Business succession involves values and planning.
The following stories are true, the information taken from court decisions and newspaper reports. They are offered as examples of the unexpected problems that may occur with family businesses.
The unsatisfied daughter
Frederic Upsher-Smith founded a pharmaceutical company in 1919. The company survived the Great Depression and the war years, but it did not prosper. In 1969 the husband of Frederic’s granddaughter purchased the firm for $1,500. At that time, the company had only one employee and two skin care products. The husband, Ken Evenstad, took the company in a new direction, focusing on generic medications. The business boomed. In 1984 Evenstad bought out his only partner for $4 million.
Beginning in 1993 and for the next 20 years, Ken and Grace Evenstad made gifts of stock to their children, Mark and Serene, until each family member held 25% of the company. Mark and Serene had worked for the company as teens. Serene chose not to work for the company after she graduated from Wellesley, while Mark eventually rose through the ranks to running it when he was 31, in 2001.
Mark did such a good job managing Upsher-Smith that in 2014 his parents gave him an additional 1.5% interest pagein the company. This greatly upset Serene, who felt that it was only fair that she and Mark have the same ownership interest. Her father could not understand why she felt that way, given that she contributed nothing to growing the company. The family members became estranged. Serene skipped her parents’ 50th wedding anniversary.
Upsher-Smith was sold to a Japanese firm in 2017 for $1.3 billion. Serene received $283 million as her share, but she was not satisfied, believing that she had been treated as a second-class shareholder. What’s more, she argued that her father and brother had “looted” the company before the sale, reducing its value. The family offered to settle the dispute with her with an additional payment of $150 million, which Serene tentatively accepted. But when she learned that Ken planned to terminate a family trust to fund the payment, Serene took the fight to a whole new level. “I couldn’t believe the betrayal,” she said.
Although Serene has received $328 million in total from the family business over the years, she is seeking an additional $228 million in damages, according to court records. She wrote to her father, shortly before he died in 2020, “You could have ended this at any time if you had been willing to treat me fairly and with respect.”
Ken did not respond to that, but Mark did. “How have you been ‘harmed’ by mom and dad? How have you helped them in their time of need?”
A court resolution of the dispute is expected later this year.
The Biltmore estate
George W. Vanderbilt, the grandson of Cornelius Vanderbilt, acquired thousands of acres of land in North Carolina, where he built a mansion from 1889 to 1895. Named Biltmore, the 178,926-square-foot building is the largest privately owned residence in the United States.
George had one child, a daughter, Cornelia, who married John Cecil. The Cecils opened the Biltmore to the public in 1930 at the request of the City of Ashville, in hopes of promoting tourism during the Great Depression. It closed during World War II. In 1932 the TBC corporation was formed to own and manage the estate.
The Cecils had two sons, George and William. They worked to make the estate profitable as a tourist attraction. After Cornelia died in 1976, the brothers disagreed on the future of TBC. George surrendered all of his shares in TBC in exchange for 3,000 acres of the estate and the dairy operation, which was more profitable at that time.
In 1995, on the 100th anniversary of the opening of the mansion, William turned management responsibilities over to his son, William Jr. According to Wikipedia, the house is assessed at $157.2 million for property taxes, but that is reduced to $79.1 million, thanks to agricultural deferments. TBC has shown a profit every year since 1995, with the exception of 2008 during the Great Recession. Money is earned by selling tickets to tour the house, and from a variety of supporting operations owned by TBC.
William Jr. and his wife, Mimi, had two children, Bill and Dini. Bill became TBC’s president and CEO, and Dini became the Vice Chairman of the Board of Directors. Around 2001 Dini met with a consultant from the Family Business Consulting Group. After reading books on the subject, in 2003 Dini started a Family Preservation Program for TBC, which involved two annual meetings of all her and Bill’s children. During these meetings they would work on policies and educational programs for the benefit of their families, which were intended to help them become more effective owners of TBC, as well as keeping TBC in the family.
The children ranged from 8 to 15 years old at the first meeting. As they grew older, the children attended educational seminars that focused on topics such as financial literacy or family-based money management.
As far as we know, this effort to give the youngest generation a sense of responsibility for the family enterprise has succeeded. We only know about these facts because of a court case, a tax issue. In 2010, William Jr. and Mimi made taxable gifts of all their ownership in TBC. They gave the voting shares to Bill and Dini, and the nonvoting shares to the grandchildren. The couple each reported taxable gifts of over $10 million. Upon audit, the IRS disputed those values, and sought additional taxes. The details on the business management by the family came out in the Tax Court testimony.
William Jr. and Mimi both died before the resolution of the case, which came this year, 13 years after their gifts. It was a complete victory for their estates, and a vindication of their estate planning strategy.
Put us on your team
These two stories may seem unique at first glance, but the issues presented are common to many family businesses. How does the older generation provide for fair treatment of those who participate in the business and those who profit passively from it? How will ownership be passed to the next generation? How will the taxes on those transfers be paid?
Over the years we’ve helped many business owners with their succession planning. Our counsel includes expertise in estate settlement and trust management, as well as sensitivity to a variety of family issues that attend wealth preservation and wealth management. We would be pleased to share this expertise with your family as well.
How to value a family business
For business owners, before estate planning questions and issues of succession can be addressed, an accurate valuation is needed. The higher the business value, the greater the tax exposure, and the more important the estate planning steps.
Business valuation is as much an art as a science. One begins with the set of fundamental factors that the IRS looks at:
- the history of the business;
- the current outlook for the economy and the industry segment;
- book value;
- the company’s earning capacity;
- the company’s capacity to pay dividends;
- goodwill and intangible assets;
- prior sales of company stock;
- sales of comparable companies.
That’s just the starting point. Valuation discounts also may apply to the transfer of interests in a small business. Discounts for lack of marketability and for having a minority interest, for example, have become routine. There may also be a discount for the loss of key employee services. IRS has experts in this area, so it is important for the business owner to rely on experts of his or her own. A business valuation must be completed with great care and without bias for it to be effective in tax litigation. As one planner was heard to comment, when it comes to arranging a professional appraisal of a business, “expensive will be cheap.”
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