Fairness is as Fairness Does
Most family firm conflicts don’t result from anything “dysfunctional” in the family. There isn’t necessarily any “baggage” from childhood rivalries; nor are there always personality issues, spoiled brats, or greedy in-laws. Conflict is often simply a result of not having thought through the consequences of business succession and estate planning.
This fictional case illustrates one of the commonest of such avoidable consequences. With variations, it’s a pattern that all experienced consultants will recognize. Jack was the second generation sole owner of a construction company. Three of his children had worked there for 22, 20, and 13 years, respectively. (I’m going to call Jack and Sylvia’s six children the siblings so the case isn’t complicated by the issue of brothers vs. sisters, which it usually would be.) Two of the three other siblings worked at Jaxco for a few years, but by the time Jack was ready to retire, they had gone on to other careers (including homemaking).
Jack and Sylvia sold Jaxco to the three who wanted to acquire it. Let’s say they purchased it in equal shares. Payment was in the form of a note, with interest, over a twenty year term, which made the payments low enough so the buyers could take distributions from Jaxco each year which were sufficient, after income tax, to pay Jack and Sylvia.
What’s wrong with that? Nothing, but you probably see where I’m going. In Jack’s mind, the successor owners “got” the business. They didn’t really buy it—the business bought itself for them. If the three of them never protested his way of describing the deal, they must not have known or allowed themselves to dwell upon the second half of Jack’s summary: “… so the others will get everything else.”
Now Jack is dead, and the eldest sibling, 54, whose children are well launched into careers unrelated to construction, wants to sell out and move to Hawaii. The owners’ buy/sell specifies a clear formula. One of the others may buy the offered stock, thereby owning two thirds of the company; the company must redeem it, leaving the two of them as equal owners.
Either way, the seller and his or her spouse still have to pay their share of the debt to Mom, as well as capital gains on the shares. They learn, if they weren’t aware before, that Sylvia’s substantial estate (she and Jack were well fixed even before investing those note payments for more than a decade) will all go to the non-successor sibs. So the eldest can’t afford to retire. Yet the other two had been looking forward to his or her doing so. Suddenly we have a reluctant owner/president and disappointed partners. Now every normal disagreement, which they dealt with reasonably in the past, becomes emotionally fraught with frustration, mutual blame, betrayal, resentment, charges of favoritism, guilt and fear of disharmony in the family as a whole.
Only now do they call a family business dynamics consultant. How I would have liked to sit in twelve years ago when Jack and his attorney figured everything out for the family! There’s not so subtle pressure on Sylvia from the three owners to change her will. “We paid for the business,” they say. “It’s not like you gave it to us.” Yet Sylvia remembers that Jack and she had been in agreement on this. For years, she thought the formula “Those three got the business, and the others will get everything else” was the accepted family definition of fairness. Faithfulness to Jack’s vision for his estate is only one of several factors that make it hard for her to even consider a change in her own will. Yet an equal number of emotional factors incline her toward “correcting the unfairness”: her fondness and sympathy for her eldest child; her disappointment with two of the others, who moved across the continent; and the fact that the third of the non-successors married into great wealth, while Jaxco, frankly, has been only modestly successful.
What’s fair? Does the answer depend on the relative value of the business today compared with Sylvia’s net worth today? Should she write the child who wants out of the business into her will, while still excluding the other two? Or what?
copyright reserved 2006, Kaye Family Business Associates, Inc.
This fictional case illustrates one of the commonest of such avoidable consequences. With variations, it’s a pattern that all experienced consultants will recognize. Jack was the second generation sole owner of a construction company. Three of his children had worked there for 22, 20, and 13 years, respectively. (I’m going to call Jack and Sylvia’s six children the siblings so the case isn’t complicated by the issue of brothers vs. sisters, which it usually would be.) Two of the three other siblings worked at Jaxco for a few years, but by the time Jack was ready to retire, they had gone on to other careers (including homemaking).
Jack and Sylvia sold Jaxco to the three who wanted to acquire it. Let’s say they purchased it in equal shares. Payment was in the form of a note, with interest, over a twenty year term, which made the payments low enough so the buyers could take distributions from Jaxco each year which were sufficient, after income tax, to pay Jack and Sylvia.
What’s wrong with that? Nothing, but you probably see where I’m going. In Jack’s mind, the successor owners “got” the business. They didn’t really buy it—the business bought itself for them. If the three of them never protested his way of describing the deal, they must not have known or allowed themselves to dwell upon the second half of Jack’s summary: “… so the others will get everything else.”
Now Jack is dead, and the eldest sibling, 54, whose children are well launched into careers unrelated to construction, wants to sell out and move to Hawaii. The owners’ buy/sell specifies a clear formula. One of the others may buy the offered stock, thereby owning two thirds of the company; the company must redeem it, leaving the two of them as equal owners.
Either way, the seller and his or her spouse still have to pay their share of the debt to Mom, as well as capital gains on the shares. They learn, if they weren’t aware before, that Sylvia’s substantial estate (she and Jack were well fixed even before investing those note payments for more than a decade) will all go to the non-successor sibs. So the eldest can’t afford to retire. Yet the other two had been looking forward to his or her doing so. Suddenly we have a reluctant owner/president and disappointed partners. Now every normal disagreement, which they dealt with reasonably in the past, becomes emotionally fraught with frustration, mutual blame, betrayal, resentment, charges of favoritism, guilt and fear of disharmony in the family as a whole.
Only now do they call a family business dynamics consultant. How I would have liked to sit in twelve years ago when Jack and his attorney figured everything out for the family! There’s not so subtle pressure on Sylvia from the three owners to change her will. “We paid for the business,” they say. “It’s not like you gave it to us.” Yet Sylvia remembers that Jack and she had been in agreement on this. For years, she thought the formula “Those three got the business, and the others will get everything else” was the accepted family definition of fairness. Faithfulness to Jack’s vision for his estate is only one of several factors that make it hard for her to even consider a change in her own will. Yet an equal number of emotional factors incline her toward “correcting the unfairness”: her fondness and sympathy for her eldest child; her disappointment with two of the others, who moved across the continent; and the fact that the third of the non-successors married into great wealth, while Jaxco, frankly, has been only modestly successful.
What’s fair? Does the answer depend on the relative value of the business today compared with Sylvia’s net worth today? Should she write the child who wants out of the business into her will, while still excluding the other two? Or what?
copyright reserved 2006, Kaye Family Business Associates, Inc.
posted by Ken Kaye at 11:30 AM
5 Comments:
I assume Dad estimated the business to be equivalent to about half his net worth immediately after the sale (including the value of the note). If the sibs who ran the business were successful, then they earned the fruits of their work, but if not, that's the risk they took - their other siblings shouldn't be expected to make it up to them.
With all respect, I think that comment might apply if the business was a gift or bequest, but Jack and Sylvia sold it. In at least one of the cases I was thinking of, the buyout contract carefully established fair market value.
I wouldn't have been qualified to draw up their buyout terms, note, new buy/sell agreement, or wills. Yet I wish I'd been there to make sure it got done in a way the next generation would later agree was fair. I think by excluding the three successors from their will, these parents penalized them for buying the business. But I'm hoping some of my legal and financial colleagues will weigh in in this.
Have the three owner-siblings form an ESOP to buy out the 33.3% share of the business from Sib 1, he or she can then roll the proceeds over into publically traded diversified stock portfolio without cap. gains. Also, this allows Sib 2 and Sib 3 to accumulate pretax income and, perhaps, retain key employees. Mom could forgive a portion, or all, of the note if she feels bad, or she could make a provision for a HEET trust for all of her children in case any fall on hard times.
Work on designing the right process to deal with what is, not what could have been. Hopefully, the individuals (and not their lawyers acting for them) will find a wayh to look at this that will make sense to them and work for them.I would let go of the fact that opporunities were missed and deal with it in the present. First, recognize this as a conflict in the context of grief, then ask what the best process is for seeing and respecting grief, recognizing when greiving individuals are truly able to give their attention to dealing with the issues (grief may defer this for a long time), affirming values, preserving family relations, establishing appropriate rules for dealing with the issues, etc. Finally, there could be an opportunity to learn some shared lessons going forward, and to revisit and hone family governance.
One can say "take responsibility for your own actions", but will Mom choose to use tough love?
I mean the 54 year old can be told "You decided to buy 1/3rd of the business. You managed it. Now you learn that you can't afford to retire to Hawaii. Okay, don't retire."
Mom may decide to do whatever she wants to do with her estate. I think she should ask the one that married into great wealth if he/she would mind not being included in the will.
The relative size of Mom's estate and the value of the business should not affect her decision, but of course it will. If she can afford to buy happiness for everyone, she will. That's what parents do.
Mom should not try to carry on Jack's wishes. Things change, Jack could not have forseen every possibility. But I'm not saying that Mom should bail anyone out. Let them grow up and take responsibility for themselves. They all should have been trained with David Bork's Nine Commandments as teenagers.
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