If you can’t find equal in estate planning, shoot for fair

Sitting in a study group dedicated to family business, I was surprised to learn how far some will go to equally divide their estate. One of the participants in the group, a psychologist, said their father had kept a lifelong ledger of what he had given each of his four children and that the estate plan took all that into account to equalize their inheritance.

If you could liquidate every asset into cash in reasonable fashion and then at one time distribute the cash you could equalize an estate. Realistically, though, it’s almost impossible to do. That’s especially true if part of the estate’s assets aren’t liquidated but continued for the benefit of the heirs.

A classic example is the family cottage. Regardless of its fair market value, to some it remains priceless. And to others, it’s nothing but a financial burden they want to sell. Some use the place frequently, and others hardly ever. There are costs of upkeep, maintenance and taxes. To complicate things, the grantor(s) really want the magical place they spent priceless summers with their children to remain a family treasure. So, how could you possibly find a division of this asset to be “equal.”

Fair market value
There are assets that just can’t be converted to fair market value and still meet the estate planning goals of the grantors. We all understand that there is a concept of fair market value – what a third party would pay. But what if the asset isn’t sold to a third party? What if it transfers through inheritance or gifting? Then, fair market value is somewhat of a myth.

Sure, there are appraisals, but they are an art, not a science. That’s why plans calling for appraisals will require two, and if they are too far apart, then a third.

So, what is something worth that isn’t sold outright? It probably goes along with other subjective values like “beauty is in the eyes of the beholder.”

Enter a family business. Now things get really complicated.

Let’s sell (or liquidate) the business and split the proceeds. Hold on! Two of the next-generation siblings work there and they want the business to continue, while the third never worked in the business and just wants his inheritance – in cash and soon. The grantor’s estate plan attempts to handle any and all potential situations. Keep in mind that the plan probably hasn’t been updated in some time and things have changed. 

There should be a current Buy/Sell Agreement in place to handle some of this. It should call for certain actions to be taken upon a “triggering event” (such as death) to buy out the interests of corporate shareholders, or in the case of a limited liability company it could be in the operating agreement.

Equal owners?
The intent is to buy out parties who the core owners don’t want as partners and give them some cash instead. But how much cash, and where does the money come from? Hopefully, the buyouts are funded with life insurance. But that isn’t always true and, even if it is, often there isn’t enough insurance.

But what if all the heirs aren’t equal owners? Or, what if they aren’t owners at all and most of the grantor’s estate is the family business? What then?

The grantors and the professionals do their best to come up with a plan that handles any and all eventualities super-imposed on the wishes of the grantors. We still have all sorts of issues about what things are worth. The situation is set up for those active in the business to want it devalued while those outside the business to want to maximize their value. How can that equate to equal?

Keep in mind that we haven’t even started with fair compensation for family employees (too much, or too little) over the years, company perks, voting/non-voting shares, etc. Or, say the business is sold shortly thereafter for much more than the value used at the time of the “settlement.” That’s why the lawyers have come up with “claw back provisions,” and the accountants have tried to zero in on the company’s true performance through EBITA calculations. And even then, value is “discounted” for marketability and minority positions. Just how discounted should they be?

All this to find truth and justice. In the end, unless you can convert it all to cash and make equal disbursements at the same time, someone won’t see it as equal, and it probably isn’t. That father who kept his ledger better have “present valued” his early disbursements compared to his later “gifts.” Even then, someone will question the inflation rate he used.

Fair in the eyes of the beholder
As hard as you may try, you can’t dictate from the grave with an estate plan. And it won’t be considered equal. Getting to fair is a nobler cause. Not everyone will see fair the same way either, and that’s why the discussion needs to be had before the estate plan becomes the decision-maker.

Keeping assets in the estate because of the tax advantages at death might be good tax planning and help equalize the estate, but it’s hardly fair to those who have worked in the business for decades in hopes that “one day this will all be yours” and that day comes in the twilight of their career.

So, I say, there is no equal and try fair instead. Start discussions with your family about how you see things before you begin the process of transferring assets whether during life or at death. Let’s face it, transfers during life are more likely especially since we are living longer. Use your professionals to facilitate those discussions. Lay out the game plan and be willing to listen to your heirs for their input.

You might start with the cottage.

Richard Segal is the family business contributor for Corp! magazine. He is the founder of the Family Business Council and its affiliated study group and operates a consulting firm specializing in issues related to enterprises with a family connection. He can be reached at [email protected].