This article originally appeared in CWB Wealth's Growth Together publication.
A leader’s lasting value is measured by succession. – John C. Maxwell, American author
While a family business can be a successful enterprise that creates employment opportunities and generates wealth for multiple generations, not every family member will want to be actively involved. Differing strengths and interests may lead some family members to find their way outside of the family business. This can make succession and estate planning a challenge for business owners when trying to sort out how to fairly bequeath their assets to children who pursue their own interests. Since the value of the family business is usually the most significant family asset, it can be especially difficult to navigate this and prevent estate litigation once the business owner is gone.
There are several strategies available to plan for the inheritances of children who are not involved in the family business, so that the assets are distributed fairly.
To illustrate these, let’s meet the Robinsons. Scott and Lynne Robinson own an incorporated cattle ranch in southern Manitoba. As part of their ongoing discussions with their advisors, they expressed their wish to ensure their succession plan was fair to both of their children. Their daughter, Karen, has loved cattle ranching since she was a child. Since getting an agriculture degree from the University of Manitoba, she’s worked on the family farm full-time. Their son, Russ, is a paramedic in Winnipeg and enjoys working and living in the city.
Scott and Lynne’s assets include1:
- Cattle farm corporation $7M
- Investment portfolio $3M
- Real estate including family home $2M
At a recent meeting with their advisors, they discussed the following succession and estate planning strategies for their family.
Draft a transparent succession plan
In the Robinson’s case, it’s clear that Karen is the only child interested in carrying on the family business. While this situation may be obvious to the family, a written business succession plan including Scott, Lynne, and Karen’s visions for the future of the family farm should be documented to ensure all three parties are aligned. If they aren’t, changes can be made now to align their collective vision for the future. This business succession plan will also be shared with Russ to allow him the opportunity to confirm he if he wants to join the family business or continue in his chosen career.
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Value the family assets
To assist with the Robinson’s planning and remove any potential biases, the family obtains independent valuations of the cattle farming corporation and real estate. With these verified values, they can proceed with their business succession and estate plan.
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Scott and Lynne own 100% of the cattle farming corporation’s common shares (currently valued at $7M). To transfer the future growth of this corporation to incentivize Karen, the Robinsons transfer their common shares to the corporation in return for fixed value preferred shares with the same value. At the same time, the corporation issues new common shares to Karen (or a trust that Karen is a beneficiary of). While Scott and Lynne can continue to control the family farm corporation with the votes attached to their new preferred shares, they can either hold these shares indefinitely or gradually redeem them to fund their retirement.
The Robinsons may also want to consider funding a separate permanent insurance policy to pay for their projected estate taxes on the preferred shares and other assets, to maximize the residual value2 of their estate for their children.
Allocate business value
By issuing Karen new common shares in the family farm corporation, she will eventually control a business worth $7M. However, the future value of this asset will depend on a number of internal and external factors, such as Karen’s management ability and the market price/demand for beef, so there is some future risk for Karen.
Since the $2M real estate consists of rural farm properties and the family home on the farm, the Robinsons will transfer these assets to Karen in their will. This means Karen will receive $9M of Scott and Lynne’s assets when they’re gone.
Equalize the non-active child
To ensure Russ receives his fair share of the family’s assets, the Robinsons will transfer their investment portfolio to him. Since Karen is scheduled to receive $9M and Russ will receive their $3M investment portfolio, how will the Robinsons make up the $6M difference?
The Robinsons' insurance advisor has told them about the benefits of a joint last-to-die universal life insurance policy that can pay out $6M to Russ when they pass. Given their current ages, health, and number of years of growth available in a tax-exempt insurance policy, the Robinsons can fund their $6M insurance policy for cents on the dollar.
By following strategies like these, Canadian families can help ensure an equitable transfer of their businesses to the next generation, and minimize the potential for personal and legal conflicts between their children. Your financial advisor can help you work through the details of your unique situation and review all options available. Then, if needed, facilitate a conversation with your family to bring everyone’s voices to the table.
1 For illustrative purposes, we have simplified this list. Typically, our clients may own additional assets, such as bank accounts, art, jewelry, cars, vacation homes, etc. The cattle farm corporation and real estate are likely the most complex assets owned by the Robinsons, given the tax and legal issues involved.
2 In this case, residual value means the market value of all assets owned by the Robinsons upon death, minus the personal taxes triggered on these assets when they’re transferred to their estate, and any additional estate costs such as lawyer and accountant fees. The residual value is the amount left over to pass onto their children.
Sources: CWB Wealth
This article is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon as advice. Please contact your lawyer, accountant or other advisor for relevant advice. CWB Group takes reasonable steps to provide up-to-date, accurate and reliable information but is not responsible for any errors or omissions contained herein. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by CWB Group or any other person as to its accuracy, completeness or correctness. Visit cwbwealth.com for additional information.