When transitioning family businesses from one generation to the next, most experts agree that good communication is critical to success. It’s also important to ensure all parties involved understand the process and the documentation in place. Not only should you be aware of the purpose of these documents and agreements, but also how they relate to one another and affect you as the next generation owner-manager.
My mother was a card player — a bridge aficionado — and the word “trump” was commonly used in our household. It’s also a useful term to keep in mind when discussing the hierarchy of the various documents and agreements.
Family trust trumps will
Family trusts are separate legal arrangements that are familiar to many family business owners. If you already have a family trust, assets owned by the trust are not actually owned by the individuals that started the business — for example, your parents. As such, these assets would not be subject to disposition through your parents’ last will and testament. Although your parents may provide direction to the trustees of a family trust as to how to distribute the trust assets, the trustees are not legally bound by this direction. Note that, since your parents are often the trustees, it’s vital for a trust document to specify appropriate replacement trustees. An untimely death could mean replacement trustees may make decisions about the distribution of the family business’ shares that is inconsistent with the rest of the family’s understanding.
Preferred shares can control
Even where a trust is not used and the family business’ common shares are transferred directly to the next generation, your parents often still own preferred shares which control the majority of voting rights of the company (“control shares”). If so, it’s important for your parents’ wills to specify the distribution of these shares when they pass away to stipulate who will then own these preferred shares (and control the company). For example, will the same individuals who own the common shares also own the control shares?
Shareholders’ agreement trumps will
While a will may direct the distribution of shares of the family business, a shareholders’ agreement can override the will and generally dictate what will happen with the shares of a company in certain circumstances, such as death or disability. On the death of a parent in a family business situation, the goal is often to keep the shares held by the family. However, if there are non-family shareholders, the shareholder’s agreement may yield a much different result than what the family might otherwise understand, particularly if, for example, you are not aware of the shareholder’s agreement until after your parents’ death.
Be proactive — find out and understand “Who holds the trump card?”
If you will be taking over your family business, be proactive. Ask questions, attend meetings, discuss plans with your family who are in control of the family business and develop your own relationship with the various business advisers. A thorough understanding of the situation will help ensure a smooth transition even in unexpected circumstances.