Planning Ahead
There are a number of advantages to early estate planning.
Estate planning isn't just for your heirs. It can save your company
Jack Bares has always been an unusual kind of guy. When his wife, Alice, decided to return to work after their kids were grown, Bares helped her start her own specialty hand-tool company down the street in Chagrin Falls, Ohio, rather than simply bring her into Milbar Corp., his hand-tool manufacturing company. Years later he set his daughter up as another potential rival in New York State.
Bares, now in his sixties, is unusual for another reason as well. This Cleveland-born entrepreneur has been practicing the fine art of estate planning for the past 29 years, nearly as long as his company has been in operation. "It's not so much that I'm worried about my business continuing long after I'm gone," he emphasizes, "but I never wanted to see Milbar just dumped on my wife's lap or left to my kids in a way that would lead to battles between them."
Estate planning is actually just another aspect of the kind of long-term, strategic thinking that helped Bares build his business. But not enough company founders and owners see it that way. After all, estate planning is distracting, taking valuable time away from the day-to-day responsibilities of growing one's business. It's also difficult, forcing owners to hunt down reliable executors and trustees, choose among possible heirs, and at least contemplate giving up some control of the business. Depressing food for thought.
Still, the advantages of savvy estate planning outweigh those disincentives. That's because estate taxes -- currently pegged at up to 55% of a business's appraised value at its owner's death -- are nothing short of murderous. After all, how many businesses valued at $10 million would have enough cash flow to cover a $5.5-million tax bill from Uncle Sam, even if the heirs could spread payments (plus all the accruing interest charges) out over 10 years? (That extension, known as a Section 6166, applies only to estates in which the closely held business is worth more than 35% of the gross estate.)
Most financial advisers recommend that company owners set up full-fledged estate plans -- including wills, executors, tax-avoidance schemes, management-succession strategies, insurance policies, trust funds, and more -- regardless of the other constraints on their time. The risks of going without are simply too great.
Jack Bares didn't have the time or interest to work out that kind of bulky estate plan. Instead, he worked out a more practical approach that geared his planning to three stages in the life cycle of his growing business and family. He may have missed some opportunities along the way. But overall, Bares's plan is a useful blueprint.
For Bares, estate planning began the day his first child was born, in 1960. He wrote a will, leaving the fledgling business and his other assets to his wife. Then he signed up for plenty of life insurance.
Meanwhile, he decided to try out an idea he had heard on a cassette tape loaned by a friend: the family partnership. Bares's scheme combined a standard family partnership with a sale-lease-back strategy, an arrangement still possible under today's tax laws. He placed the few assets Milbar owned within the partnership; then the corporation leased those assets back from the partnership. "We wound up with the corporation basically owning its working capital and the family partnership owning everything else," says Bares.
The family partnership was structured with estate planning in mind. Jack and Alice began as equal partners with the children; they have since reduced their stake to a scant 0.5% each, while their daughter and three sons split the remaining shares. Year in and year out, the Bareses made tax-free contributions in each child's name to the partnership -- starting out at the Internal Revenue Service's then-limit of $6,000 (per couple and child), eventually reaching the current $20,000 cap. Meanwhile, thanks to the regular addition of leasing fees, Bares was able to pass on more revenues to his children than would have been poss-ible had he stuck to the tax-free gift limits. And because the revenue was in the form of leasing fees, he didn't have to pay gift taxes.
Bares and his wife were the general partners. They controlled the use of the partnership's growing funds, spending the money on machinery, trucks, and finally, a combined factory-office building that Milbar leased for use at fair-market value. This was a safer strategy than simply giving money to the kids, who might have used it for fancy trips or cars. And thanks to tax reform, there's another advantage to Bares's family partnership/leasing strategy: income earned by the partnership, mainly in the form of leasing fees, is taxed at low personal rather than corporate tax rates, since it is treated by the IRS as income to each individual partner.
Bares's instincts were right on target: he had set up a preliminary estate plan that was flexible enough to adjust to the changing needs of a growing business, without a lot of unnecessary paperwork and administrative costs. (The family partnership/leasing scheme would work just as well for families that share ownership in their businesses, whether with venture capitalists, employees, or other partners. All that's required is agreement about which assets need to be owned by the corporation and which can be leased just as easily from the partnership or another third party.)
It took Bares longer than it should have, perhaps, to slip into stage two. It happened long after his company had passed from start-up to success, right around the time that his first child went off to college. By then, Bares had about 70 employees and a business that he knew had the potential, at least, to survive its founder.
Ideally, an estate plan at this stage of a business's development should focus on 1) reducing future estate taxes; 2) planning for future ownership of the company; and 3) contingency arrangements for management succession. Bares ignored the succession issue -- in hindsight a risky omission, since no one in his family was interested then in running the business.
