familyownedbusinessblog

Structuring the Business for Success: Choice of Entity

In Albuquerque recently, I presented this materials to owners of agribusinesses.  In the next several blogs, I share that presentation. 

In choosing an entity there are seven key factors to consider:

1. Purpose.  What is the purpose of the entity?  The entity chosen should be "right" for the purpose. One entity does not fit all purposes. For example, a going concern will have operations and may have real estate.  A S corporation may be right for the operations but wrong for the real estate (more on that in subsequent posts).  The "right" entity for the real estate is likely to be a limited liability company (LLC). 
2. Liability.  Limiting the owner's personal liability for the debts of the entity is an important factor in choosing an entity. Corporations and limited liability companies provide such protection to its owners.  Sole proprietorships and partnerships do not with the exception of limited partnerships.  In limited partnerships, the limited partner's contribution to the partnership is at risk but the limited partner is not personally liable. However, the general partner of a limited partnership is personally liable. Note that an owner can become personally liable by guaranteeing the debts of the entity.  The owner may also be personally liable for their own actions.  In this instance the personal liability arises out of those actions and not because of ownership of the entity.
3. Cost.  A factor to consider is the cost of forming the entity and the cost of maintaining the entity. Nothing comes free. There is a cost.  More on this in subsequent posts.
4. Size and complexity of the enterprise.  The choice of the entity or entities will be driven in large part by the size of the operation and the complexity of the enterprise.  A simple form of business is sole proprietorship but this does not allow for the addition of venture capital or partners.  Nor does this simple form protect its owner from liability for its debts or claims. In a complex operation with risk of liability, it will be desirable to have an entity that provides limited liability.
5. Regulatory requirements. The requirements on a particular operation may make one form of entity better than another form. In some personal services operations, the requirements and licensing is personal to the person delivering the services. This may make partnerships or limited liability partnerships more attractive than a corporation. 
6. Valuation.  If transferring business interests to a younger generation of owners is important, valuation of that transfer will be important, too.  The type of entity and the limitations on transfer will be factors in determining the value of the business interests.
7. Taxation.  How business entities are taxed is a significant factor in which entity is chosen.  The purpose served by the entity is largely a tax driven decision.  For example, C-corporations are taxed at the corporation level and dividends are taxed at the corporate and shareholder level (taxed twice).  Partnerships, LLCs, and S-corporations are pass-through entities meaning that the shareholder pays the income tax of the portion of the entity allocated to that shareholder.  Recognition of gain is treated differently among the entities.  Usually there is a recognition of gain when an appreciating asset is distributed to shareholders of a corporation.  Typically there is no recognition of that gain when the same appreciating asset is distributed to partners of a partnership or members of a limited liability company. 

 Next post:  Basic Governance Structure

Raising the Next Generation: Capital Accounts

Generally, the Legacy Family has four capital accounts which it attempts to keep in balance. Those accounts are:

1.  Financial Capital.  This is the money earned as well as the investments under management.  This account also includes wealth transfer strategies, family business operations, financial parenting and understanding the psychology of money.

2.  Intellectual Capital.  This is the family's experiences, its know-how and general knowledge. It includes education, career choices, mentoring/coaching, governing the family (how rules are made for future generations).

3.  Human Capital.  This is general parenting and grand-parenting skills, communication skills, values, morals, ethics, collaborative decision making and conflict resolution.  This account will also contain leadership training and team building so necessary to the Legacy Family.

4.  Social Capital. This is the philanthropy of the Legacy Family whether it is a donor advised fund or a family foundation.

A Legacy Family will engage in activities that build each of the four capital accounts so that the accounts are in balance. The Legacy Family will develop activities that provide for:

• effective communication among the family and other stakeholders;
• a process for collaborative decision-making;
• conflict resolution;
• identification of shared values;
• code of conduct that articulates the behaviors acceptable for family members;
• a process for acceptance of non-bloodline family members including partner choices;
• managing expectations of future generations;
• developing financial competency in all generations; and
• a process of accountability.

The following reading list will help in developing useful activities to build deposits in the capital accounts:

Eileen Gallo, PH.D. and Jon Gallo, J.D., Silver Spoon Kids:  Communicating about money in healthy ways. Teaching strong values and compassion. Preventing a feeling of entitlement, 2001, Contemporary Books.

Eileen Gallo, PH.D. and Jon Gallo, J.D, The Financially Intelligent Parent, 8 steps to raising successful, generous, responsible children, 2005, Penguin Books. 

Joline Godfrey, Raising Financially Fit Kids, 2003, Ten Speed Press. 

James E. Hughes Jr., Family Wealth, Keeping it in the Family: how family members and their advisers preserve human, intellectual and financial assets for generations, 2004 Bloomberg. 

Thayer Willis, Navigating the Dark Side of Wealth, A life guide for inheritors, 2005, New Concord Press.

 

Raising the Next Generation: Legacy Families

Like most families, financially successful families hope that each of their members in this generation and the next will be successful, happy, healthy, and content. To break cycle of rags to riches to rags in 3 generations will require intention and attention. 

It is important to remember that yesterday’s wealth is no guarantee of tomorrow’s success. The adage “shirtsleeves to shirtsleeves in three generations” is not unique to thos living in the United States.  Here and elsewhere there are many families who have been able to perpetuate their success for many generations. Their progeny have become new titans in business; assumed leadership roles in public service, etc. all by effectively developing their individual talents. Their extended families enjoy each other. Each new generation seems to build on the shoulders of those who preceded them. These special families are called “Legacy Families”.

What is it that differentiates a Legacy Family from all the rest? Legacy cannot be mandated or guaranteed. It is thoughtfully designed, carefully implemented, and perpetually nourished. It is also quickly lost and easily broken. Not all those for whom the legacy was created accept or appreciate their gift. For many it is not even a gift, but perhaps an unwanted burden.

A Legacy Family has four characteristics:

1. They have the capacity to add value to our society and to recognize the importance of contributions to the financial, human, intellectual, and social capital of their family and community;
2. They have the necessary skills and education as a family to develop the competencies to handle the responsibilities of wealth; to effectively utilize the opportunities that have been provided to them; and to become productive members of their communities;
3. They have a connection to their ancestors, current and future descendants including a connection to their heritage;  maintain positive family relations; communicate effectively; and promote generational governance structures, which will assure the success of future generations; and
4. They are generous of their time, talent and treasure; recognize their good fortune; and empower each family member to become the best he or she can be.

Family Dynamic: Resolving the Fear

Parents should be transparent to their children about their wealth and their plans.  This may not mean opening all of the parent's financials, but the children should be aware of the extent of the wealth and the parent’s intentions for distribution during life and at death.  The parents do not and should not allow their children to dictate the estate plan; however, there are opportunities to involve the children in the process without a parent losing control of their funds.  Parents should begin raising financially fit kids at young ages by communicating and demonstrating health behaviors about money, teaching strong values and compassion.  Some examples are providing allowance to children and setting the expectation that a portion will be set aside for long-term savings, a portion for charitable gifting and remainder for discretionary spending. 

If parents want to have their children support charitable endeavors, then parents must support charitable endeavors and make your behavior known to your children.   Parents should talk to their children about why charity is important to the family, why you have chosen the charities that you wish to support, and how you should choose a charity.

If a parent requires that a portion of the allowance  be given to charity, the child should participate in choosing the charity.  It works best if the parent is open to a variety of ways that the child can be charitable – not just giving to the parents’ charity, but actually allowing the child to choose how and when so that they are vested in the process.  For children, the link between giving to a charity and the charity, will be the opportunity for volunteerism.  Parents find their kids more involved with giving when the child can also volunteer their time rather than just providing financial support. 

For older children, parents may encourage and allow children to manage a portion of the family’s donations.  This can include involvement in the investment decisions, researching the charities that will be supported by the donations, being part of the decision-making process for making decisions, follow-up with charities on the use of the funds with a report back to the family.

Everyone learns through doing and through failure.  These children may fail, but that failure can lead to education and an opportunity for learning.  Whether it is an 8 year old with an allowance or an 18 year old with a small fund to manage, the donations to charity and the investment of the assets could lead to failure – failure to grow or  choosing a charity that doesn’t use the funds for the intended purpose.  If parents use these failures as teaching moments, then it is not really a failure because the intended purpose for the allowance or fund management was to teach the children about fund management and charitable giving.  The whole purpose of these endeavors is to teach financial responsibility, the value in having money serve others and the value of that service.  Successfully raising involved and charitable children will go a long way to reducing the fear parents have about transferring wealth to their children and children have about what, when and how they are going to inherit.

 

 

Fear: Family Dynamics in Estate Planning

Fear sums up the feelings of many parents and their children about receiving or inheriting wealth, whether large or small.  Parental fears are often identified by the parent’s concerns about their children’s ability to manage and have wealth.  They are often concerned that the wealth will be wasted or that the children will be "ruined" by the money – they do not want their children to become the stereotypical “trust fund” children.  Specifically,they fear that their children will lack purpose or direction and make no significant contributions to the world in which they live.  Parents are concerned that the wealth will be used to maintain a harmful lifestyle (for example – alcohol, drug or gambling addictions). 

Children fear that there will not be any family wealth for the children to inherit because another sibling is receiving more than his/her fair share; or the parents are giving it away to charities; or consuming at a rate that there will be no funds to inherit.  Parents may be more generous to grandchildren than to their children.  Children also fear once they inherit, this is all the money they will receive and they don’t know how to manage because mom and dad have always taken care of them.  If they do inherit, when will they inherit?  What, when and how are the concerns of the children.

Parents are less fearful when their children show maturity to manage money, demonstrate a service of purpose outside of themselves, and are free of harmful lifestyle choices or are successfully managing their addictions.  Children are less fearful when the parents involve the children in the estate planning decisions and make the estate plan and wealth known and transparent to them.