Parasites vs. Plunderers: A No-Win War
Whether Sallie Bingham was the heroine or the villain in the real-life family business melodrama of the year depends largely on one's point of view. As most of us know from the press reports of her story, not to mention the three books that have recounted it, Sallie forced the sale of the Bingham newspaper empire because she felt her ideas — not to mention her 4 percent interest in the company — were not being accorded sufficient respect. It was her parents who gave her the stock she later used as a weapon against them. Had they given her something else of equal value, the company might have stayed in the family.
The Bingham experience is, unfortunately, a familiar one in family businesses. When gifts are made, future battle lines are drawn. On one side are the inactive shareholders, outsiders who are likely to end up regarding the insiders as plunderers of their legacy. In the other camp are the insiders, who play an active role in the operation of the company and see the outsiders as parasites.
Sooner or later, inactive shareholders, "parasites," will have a chance to cause trouble. They may view their shares as poor investments because they are too concentrated, offer too little return, and are subject to too much control by insiders who divulge too little information. Ordinarily there is no market for outsiders' shares except for other shareholders, who don't care to buy. Active shareholders, "plunderers," may see the outsiders as detached investors, uninterested in the growth of the business, too insistent on distributions, too vocal with advice and criticism, too willing to inject family concerns into business decisions. Of course, some families work out these differences, but very few.
Sallie Bingham, in her own book, Passion and Prejudice, complains about the lack of communication in her family. She has a point. Too often the older generation does its estate planning in secret. There is no discussion with members of the younger generation, who may be asked to invest the rest of their lives in their inheritance, the family business. The younger generation learns the details only after an elder dies.
Estate planning without communication can be hazardous. Intergenerational estate planning works best when frank and free discussions take place between the givers and the receivers. One item both generations should discuss is the potential parasite-plunderer scenario. Parents who feel strongly, at first, that the company must be divided equally among the children, may learn that the children don't want it that way. Sallie Bingham might have been perfectly satisfied with other assets, but no one asked her. They just gave her stock.
Regardless of how well the family gets along now, don't count on continued harmony forever. Old rivalries, new in-laws, or something completely unforeseen can trigger a conflict between the parasite and the plunderer.
Estate planning in the first generation is the very best time to head off the problem. This means early estate planning, before those annual gifts of voting common stock begin. Even at $20,000 per year tax-free, they can add up. Sallie Bingham may have received her stock because her parents' advisors pushed for annual gifts that would escape tax. Annual gifts make estate planning sense, but annual gifts of voting common stock in the family business don't make sense if they create the potential for a parasite-plunderer situation. Give something else to the child who won't be working in the business.
If, like most family business owners, your assets are predominantly locked up in the firm, one way you can create additional wealth is by investing in one of several breeds of life insurance. But non-voting preferred and common shares for inactive children are not the answer. Depriving them of a voice in company affairs just rubs salt in the wound. After all, shareholders wbo can't vote are at the mercy of those who can.
Unfortunately, most parents don't take this advice. They give equal shares of voting common stock to active and inactive children alike. What then? Consider an outside board of directors — at least two directors who are not family, employees of the business, or outside advisors to either the family or the business. Many family companies stack their boards with insiders while allowing only token representation of inactive family members. Ultimately that situation serves no one's interest. Outside directors must represent all shareholders, active and inactive family members. Their job is to exercise their best judgment for the benefit of the company as a whole. Their impartiality should regulate the flow of perquisites and dividends. Having outside board members is desirable for lots of good reasons. If the board keeps the lid on parasite-plunderer conflict, that alone is reason enough to justify its existence.
If shareholders balk at an outside board, at least try to expand communications among them. Circulate financial information, make the annual shareholder meetings informative as well as cordial, keep outsiders abreast of what is happening in the company, call regular family meetings to discuss the business. If company hunting camps, aircraft, apartments, and the like are available, make sure that all shareholders have fair access.
By all means, keep direct communications flowing. Discuss ways of buying out inactive shareholders, and keep that topic of conversation alive. Negotiate if you can. Get everyone to understand that sooner or later the parasite-plunderer tensions could destroy the business.
Keep your lawyer, accountant, and other advisors abreast of your discussions, but weigh carefully the effect of asking your lawyer to speak for you to other family members. Smart families communicate directly with each other, not through third persons. Once families start communicating through lawyers, the risks of family war escalate dramatically. Of course, if there is serious talk of buying or selling, you will want your lawyer present for technical advice and negotiating skills.
Gerald Le Van is an attorney, lecturer, and president of the Family Business Foundation, a consulting firm.