An advisor team for a multi-generation family business was reviewing some estate planning documents and discovered that the fourth generation (at the time, children and young adults) not third generation (the three brothers that ran the business) were actually the owners. In other words, some elaborate planning had led to a situation where the kids could fire their dads and uncles. When teenage angst can turn into a hostile takeover, estate planning may have gone a bit too far. It was an unusual situation!
Some business owners worry about losing control of their business. A recent Forbes article, “Control Freaks Take Heart: How To Maintain Control Of Your Business,” offers some ways to assure firm control of a closely-held company.
Take stock. Business owners can frequently breeze over legal decisions involved in incorporating their business, which can have lasting ramifications.
These decisions are critical in determining who is in control and over which aspect of the enterprise. One common way to share stock ownership without sacrificing control is by issuing non-voting stock. This gives individuals an equity interest in the business without voting rights as to the governance of the business. This can work with an S Corp, provided the stock rights are otherwise the same.
Close counts. Many states have corporate laws for closely-held companies, but many of these laws only apply if specifically provided for in the company’s articles of incorporation, bylaws, or other legal documents.
These provisions are good to consider and also may help lock in control. The original article provides some examples of closely-held corporation laws that can potentially impact shareholder control, to include:
- Permission to dispense with the annual Board of Directors meeting
- Allowing voting trusts
- Requiring straight voting versus cumulative voting
- Mandating that major corporate actions can only be undertaken with approval of a super majority of stockholders
Depending on how ownership of a closely-held business is set up, these types of terms allow owners a bit more control—both in running the business and determining future.
Rent versus own. Simply stated, if you want total control of the business as an owner, don’t give away stock. Stock options, in essence, are just delayed ownership of stock, and restricted or non-voting stock still entitles owners to demand corporate information and allow them to file derivative lawsuits.
If you want a key employee to share in the wealth of the company, but not in the direction of the business, the original article suggests that you use other incentives than stock. It gives the example of nonqualified deferred compensation arrangements like phantom stock and stock appreciation rights (SARs) that can mimic stock value without giving up the stock itself. Better yet, create a nonqualified plan that has defined metrics to target the desired behavior of key employees such as where: (i) the sales VP shares in a part of the sales success; and (ii) the CFO shares in a piece of the profit; however, (iii) neither share in the control. If you do this, then the business owner is “renting” the company’s success to fund incentives but isn’t giving up ownership.
Before taking any of the actions described in the Forbes article, consult an experienced estate planning attorney.