My company is successful, and I've started taking steps to pass along stock to my children as part of an estate-planning strategy. Should divorce planning be part of my overall strategy, too?
Absolutely. Once you start giving stock to your children, your company is as vulnerable to the problems that might arise from their future divorces as it is to the possibility of your own divorce.
Richard Rampell, a certified public accountant with Palm Beach, Fla., accounting firm Rampell & Rampell, has a story he likes to tell when asked whether it pays for an entrepreneur to take precautions against an adult child's divorce. "There was a successful restaurant founded by two brothers," he recalls, "and they eventually passed on some of the stock to the second generation, especially to one child whose husband was active in the business. Then that daughter's marriage fell apart. And things got ugly."
The former son-in-law wound up with some of the stock. "We were retained by him to do a valuation of his stock," Rampell says, "as well as to look at whether any of the founders were skimming money out of the business that should have gone to him and other shareholders. The founders wound up paying much more than they would have liked to in order to remove that hostile minority shareholder from their business."
The most effective estate-planning strategies almost always involve the transfer of minority stakes. The danger is that such stock could end up in the hands of a combative former in-law or even be sold to outsiders in order to facilitate the payment of a divorce settlement.
The solution is not simply to skip stock-gift strategies and avoid estate planning. Successful privately held companies can be destroyed just as easily by the costs of an unplanned-for estate-tax bill as they can by proceedings within a divorce court. The trick is to plan for both contingencies at the same time.
The easiest way to do that is, again, through a buy-sell document. The issues are exactly the same, no matter whose divorce you're worried about: When must stock be sold back to active owners? How will that stock be valued? How will the stock be paid for?
Michael Brown recommends not only making a buy-sell agreement but also issuing only restricted stock. Restricted shares "say right on them that they can't be sold or passed on to someone other than the original recipient," Brown says. A divorce-court judge would be legally required to respect that.
What if my estate-planning arrangements are more complicated than just giving some outright gifts? Can I coordinate divorce-planning goals with the use of trusts or other methods?
If you and your attorney have set up a legal structure to accomplish estate-planning goals without passing ownership rights to your offspring, you may already have in place protection against second-generation divorce.
Allan J. Landau, a senior partner at the Boston law firm Sherburne, Powers & Needham, notes that "so-called spendthrift trusts work particularly well in this regard. If you put company stock and perhaps even other assets in trust for the lifetime of your child and he or she has no control over those assets--because it's a trustee who makes all decisions about the interest and principal--no one, not a divorcing spouse nor any creditor, can get at the trust's assets."
Landau recommends that you give your children the right to name and remove the trustee. "That gives them some degree of control, while still achieving your objective of minimizing estate taxes and protecting against the risks of a marital breakup," he says.
Is there a way to manage my company's future growth that will make second-generation planning less cumbersome?
Lawyer Jerome Deener, senior partner at Deener, Feingold & Stern, in Hackensack, N.J., recommends the use of limited-liability companies (LLCs), which could make sense if you're diversifying into new business lines or making acquisitions that could just as easily be spun off into separate corporate entities. (It's complicated to switch to the LLC corporate structure with an existing business operation.) If you follow the strategy of setting up an LLC, confine your gifts to LLC shares rather than stock in your existing C or S corporation.
LLCs work nicely because the rights of their owners can be tightly controlled according to a management agreement that restricts stock transfers. You can build all kinds of instructions into the writing of the agreement, such as the requirement that no partner be able to transfer his or her ownership interest to anyone without the consent of all partners. In such cases, a divorce-court judge would be unable to award ownership of the stock to an ex-spouse who was not an original recipient.
It goes without saying that this type of agreement would also require all partners (even if that means just you and your spouse) to vote and agree to pass shares along to children as part of an estate-planning gift. And if your LLC is structured to include multiple owners, among them nonfamily members, you do need to feel fairly certain that they'll go along with your basic program (voting yes on gifts to family members and no on transfers of children's stock to ex-spouses in the event of a divorce). If not, you might be better off skipping the LLC strategy entirely.
One final caveat: don't delude yourself into thinking you can avoid the risks that accompany second-generation divorces simply by restricting your lifetime gifts to assets other than stock. CPA Rampell has another story he likes to tell on this front: "A client of ours owned a retail chain, and when she started doing some estate planning, she decided to keep the company stock to herself but to give the company's real estate assets--the property on which her stores were based--to her kids. When one got divorced, she found herself forced to negotiate with a hostile ex-in-law on one of the stores' leases...and eventually wound up having to relocate that store because those negotiations just got too expensive."
