(NOTE: For the purposes of these Case Histories, all names have been changed,
and some facts have been altered, to preserve our clients’ confidentiality.)
In our years of working with family businesses, we’ve helped families with virtually every possible issue and problem they can face. Here are just a few examples.
Structuring for Growth
The Turn-Around
The Strategy of Alliances
The Golden Opportunity
Working for Free may be Good Estate Planning
Structuring for Growth
We had recently helped Bob Smith sell his light manufacturing business. Bob and his wife Ellen wanted to start a new real estate business owning and managing upscale apartment buildings in the greater Los Angeles area. Their goals were to build an appreciating real estate portfolio, and to bring their son and one of their two daughters into the business. Their other daughter has her own career, but they did not want her to feel “left out” of the family business. Also, it was critical that Bob and his other assets be insulated from any liabilities arising from this new real estate venture.
We created a multi-level structure of limited liability companies (“LLCs”) for this new venture, with a Master LLC formed to hold a series of Second-Tier LLCs, each formed to acquire a particular apartment building. We designed this structure to (a) insulate the operations and value of each building from the liabilities of the others, (b) allow operating losses from any building to be passed up as an offset to the Master LLC’s income from the others, (c) allow the family to borrow for each project without cross-collateralizing separate buildings, and (d) allow them to bring in outside investors for particular acquisitions by Second-Tier LLCs.
Bob and Ellen retained a majority percentage interest in the Master LLC and control over all major decisions. Their son and daughter who are active in the business each received a 20% interest in the Master LLC, subject to a 5-year vesting schedule, to incentivize them. The daughter not active in the business received a 5% interest in the Master LLC. The net effect for the Smith family is a multi-level structure which (a) insulates assets from liabilities, (b) allows flexible financing and tax planning, (c) gives the next generation present equity stakes, and (d) leaves Bob and Ellen free to create an estate plan for their other assets.
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The Turn-Around
Marshall and Deborah Goldman, brother and sister, had recently inherited a company which distributed aluminum extrusions to aeronautics manufacturers. The company was run by an independent CEO, recruited by their father. He had built up a very large inventory of materials on the theory that this would impress customers with the company’s ability to fill orders quickly.
When the Goldmans came to us, their business was on the brink of bankruptcy. Our review of their financial statements revealed that their inventory carrying costs were strangling what should have been a successful business. And, on further investigation, their CPAs discovered that the CEO had engaged in financial improprieties. Terminating the CEO, however, was no easy task, since (a) he’d received 5% of the company’s stock when he was recruited, and (b) he was the company’s “face” to lenders, landlords and its main supplier.
We devised a successful strategy to (a) meet secretly with the company’s key business partners to discuss the company’s “new direction”, and (b) terminate and buy out the CEO. We then worked with the Goldmans and their CPAs to (a) refinance their inventory and A/R loans, (b) reduce the inventory by selling excess and slow-moving items at discounts, and (c) terminate leases for unnecessary storage facilities. The result: A return to profitability and, later, a very successful sale of the business. Three years after that sale, we helped the family purchase a similar business out of bankruptcy and they used the lessons learned to turn this into another profitable operation.
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The Strategy of Alliances
Todd and Charlie Samuels had developed several popular children’s educational software programs. Now, they were becoming victims of their own success. Though they outsourced the manufacture of discs carrying their programs, they handled marketing and distribution internally. At first, this had been manageable within their small family business. Now, demand for their programs had grown to the point that managing these activities was a burden on their time, energy and capital.
We had set up their limited liability company and handled a variety of matters for them. When Todd and Charlie expressed their concern about managing the business’ growth, we explored various alternatives with them. This led to our helping them enter into a strategic relationship with a large software company who would market and distribute these programs as a complement to its own product lines. We also helped them establish a licensing relationship allowing another company to use several characters from the programs on a line of children’s clothing.
These steps greatly reduced the time and capital needed for their business, while creating a new revenue stream with minimal resources from Todd and Charlie. Most importantly, it allowed Todd and Charlie to turn their energy back to what had made them successful in the first place—designing new programs for the children’s educational market.
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The Golden Opportunity
One of our clients was the CEO and owner of a small manufacturer and distributor of industrial fasteners. When his manufacturing business lost market share to foreign competitors, he was approached by a manufacturer from mainland China to serve as their sole distributor in North America. Fortunately, he mentioned this prospect to one of our partners at a casual luncheon meeting. We suggested that this was a perfect time to make gifts of equity to his children, each of whom worked in the business. The Company's declining manufacturing profits over the past few years had severely depressed its value, and the potential distribution agreement with the Chinese manufacturer had not yet been put in place to increase the Company's value. If he made the gift transfers before consummation of the Chinese deal, they would be at the depressed value.
Our client wanted to have his children participate in the company's future growth, and he knew that he could restore his company's value by selling off its manufacturing equipment and becoming a full-time distributor for foreign concerns. We advised him to immediately (a) get an appraisal of the value of the company to "lock in" evidence of its depressed value, (b) create irrevocable trusts for each of his children, and (c) transfer gifts of stock to the trusts, each of which would have an independent trustee, our client’s brother.
The result? The value of the company stock transferred to the children’s trusts was well below the gift tax exemptions of the client and his wife. When the company was sold five years later for nearly four times its appraised value at the time of the gifts, the client effectively had transferred millions to his children, gift and estate tax-free. Further, because those millions were contained in irrevocable trusts for each child, this wealth was preserved as each child’s separate property, thus having some protection from the child’s creditors and one soon-to-be-ex-spouse.
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Working for Free May Be Good Estate Planning
A client who had successfully transferred a majority ownership in his family business to his children came to us with this dilemma: he’d taken every opportunity to move money and assets to his children and grandchildren, but seemed to be out of tax-favored options to continue his generous ways. When we asked what compensation he was receiving as Chairman of the family business, we learned that he was still the highest paid employee, even though his children's trusts owned over 70% of the company's stock.
We advised him to take less compensation (keeping his health benefits and certain other perks), so that greater profits (or increased compensation) would flow to his children. To date, the IRS has not deemed free services to be a taxable gift. This action increased the value of the stock in his children’s trusts significantly (since value could be derived from a multiple of earnings) without any gift tax. And our client’s children enjoyed the benefit of having their father continue in the management and operations of the business.
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