.

This article first appeared in the Spring 2017 issue of Massachusetts Family Banker magazine.

Alexander Bove

Many family business owners become complacent about creditor exposure because they believe their corporate or limited liability company structure will protect the business. The fact is that if it is a corporation and you or anyone else owns shares in their own name, jointly with another, or even in a revocable trust, the answer is, it’s not protected. If it is held in a limited liability company (LLC), formed in Massachusetts or one of several other states with similar LLC law, the answer is, it’s not protected. Unfortunately, most business owners are far less familiar with the principals of asset protection than they are with how to build and maintain a successful business.

It is common knowledge, for example, that running a business in corporate form can protect the shareholders from liabilities of the business itself, but few stop to realize that the liability of a shareholder, especially a majority shareholder, can be satisfied by the assets held by the corporation. That is, a judgement creditor can reach the shares owned by a debtor and could exercise ownership of the shares.

If the shares represent a controlling interest in the business, the creditor can literally “take over” the business and run it (profitably or into the ground), sell it, or liquidate it. And don’t think that holding these shares in an estate planning trust helps. Such trusts are typically revocable by the “owner” and offer no protection whatsoever.

Many think an LLC will avoid this exposure, since the LLC laws protect the business from the debts of a member, and a judgement creditor may not become a member or vote the debtor’s interest, or look at the LLC books. Therefore, the LLC does offer somewhat of an obstacle, at least slowing the creditor down, but by no means does it offer true protection. The immediate protection it offers is a wall between the creditor and the assets held within the LLC. Unlike using control of corporate stock to reach the assets held in a corporation, a judgement creditor of a member of an LLC has no right to reach the assets inside the LLC.

But the “wall” does not make the judgement on the debt go away. Despite the wall, a determined creditor could conceivably acquire the debtor/member’s interest in the LLC, depending on the circumstances and the governing state law. The first remedy of a creditor of a member of an LLC is to obtain a “charging order” against the LLC interest. This is a court order directing that any payments that are to be made to the debtor/member must be paid instead to the creditor until judgement is satisfied.

In some states, including Massachusetts, if it looks like the LLC is stalling or contriving to circumvent the court’s order, the court can order a foreclosure (forced public sale) of the debtor/member’s share, causing the interest to be lost entirely (unless, of course, the LLC pays the creditor). Thus, even under the “better” of the two possible outcomes the debtor/member’s share of the profits is cut off until the debt is paid. This is not asset protection. Under the “worse” of the two outcomes, the creditor could purchase the debtor/member’s interest at the foreclosure sale and just sit with the interest until distributions are made or until the LLC is sold.

Asset protection begins with a careful review of the family’s interests, circumstances and objectives, with a view towards protecting assets from creditors without giving up benefits or control. And it must be noted that any such plan will require a considerable move from the status quo and the introduction of new documents into the family plan. It will also typically require re-titling of major assets. Once this small hurdle is overcome, the business owner would see that there are ways to retain control over a company without exposing ownership of the company to creditors; and there are ways of protecting children’s and grandchildren’s company interests and other assets from their creditors; and there are ways of passing the baton without passing the exposure.

To accomplish such objectives requires not only a careful and expert structuring of the underlying entities, having in mind the family’s immediate, intermediate and long-term objectives, but also recognition of the need for, and ways to develop, flexibility. Even the best current plan can be subsequently handicapped or rendered vulnerable to creditors by unforeseen changes in the family, such as divorce or disability, a change in the law or a change in the nature of a major asset. Flexibility must be built into the plan, as well as provisions for a periodic monitoring of the plan to consider ongoing family developments, objectives and changes of any sort that might affect the plan.

Alexander A. Bove Jr. is a partner in the Boston office of Bove & Langa, an estate planning and asset protection firm. He is adjunct professor of law, emeritus, of Boston University Law School Graduate Tax Program. He may be reached at bove@bovelanga.com.

Business Continuity Strategies Don’t Have to Be Complicated

Business Continuity Strategies Don’t Have to Be Complicated

By Joseph H. Guyton

This article first appeared in the Fall 2016 issue of Massachusetts Family Business magazine.

Have you been thinking about a business continuity plan? Many business owners are aware of the need for such planning. Some are even concerned about the issues and problems that a lack of planning brings. These issues include loss of key management, interruption of income, concerns over family control and equity, and retirement income planning. But the day-to-day challenges of managing a family business can often complicate or even prevent the development of a continuity plan.

What are these challenges? There are several:

  1. Business owners are busy running their business!
  2. When not at work, they like to pursue hobbies or spend time with their family.
  3. They are not sure what is involved, what needs to be done or how to start; the process may involve difficult conversations with partners or family members, and the potential solutions are not necessarily well understood. Questions may include:
  • What is a buy-sell agreement?
  • Who would buy the business?
  • How do we finance the transaction?
  1. Existing advisors may not be familiar with potential options; you don’t know what they don’t know. Advisors may also have a focus on product rather than strategy, which may create a bias in your plan.
  2. Other challenges include a feeling that the family business doesn’t need a continuity plan, can’t afford the planning process, or that there is no one to help establish it.

Joseph Guyton

If some of these challenges sound familiar and you are concerned about the survival or transition of your business due to disability, death or retirement, take heart. Solutions are available. They are not necessarily too complex, and they may help you meet multiple planning objectives.

The best place to start is with your existing advisors – your attorney, CPA or financial planner. Describe your concerns to them and ask for ideas and feedback – ask a lot of questions. Don’t stop asking until you feel satisfied that you are on the right track. If they refer you to someone, be sure to interview them before committing to work with them. You need to be sure there is philosophical and business alignment between you and the advisor. You need to be comfortable with how the advisor will be compensated. Many advisors are purely product-driven, which may create a bias in your plan or may leave important areas that directly impact your plan uncovered.

It is important that you have a team, and a “quarterback” for the team, to serve your purposes. Business continuity planning is important by itself, but it needs to be coordinated with many other aspects of your plan such as estate, portfolio management, retirement income and life and disability insurance.

Not all of your advisors are expert at all of these areas, so they need to work together to get you the best ideas and outcome. Some advisors may not be in favor of a particular strategy, but you need to hear all of the ideas and decide for yourself how one or another will ultimately affect you and your family. These are decisions that will affect you and your family for years to come. They may also affect the level of retirement income that you have to enjoy.

Attributes of a good plan include the following:

  1. Fits with your objectives and makes sense to you
  2. Accounts for variables beyond anyone’s control and is likely to work “no matter what”
  3. Has flexibility to be amended as circumstances dictate
  4. Protects the various parties from actions of the other parties. This is essential if you plan to exit your business as a retirement income strategy, and may include the following considerations:
  5. Will you hold a note from your buyer?
  6. How capable is the successor management?
  7. Will your buyer control the real estate that houses your business?

With the help of a qualified team, you will be able to develop a plan that provides a smooth, predictable transition in the event of retirement, disability or death. It will provide liquidity and equity among family members as well.

It will give you the confidence that more than one of your long-term concerns has been addressed and allow you to focus on your business and family.

Joseph H. Guyton is principal of The Guyton Group, a Portsmouth, New Hampshire-based family-owned business that provides wealth and legacy services to businesses of all sizes. He may be reached at (603) 766-9200, info@guytongroup.net, or www.guytongroup.net.

As it Returns to Family Leadership, A.W. Chesterton Also Returns to Family Values

As it Returns to Family Leadership, A.W. Chesterton Also Returns to Family Values

By Abby Patkin

This article first appeared in the Fall 2016 issue of Massachusetts Family Business magazine.

Andrew Chesterton

At family-owned A.W. Chesterton Co., they start ’em young; “Some of my earliest memories are my father really talking to me about the business when I was a boy. I think he probably even talked to me when I was in my crib,” jokes CEO and President Andrew Chesterton.

Chesterton credits his father’s stories with sparking his interest in the family’s sealing solutions and industrial equipment business. “My father was really very passionate about the business, and he would always talk to me about what was going on, and how we were growing a business,” he said. “That was probably the thing that got me really interested in the company, just seeing how passionate my father was about the business.”

His recent appointment – he took over the reins from Brian O’Donnell, a longtime Chesterton executive, in June – marks a return to family leadership for the company, which was founded in 1884.

The Groveland-based A.W. Chesterton has over 1,250 employees, sales in over 113 countries and locations spanning five of the seven continents, but what it stresses most is the uncompromising importance of customer care. In a statement regarding his appointment, Chesterton emphasized his company’s commitment to family values and individualized customer service. In his statement, he noted that his immediate plans for the company focus primarily on “exceptional customer care, unparalleled product quality, and technical innovation.”

These are values that the company has held close since Chesterton’s great-grandfather, Arthur Wellington Chesterton, founded it as a small steamship supplies shop on the Boston waterfront. The engineering supplies side of the business followed soon after and the company – which has remained under family control for over 132 years – has gradually expanded its services and offerings ever since.

‘A Winning Business Model’

With A.W. Chesterton in a state of regular growth since its inception, Chesterton points to a rather straightforward business model as the key to the company’s success. The model, he explains, is twofold: equal parts professional management and hands-on customer service.

When Chesterton first joined the company 29 years ago, the then-recent Duke University graduate took an entry-level job in the company’s customer service department. “It really taught me a lot about who our customers were and what they needed, and how we had to really be customer-focused to be a successful company, which is why one of my emphases as CEO now is that we’ve really got to become a truly customer-focused company again,” he explained.

Chesterton also notes that one of his fondest memories from his time at the company was from his tenure as the strategic business leader for the company’s hydraulic pneumatic business line, an assignment that involved calling on customers and developing corporate accounts. “That was a really exciting time for me. I really enjoyed that and it took my experience in the business to a whole other level to have that role,” he said.

Now, he and his wife – Darina Chesterton, who leads the corporate quality organization – are the only two family members currently working at the company, though ownership of the private company is divided among Arthur Chesterton’s descendants.

But despite the strong emphasis on family values, Chesterton is careful to note, the management team’s professionalism and determination are what help keep the gears in constant motion. Although the company puts heavy focus on its customer service department, “We have a very strong management team, and I think that’s important too,” Chesterton said. “Sometimes people think that a family business is less serious than a regular business, but it’s definitely not at Chesterton. … We’re very serious, we want to perform at a very high level and the Chesterton Company has always been about high quality and it’s always been about high performance, and that’s very much a part of our business model.”

Still, he said the company would not be as successful as it is today if not for its dedication to its customers – part of the reason why he has stressed the importance of renewing the company’s commitment to those values. “I think as we’ve gotten bigger over the years … we’ve developed more administration and more bureaucracy and things like that, which is a pitfall for all companies as they grow,” Chesterton said. “And I think what we really need to do now is really think about how we can be a truly customer-focused company again.”

“We really want to be driven by our sales force and what they tell us about the market and what they’re seeing out there so we know what we do internally will really be of value to the customer,” he added.

Abby Patkin is the summer editorial intern at The Warren Group. She may be reached at editorial@thewarrengroup.com.

Estate Planning for the Family Business Owner Requires Special Knowledge

By Kenneth P. Brier

This article first appeared in the Fall 2016 issue of Massachusetts Family Business magazine.

Estate planning is never more challenging than when it’s for the owner of a family business. Such planning is fundamentally different from planning for other individuals, so the one-size-fits-all standard estate plan is virtually certain to fail the owner’s needs.

Why the Standard Plan Will Fail

Worst is the unplanned estate. Everyone has an estate plan, whether you realize that are not. If not planned by you, the government has a standard plan for you.

Only slightly better is a “standard” lawyer-draft estate plan. Though it may be sophisticated in a generic sense, it may well fail to address the critical issues of business owners. For example, passing S corporation stock on to trusts of the kind commonly provided in the “standard” estate plan will blow the corporation’s S election.

Finally, even a well-executed estate plan, sensitive to special business issues, can fail if it is out of date. Personal and financial circumstances often change. And applicable state and federal laws have been in a continual state of flux.

 Four Precepts for Planning for the Business Owner

I boil the special attributes of estate planning for the business owner down to four precepts: one, think globally; two, face succession or face extinction; three, deal with liquidity issues; and four, divide, discount and conquer.

Thinking globally: There is never a clear dividing line between planning for the business owner and planning for the business. If a business owner does not like the currently available choices, he or she often has the ability to change the menu. For example, an owner, unlike a rank-and-file employee, can amend an existing retirement plan to obtain further options or terminate it and adopt a whole new plan. To avoid making a taxable gift, I have sometimes suggested that an owner transfer business opportunities to the children, rather than the whole business. The owner can set the children up in a new company, primed with contacts and know-how and poised to grow at the expense of the old one.

Facing succession issues: Every business owner needs to pay attention to succession issues, addressing the orderly transfer of ownership, responsibility and control of the enterprise upon eventual retirement, disability or death.

Lifetime transfers, often made in conjunction with the founder’s winding down or retirement, can promote an orderly transition. Ownership, responsibility and control need not be vested in same person. Those attributes can be separated by, for example, issuing non-voting stock or hiring professional managers. The owner needs to determine whether the stock will be gifted or sold, and if the latter, whether within the family or to an outside party. A common issue is how to deal with several children, only one of whom works in the business. Does that child get all of the shares? If an unequal distribution, should the other children’s inheritances be evened off with other property? The owner needs to exercise special care in the choice of personal representatives and trustees. Who will have the ability to run the business until an orderly disposition can be made? A buy-sell agreement can address many of these issues.

Dealing with liquidity issues: The government still extracts a sizeable estate tax from any large estate, and it wants payment in cash, not stock, within nine months from the date of death.

Often neither the business owner’s estate nor the business has enough cash of its own to pay the tax bill. Borrowing is only a temporary expedient. But cash that is otherwise unavailable can be generated through life insurance. Though it is not free, it does provide a tax-advantaged way to pre-fund the cash needs and make cash available exactly when it is needed. Whether or not there is insurance, either the estate or the business commonly will have to sell assets to a third party, often a life insurance trust.

A buy-sell agreement can come into play as a liquidity vehicle, prescribing in advance the arrangement whereby the estate will sell its shares to the party with the cash, usually derived from an insurance policy. If the sale is made to the company, it is a redemption agreement. If the sale is to the other owners, it is a cross-purchase agreement.

Divide, discount and conquer: Transferring interests in closely-held businesses at the least tax cost commonly has involved various strategies to suppress value. This is done by carving the business up into various minority interests, or more generally, restricting the individual owners’ rights in the business interests. The premise is that the sum of the parts then does not equal the whole. These techniques are often labeled as creating discounts, though the term “discount” in many respects is a misnomer, because you really do need to affect the current value of the individual owner’s interest. There are two kinds of basic discounts that may apply, namely discounts for lack of marketability (illiquidity) and minority interest (lack of control).

Strategies to divide and discount got a substantial boost in 1993 through the IRS’s issuance of a revenue ruling retreating from its position of aggregating family interests for valuation purposes. Neither Mom’s stock nor Daughter’s stock was now to be considered in determining whether or not Dad had a controlling interest. In fact, even if Dad did have a controlling interest, he might carve off a smaller piece and give it away as a minority interest.

The IRS since then has since waged a rear-guard campaign to combat such discount planning, especially as it extended to non-operating family limited partnerships and LLCs. This counteroffensive has recently culminated in new proposed regulations on valuation discounts for intrafamily transfers of business interests, seeking to breathe new life into 1990 tax legislation providing for the taxation of certain lapsing rights and the disregarding for valuation purposes of certain restrictions on liquidation. It remains to be seen whether these controversial proposed regulations will be finalized in something like their present form and what effect they might have on an operating businesses.

Kenneth P. Brier is a partner of Needham-based Brier & Ganz LLP, a boutique law firm focusing on tax, business, estate-planning and wealth preservation matters.