The three spheres of succession and estate planning

By Allen T. Ratcliffe Jr.

When faced with a problem, we all desire simple solutions. For many family business owners, however, the respective dynamics of the business and the family create a complex environment.

The process of business succession proceeds smoothly only when the relevant concerns are identified in detail and less relevant issues are disregarded. Once core objectives are determined, it is easier to apply a solution.

Defining core objectives

Of course, when we develop a plan, we expect that it will accomplish our objectives. However, many plans fail because the solution did not take into account other equally important, and perhaps conflicting, objectives or did not adequately consider deeper issues.

Business succession planning integrates your personal and business objectives. You must identify and prioritize your objectives before seeking solutions from advisers. Typically, when decision makers consider only one or two obvious constraints in defining an objective, they miss the underlying issues. In order for the process to succeed, you must understand the details that drive the decisions.

Business succession can be broken down into three spheres: Family, Ownership Succession and Management Succession. Sometimes when each category is examined independently, core objectives become apparent.

Fred’s Excavating Company

Years ago a client, “Fred,” consulted me regarding succession at his successful excavating company. He was unmarried and had three children. Only one child, “Barney,” was active in the business and was interested in eventually taking over. The other children had no interest in the business but expected to inherit equally. Fred’s revocable trust directed that upon his death, his estate would be divided into equal shares. No mention of the business was made in the trust.

Defining Fred’s objectives and constraints. First, Fred identified a “core planning team,” consisting of Fred, Barney and Fred’s CPA. Then, the core planning team brainstormed all potential objectives and constraints within each of the three spheres of business succession.

These brainstorming sessions uncovered many relevant issues. Barney did not want to become partners with his siblings; a valuation dispute was likely; there may have been insufficient assets to equalize among non-participating children; and cash flow from the business was likely not sufficient for Barney to buy out his siblings’ interests without adversely affecting operations.

When he looked at management separately from ownership, Fred easily determined that if he died or became incapacitated, Barney should manage the business. When he considered who should succeed him as owner of the business, it was clear that the family objective of treating the children equally conflicted with the business ownership objective of having Barney inherit the business.

The team considered four methods to equalize the estate and assessed the ramifications of each method:

1. Provide in the estate plan for equal division of the entire estate to the children upon Fred’s death, with the business also divided among the children equally. The non-participating children may demand income commensurate with the equity value of their interest in the business; this may create friction between Barney and his siblings. A non-participant may not be able to sell her share, draw a salary or receive a distribution, thus reducing the value of the interest to her. Conversely, if a non-participant is guaranteed a reasonable distribution, it may be more than the company is able to pay without adversely affecting the business.

2. Provide for equal division of the estate, allocating the business to Barney and allocating other assets of equal value as of the date of Fred’s death to the non-participating children. The participant child may argue for a lower value for the business, whereas each non-participant may argue for a higher value for the business in order to receive more non-business assets. Arriving at the property value is an expensive and inexact science and may result in a disagreement, which may lead to resentment, hostility or a lawsuit among the children.

3. Provide for equal division of all assets and mandate that Barney purchase any business interests allocated to his siblings. Property to be given to the non-participants will come from cash flow of the business. The question is whether the business will have adequate cash flow to make the payments without jeopardizing operations. In addition, there is the potential for a valuation dispute.

4. Provide in the estate plan that the entire business be allocated to Barney regardless of its value at the time of Fred’s death, with other assets equal to a specified amount allocated to the non-participating children. Problems may arise if non-business assets specified as going to the non-participants are no longer owned by Fred at the time of his death. Also, the value of the business and any non-business assets to be distributed may differ substantially between the date of the plan and the date of distribution, causing disparity in the children’s inheritance. The participating child takes all the risk of a decline (and reward of an increase) in the value of the business from the inception of the plan.

Fred’s decisions

Fred decided to amend his revocable trust to provide that, if he died or became incapacitated, Barney would serve as Special Trustee for Business.

Because Fred wanted to avoid a valuation dispute upon his death, he decided to give the business to Barney, regardless of its value. Fred felt that if the business value increased or decreased, the change in value would either be enjoyed or suffered by Barney, since his son had already taken over operations.

In order to determine an amount to give to his other children, Fred obtained a current business valuation by a qualified appraiser. Then, rather than using the company value as of the date of death to measure the inheritance of the other children, Fred specified a stated dollar amount to go to the others upon his death to be satisfied by other estate assets, including life insurance proceeds payable to his revocable trust, to be determined by an independent successor trustee. The balance of the estate, if any, was to be divided equally among all the children. This rough justice eliminated the potential valuation dispute, and the children were treated fairly, if not equally.

Barney was happy that he would be able to continue the business without having to consult with his siblings regarding business decisions and that business cash flow would not have to be expended to purchase his siblings’ shares. However, he raised a issue that bothered him. He felt that he worked for part of his inheritance by helping build the business, while the others received their inheritance by doing nothing at all.

In order to recognize Barney’s contributions to growing the business, Fred decided that 20% of the value was attributable to Barney’s efforts. (This may be referred to as sweat equity vs. blood equity.) All of the business was allocated to Barney; other estate property equivalent to 80% of the current value of the business was allocated equally between his other two children.

A successful process

Of course, Fred’s decision is not the answer for everyone. Each situation is different, and care must be taken in choosing a course of action. But all business owners can benefit from identifying their core objectives and examining each in detail. Fred understood that making decisions at this detailed level drove the successful outcome of his plan.

Fred’s willingness to navigate patiently through business succession planning was rewarded. The Family would not experience resentment and possibly a costly dispute; Ownership of the business would remain in the hands of his designated successor; and competent Management was in place. Fred was satisfied that his core objectives within each of the three spheres had been met.

Allen T. Ratcliffe Jr. is an estate and business attorney in San Ramon, Calif. (





Copyright 2012 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permssion from the publisher. For reprint information, contact

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May/June 2012


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