How ESOPs can help with Family Business Transitions and Estate Planning

How ESOPs can help with Family Business Transitions and Estate Planning by Jack Veale an ESOP Advisor.

Sometimes, families working in the business have conflicts caused by the differences with behaviors and expectations.  Some of these family business conflict stories show up as great novels and news articles.  Have you heard of children who can no longer work with each other, and they are partners due to estate planning by Mom and Dad?  How about the son or daughter who is CEO, and has partners who are siblings and don’t think the CEO is running the company well?  Sometimes, Dad is struggling with a difficult business environment, cause by the employed children who aren’t performing well.  Or Dad is still running the business while in his late 70’s and the employed children have lost interest in the business.  There are so many stories, and sadly, many never get solved, don’t reconcile or they cause further harm.  This article is about how ESOPs can help solve the ownership issues.

When a company is owned by person, with family members and distant relatives employed in the business, a set of behaviors develop that are commonly described as a “Family Business.”  When you look at family systems, and compare them to the business behaviors or systems, which typically is blended and managed, you can help pinpoint the causes of family conflict in the business and develop remedies.  The underlying theme is “whole is greater than the sum of the parts.”  ESOPs are a great remedy for many family business issues that surface when conditions or expectations change.

To understand the challenges, one needs to understand the differences between Family systems and Businesses systems, as they relate to a systems/behavioral approach.  Family behaviors usually involve some level of emotion; have an inward focus with interdependencies and relationships/alliances; prefer retaining traditions which typically minimize or restrict change; typically desire to have unconditional acceptance of each other, which then causes misbehavior to be regularly overlooked; and the family’s task includes nurturing each other, growing self-esteem and preparing the family members to become mature adults.

Business System behaviors, in contrast to family system behaviors, seek rational behavior and decisions over emotional ones; have an “outward” versus Inward orientation to find new customers and seek growth, which requires continual change of products, services and leadership.  Members of the company are conditionally accepted, provided they meet performance expectations, and don't put up with misbehavior.  And their business task is to develop skills, foster innovation (change), focus on profitability and seek market penetration.  As you review these conflicting system behaviors, one can quickly realize why many family businesses many times can’t survive through several generations.

One way ESOPs help in Family Business transitions is by helping parents or key shareholders liquefy their primary asset: Company Stock.  One of the challenges business owners have is “how to get money out of the business without losing control?”  A properly designed ESOP can meet these expectations.  When an ESOP Trust owns 49.9% of the stock, the other 51% are in “control.”  Depending on the conditions, the selling shareholder(s) can take a tax benefit, typically called a “1042 Rollover” to help with the tax burden.  Good ESOP Advisors can complement your team of trusted advisors.

Many times, the founding spouse, passes away and the surviving spouse needs the money, but the kids who work in the business want to retain control, and cannot raise the money to buy “Mom or Dad” out.  An ESOP approach can be a blessing to all family members, as it allows for the family's legacy and control to continue, Mom and Dad get what they need for now, and the company retains family legacy.

When the parents set up Estate trusts with company stock as the primary asset, in most cases, the beneficiaries, who are typically the children of the founders, want to liquefy their holdings once their parents have passed away, much like the surviving spouse in the prior paragraph. This puts a huge burden on those who remain in the business. Again, ESOPs can provide a way for the trusts to be liquefied. 

In another scenario, the children are not ready to run the business, and the Family CEO wants to retain legacy, maintain control and provide a future for their young, inexperienced children.  In many cases, the Family CEO has groomed a “right hand” person who will eventually groom the children and become the CEO until one child emerges as the replacement CEO.  With the challenge of keeping key people and aligning them to perform well, an ESOP can become a great succession and management retention tool.

In another scenario, the partners are arguing over the value of the company.  Most advisors try to navigate through this conflict by hiring a valuation person without working through the underlying issues that are causing a valuation to be made in the first place.  The best ESOP Advisors have the experience and/or advisor relationships to help families work through their issues that will reduce those conflicts and allow for a mutually beneficial solution.

In most cases, these and other stories have an emotional impact on the family and the business. Employees leave to avoid the fallout, the banks raise concerns and call back debt, and competition starts smelling blood causing market disruption. Buying out family members can be a great solution and help restore and/or maintain family & employee relationships.  There aren’t many funding sources or buyers of company stock who will buy a minority interest in a company with the family retaining control.  ESOPs are a great way to help families navigate through these difficult stories and provide a meaningful way of improving relationships and mending wounds.

Financial or legal advisors who specialize in ESOPs can be an excellent resource for helping family businesses navigate through these tough waters, as they are adept in working with families and their trusted advisors.  When checking if you have the right ESOP Advisor, the most important question is “can my family and key advisors work with the ESOP Advisor?”  The second is: “Are they involved in the ESOP communities?” as only the best advisors invest in the ESOP community; thus benefitting from interaction and involvement.  Successful business owners do exactly the same thing.  And finally, “do they have the experience with “families” to not add more disruption to the current state?”  The best advisors work with family systems and know when to bring in the right advisors who can navigate through these issues.