I was in an online discussion with another estate planner recently. She practices in Indiana, and she raised an issue which, for her, mostly related to family farms. We don’t have all that many farms up here in Alaska (a few, I know, but nothing like the Midwest), but I have seen the same issue come up regarding small businesses.
Here’s the underlying problem: What do you do when you have a single asset which dwarfs the rest of the estate, and one kid wants to take it over?
Here’s what I’m talking about: Let’s say you have a couple, Mom and Pop, who have a pretty productive business. It’s a very specialized business, and while it doesn’t have a whole lot of employees, it does turn a nice profit.
Over the years this couple has made some pretty good money, but a lot of it went into building the company. They had some savings but lost a lot of that in the stock market crash in 2007. Their other assets are their home, which is worth about $300,000, and about $100,000 in savings.
Mom and Pop have three kids: Junior, Suzy, and Bill. The older two aren’t really interested in taking over the family business; Junior has a pretty good job, and Suzy lives in New Mexico. Bill, on the other hand, has been working for the family business since he was a teenager. He knows how to do everything, and he would love to take it over when Mom and Pop are gone.
But this couple want the overall estate divided equally between their children. They figure the business is worth at least $800,000. If they let Bill have the business outright, he gets $800,000, the majority of the estate, and the other two kids will get only $200,000 each. So, the question is, how do you even things up?
There are some options, but they’re not ideal. They could say that the business goes to all three children equally and then assume that the other two will agree to let Bill run the business. But are the three of them going to be able to agree on fair compensation for Bill, who will be working in the business full time? And will Bill be happy having to run all of the major business decisions past his siblings?
Another option may be that Bill gets the business, but he has to buy out the other two kids with notes to be paid over time. There is still some risk involved, because if the value of the business goes down (say, some new competition comes into town from Outside) Bill is locked into paying the notes but no longer has the same amount of income.
Another possible option is life insurance, sufficient to pay off the other two kids and make everything even. Unfortunately, for most older folks life insurance is not an affordable option. I know a lot of you see those TV commercials promising guaranteed life insurance for seniors, but the amount those policies pay is actually pretty small.
One thing is certain: If the solution involves putting a value on the business, there should be a pretty tightly drawn formula for how the business is valued. There is a lot of leeway in how to appraise a small business, and two different accountants can come out with two wildly different numbers. If you have a formula that says Bill gets the business but has to pay off Junior and Suzy for their shares, don’t leave the question of the underlying value of the business open.
There is not necessarily a perfect answer to this question. A lot of it depends on the personalities and family dynamics involved. But these kinds of decisions are why I am not worried that my job will be replaced by artificial intelligence. There is no way an AI program is going to sort this one out.
Kenneth Kirk is an Anchorage estate planning attorney. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. And get it done, before you buy the farm.
