Most owners of a family business have one class of common, voting stock. One challenge faced by these owners is how to divide the stock among their children, who may have very different personal circumstances. It may not make sense to give each child the same stock.
Suppose, for example, that you have three children:
Your daughter is active in the business and is married with two young children. Unfortunately, her marriage is troubled and a divorce is not out of the question.
Your second child also works with you in the family business. He is single, but is living with someone. She has children from a prior marriage who have not been adopted by your son. It is unlikely that he will marry her nor will he have children of his own.
Your third child does not work in the business and lives on the West Coast with his wife and children.
Does it make sense to give to each child the same common, voting stock now or when you die? Probably not if one of your goals is to keep ownership of the business within your family.
The first step should be the creation of an updated buy-sell agreement. Transfers incident to divorce will trigger the purchase of any shares awarded to an exspouse. The divorcing shareholder will have the first option to buy back those shares, so as to preserve his or her equity ownership. Other transfers outside of your family also will trigger the operation of the buy-sell agreement.
You could then restructure the common stock of the family business so that each type of stock has its own restrictions on transfer. This can be done even in the case of an S corporation, because all the stock is still treated as one class of stock even after the restructuring.
Based on the family described above, the business could create voting A stock, which could be given to your daughter now or when you die. This stock could permit her to transfer shares to her children or to an irrevocable trust for her husband (but not outright to him). She also could give or sell her voting stock to her brother who works in the business. You would have the assurance that the voting A stock will stay in your family after you die even if she and her husband were to divorce.
The business could then create voting B stock, which could be given to your son who works in the business now or when you die. This stock could permit him to give or sell shares only to your daughter or her children. Transfers to anyone else, including the woman with whom he lives (or her children), would be prohibited and would trigger the operation of the buy-sell agreement.
Finally, the business could create nonvoting C stock, which could be given to your West Coast son now or when you die. This stock could permit him to transfer shares to his children or to an irrevocable trust for his wife (but not outright to her). He also could give or sell his non-voting stock to his sister (and her children) or his brother. Once again, you will have the assurance that even the non-voting stock in the business will remain in your family.
Because you have two children who work in the business and one who does not, the buy-sell agreement should give to the business children the right to buy the non-voting stock that will be owned eventually by your non-business son. They can convert his equity ownership into a promissory note, payable over time with interest. The two children who work in the business will thereafter be able to reap all the success (future appreciation in the value of the business) that is attributable to their efforts.
In a similar fashion, the buy-sell agreement should give your non-business son the option of requiring your other two children to purchase his nonvoting stock, payable over time with interest. Because he is not active in the business, it seems reasonable to give him a mechanism by which he can convert his non-voting stock certificate into cash he can spend or invest.
If these steps were followed, your daughter and older son may end up being the equal owners of all the voting stock after you have died.
Should there not be some mechanism to avoid disagreements between them? The answer seems obvious, but many family business owners do not think that far ahead. I suggest you do so.
Manterfield, a partner in the law firm Krieg DeVault LLP, assists family businesses with succession planning. The information in this column is not intended to be legal advice.