A Guide to Fairness in Family Business Transfers
Meet the Johnsons: A Family Business at a Crossroads
Sarah and Michael Johnson started Johnson's Gourmet Foods 30 years ago. What started as a hobby has grown into a real business with several locations and a significant online presence. As they are getting older, the Johnsons are thinking about retirement and the challenge of transferring their business to the next generation.
The Johnsons have three children:
• Emily (35): Has worked in the business for 12 years and is the operations manager.
• Alex (32): A marketing executive at a large corporation with no direct involvement in the family business.
• Ryan (28): After finishing his MBA, he just started working at the company.
As Sarah and Michael consider their options for selling the business as a part of their retirement, they face difficulties balancing fairness and family harmony while keeping the business running profitably.
Understanding the Challenges
The Johnsons' situation is common among family-owned businesses. They have several questions:
1. Defining fairness: Should ownership be divided equally? Or should it reflect each child's contribution to the business? How do you keep things fair when each child has not contributed equally to the company?
2. Valuing the business: How can they determine a reasonable number for what it might be worth?
3. Maintaining family harmony: How can they ensure that their decisions don't create lasting resentment or conflict among their children? Sarah and Michael want to spend time with the grandkids in retirement, and they don't want this business transfer to get in the way of that.
4. Securing their financial future: How can they transfer the business while ensuring they have enough for a comfortable retirement? What's our number, and how much will we net upon the business transfer? Are there any gaps, or will we have more than enough?
5. Preserving the business legacy: How can they ensure the business continues to thrive after they step away?
Step 1: Open Communication
The Johnsons decided to start the process by having an open family meeting over the holidays while everyone was together. They shared their desire to retire and their hope that the business will continue to thrive under family ownership. They also shared some of the struggles they have been facing in finding a solution that's fair to everyone. With no surprise, this conversation had the full attention of the kids and their spouses.
This first conversation revealed a few key insights:
• Emily feels she's earned a significant stake in the business through her years of hard work.
• While not interested in joining the business, Alex expects an equal share of his parents' assets.
• Ryan is eager to take on more responsibility. However, not everyone feels he has proven himself since he only started with the company this year.
Step 2: Seeking Professional Guidance
After that first conversation, the Johnsons felt a bit overwhelmed. Sarah and Michael didn't even know what options were available to them. Recognizing how complex their situation has become, the Johnsons engage a team of professionals:
• A financial advisor
• A business valuation expert
• A family business consultant
• An estate planning attorney
• A tax advisor
After meeting with the team, the Johnsons realized they had quite a process in front of them. They needed to understand what they needed to retire, the value of their business, the tax ramifications of different transfer strategies, and ways to make things fair for those not involved in the company while keeping an eye on maintaining their retirement security. This team helped the Johnsons understand their options and the potential consequences of the different transfer strategies.
Step 3: Valuing the Business
After completing the business valuation, Johnson's Gourmet Foods is worth $5 million. This fact is essential for planning the transfer while ensuring things stay fair among the kids. Now they know the value of what they are transferring, and they've obtained it in a way everyone can agree on, which was fair. This process proved far superior to the rules of thumb they heard at a conference and had been going by until now because they also got more buy-in from the kids on their plan.
Step 4: Exploring Transfer Options
With professional guidance, the Johnsons explore several strategies for transferring the business:
1. Selling the business to Emily and Ryan: This option would require financing and could strain the business's resources. Emily and Ryan had little cash to put in for a downpayment.
2. Gifting shares over time: This strategy could minimize tax implications but might not provide enough retirement income for Sarah and Michael.
3. Creating a family trust: This could provide for equitable distribution of assets among all children while maintaining business control.
4. Starting an Employee Stock Ownership Plan (ESOP): This could allow for the gradual transfer of ownership to Emily, Ryan, and other key employees.
Step 5: Crafting a Tailored Solution
The Johnsons put much thought into developing their plan and decided on a hybrid approach. They designed a plan with options they didn't even know existed before they started working with their team. The plan the Johnsons and their team came up with addressed their unique family situation and their goals:
1. Gradual transfer of ownership: Emily and Ryan will have the opportunity to buy into the business over time, with their shares increasing as they meet specific performance benchmarks. The Johnsons set up this portion of the business transfer to look much like Alex's at his job outside the business. The kids agreed that it was fair for ownership transferred as a part of a work benefits package to only go to those who work in the business.
2. Compensation for sweat equity: Emily will receive additional shares as recognition for her years of service and contribution to the company's growth. The Johnsons realized that while they wanted to be fair to all of their children, Emily had put much work into the business that the other two hadn't. They decided it wouldn't be fair for that difference in contribution to go entirely unrewarded.
3. Family trust for non-business assets: The Johnsons didn't leave Alex out because he wasn't involved in the business. They decided to create a trust that includes the real estate the company operates out of, the family home, and a life insurance policy, ensuring that Alex receives a fair share of the family wealth.
4. Retained ownership: Sarah and Michael will retain a percentage of ownership, which will provide them with ongoing income in retirement and allow for a gradual transition of control. By not selling all their ownership in the same year, they could spread their gain over several years and lower the total amount they paid in tax.
5. Clear governance structure: The family will establish a board of directors, including non-family members, to provide objective oversight and resolve potential conflicts.
Step 6: Implementing the Plan
Having a plan is one thing, but they know it isn't good unless they act on it. With their strategy in place, the Johnsons begin the implementation process:
1. They work with their attorney to draft new company bylaws and a shareholders' agreement outlining the ownership transfer terms.
2. They establish a formal performance evaluation system to determine when Emily and Ryan qualify for additional shares.
3. They create a family council to facilitate ongoing communication about business and family matters.
4. They develop a mentorship program to help Ryan grow into a leadership role.
5. They begin the process of transitioning day-to-day management responsibilities to Emily.
The Outcome
So what happened? Two years into the implementation of their plan, the Johnsons are seeing positive results:
• Emily feels recognized for her contributions and is motivated to continue growing the business.
• Ryan is developing his skills and gradually taking on more responsibility.
• Alex understands and accepts the rationale behind the unequal distribution of business assets.
• Sarah and Michael feel confident about their retirement and the future of the business. They have enough coming in to live the life they dreamed of without jeopardizing the business's success.
• Johnson's Gourmet Foods continues to thrive with a clear succession plan.
• Holidays are still a happy time with the family, and the Johnsons thoroughly enjoy spending time with the grandkids throughout the year. Even though it didn't necessarily transfer the equity equally, developing a fair solution was worth the effort.
Key Takeaways for Family Business Owners What can we learn from the Johnsons? The Johnsons' story illustrates a few essential principles to keep in mind for family business transfers:
1. Start early: Succession planning takes time. Begin the process several years before you intend to retire. Business owners always have something important to focus on. Between revenue, expenses, and keeping clients happy, there's always a good reason to put succession planning off. Many owners don't see themselves retiring, so they ask themselves, "Why even bother?" Start early to give yourself flexibility. As time goes by, so do your options.
2. Communicate openly: Regular, honest discussions with all family members can prevent misunderstandings and conflicts. Those working in the business will likely see things differently from those not involved. Open communication is key if one of your goals is to maintain family harmony. Setting expectations, hearing objections, and genuinely understanding people can be difficult and uncomfortable. That's why it is essential to -
3. Seek professional help: Successfully transferring a business takes a team. The process has so many facets that no person can do it all. However, you must have someone who ensures your team works in a coordinated fashion for your benefit. The expertise of financial advisors, valuation experts, family business consultants, attorneys, and tax advisors is invaluable in navigating complex transfer strategies.
4. Define fairness: Recognize that what is equal is not always fair. Consider each family member's contributions and circumstances when allocating assets. Remember that the business may be only one piece of the overall puzzle, so consider other assets.
5. Be flexible: A hybrid approach that combines multiple transfer strategies can often provide the best solution for complex family situations. Equity transferred through work benefits, employee incentives, and gifts often makes more sense than only pursuing one route to transfer ownership.
6. Plan for the future: Implement governance structures and mentorship programs to ensure the business's continued success.
7. Review and adjust: Regularly review your succession plan and be prepared to adjust as family dynamics and business conditions change. Life is uncertain, so stay flexible as things change.
By following these principles and carefully considering their unique family dynamics and business needs, family business owners can put together a succession plan that ensures fairness while not necessarily transferring equity equally, preserves family harmony in children active in the business and those who are not, and sets the stage for continued business success across generations.
This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2025 Robert Engel.
