Family Business Heir

If your children
have received, or will receive, interests in your family business, what steps
can be taken to protect the business?

o Active
Involvement: Carefully evaluate if and when to make your heir an officer or
director of the  family
business.  Involving an heir may
increase loyalty and motivation.
However, bestowing officer or director status may also increase the
claims the heir’s spouse may have in the event of a divorce. Depending on state
law, active versus passive involvement can have significant implications to the
determination of what the spouse is entitled to in equitable distribution.

o Lifetime Trust:
Set up a trust for your child and gift the equity interests into a lifetime
trust (sometimes called an inheritor’s trust). This can protect the business
interests from the child’s divorce or malpractice claims. A lifetime trust, if
GST exempt, can hold the business interests in trust forever without them ever
being subject to estate taxes. Distribution provisions may expressly prohibit
distributions of family business stock. Trustees should be carefully chosen to
carry out your wishes to preserve the family business. This is one of the most
important safeguards.

o Revocable
Living Trust: While these trusts can avoid probate they can do more. If you’re
married and you’ve inherited assets or received gifts, setting up a revocable
trust designed expressly to only hold inherited/gift assets  can be powerful tool to protect those
assets from becoming tainted as marital assets subject to distribution if you divorce.
Name the trust to highlight its limited purpose, limit trustees to your family
members (not your spouse), transfer only inherited/gift assets to the trust
never marital assets, and operate it so as to avoid commingling trust and
marital assets. It’s not only avoiding probate, it’s a supplement to a pre-nuptial
agreement or “divorce insurance”.

o Prudent
Investor Act: This law, enacted in various forms in most states, mandates that
estate and trust assets be diversified and invested in accordance with an
investment policy. Be certain that your will and any trusts you establish
(including insurance trusts) modify these rules to permit your executor and
trustees to hold family business interests.

o Shareholders’
Agreement: Be certain to have a comprehensive shareholders’ (or other)
agreement governing the operation of the family business and severely
restricting the right of any owner to transfer business interests. When you
gift shares to an heir (or preferably a trust for that heir) the heir, or
trustee, must obviously sign the agreement acknowledging that they are bound by
the restrictions. But you should also have the heir’s spouse sign acknowledging
that he/she has read and understood the agreement.

o Pre-Nuptial
Agreement: If your heir balks at a full blow prenuptial agreement as being contrary
to his/her professed love, at least a limited prenuptial agreement addressing
family business interests should be signed. Do it right. The new spouse should
have his/her own counsel, it should be done with full disclosure (attach a
business financial statement, tax return, and shareholders’ agreement as
exhibits), consummate it well in advance of the divorce (not on the Church
steps!), and make reasonable provisions for the new spouse (e.g., life
insurance, etc.).

o Voting vs. Non-Voting: At
certain points in time it may be advisable to only transfer non-voting equity
interests to maintain consistency in the control of the family business.
Caution: This might raise estate tax issues under Chapter 14 of the Internal
Revenue Code, so review this with your estate planner, not only your corporate
attorney. You might even consider mandating that if stock is distributed from
certain trusts, that distribution will trigger a conversion to non-voting
status. In some instances a voting trust arrangement might be helpful. In such
an arrangement the heirs could continue to own the beneficial interest in the
stock but a named voting trustee may be given the right to vote. Caution: Have
your estate planner review Code Section 2036 issues in this regard.