The situation presented here is an illustration based on real life circumstances. It demonstrates the approach Whitnell might use to resolve a complex set of issues related to the transition of a privately owned business. Please note that we have changed the names and details of this client to protect their privacy.

 

The Client Situation

Fred is a 62-year old entrepreneur who is now facing a very difficult situation that puts his net-worth at tremendous risk. Fred is the minority share-holder in a steel manufacturing business that comprises the majority of his net worth. While Fred has a healthy investment portfolio, it pales in comparison to the value of his equity in the company.

The steel manufacturing business is worth more than 50 million dollars and it has provided a very comfortable living for Fred and his family for over two decades. However, the majority share holder in the firm, Steven, recently passed away, very unexpectedly.

Steven was far more than a business partner to Fred. When Fred was just out of college, Steven became his mentor and saw some things in Fred that he didn’t see in himself. Steven believed in Fred and taught him a great deal about business. Steven even offered Fred a minority share when they opened the steel manufacturing business together.

Over the years, Fred and Steven’s families became very close and they watched each other’s children grow up. Truth be told, Fred saw Steven as a father figure as much or even more as he did a business partner. Fred’s loyalty to Steven was immeasurable. Fred felt like he owed Steven a great deal for all that Steven had done for him.

Steven’s unexpected death had a major impact on Fred. Not only did Fred lose a dear friend, he also lost a business partner who had been instrumental in the success of the company. Steven’s intimate knowledge of the industry would be very hard to replace. Even thought Steven was in his 70s, he still worked 40-50 hours per week and handled a lot of responsibility. Fred did not know who would do the work Steven used to do.

But there was another, even bigger problem for Fred. Steven had expected to live much longer and so had not drafted any formal agreements regarding how his equity in the company should be handled. Steven had been married to Jessica for over 40 years and they had a grown son named Thomas who did not work in the business. Thomas was something of a free spirit who never quite grasped the value of hard work.

Even though he never anticipated this, Fred was now in business with Jessica because all of Steven’s equity passed to her upon Steven’s death. What’s more, should something happen to Jessica, Fred would be in business with Thomas – and in a minority decision-making position. This possibility was very unattractive to Fred.

Fred was feeling tremendously torn. The steel manufacturing business was all he had ever known. He wanted to keep the business thriving not only for his own family, but also to maintain Steven’s legacy. Fred felt that he had many good working years ahead of him.

Although Jessica did not want to step into a management position in the business and was not qualified to do so, she did want a living income similar to what Steven used to provide. Fred felt completely obligated to deliver this. If Jessica demanded the equity from her husband’s estate, Fred would be forced to liquidate the business.

Fred had intended to grow the business 10% per year until he was 75 and then seek an exit strategy. When Fred analyzed the impact on the value of his net worth between selling at age 62 and age 75, the difference to him was in the millions of dollars.

Fred and Jessica sat down and had a conversation about these topics. Quickly they discovered that they really didn’t know what to do to ensure everyone’s goals were met. They decided to seek out a professional advisor to help them sort through the issues and create a plan.

 

Key Challenge

Fred was feeling tremendously torn. The steel manufacturing business was all he had ever known. He wanted to keep the business thriving not only for his own family, but also to maintain Steven’s legacy. 

 

Our Analysis & Recommendations

When we first met Fred and Jessica, we listened to their story carefully. After considering their situation, we arrived at a few conclusions. Our analysis suggested that three entities were at risk: Jessica and family, Fred and family and the business.

Jessica and family’s risk:

  • If Fred were to pass away unexpectedly, the business would be left without senior leadership. This would likely mean that Jessica would have to sell the business. Since it would be without leadership, the value of the business, and thus Jessica’s proceeds, would be greatly diminished.
  • If Jessica were to become disabled or of diminished capacity, her son Thomas could legally seek powers of attorney. With these powers, he could choose to exercise decision-rights in the business which Jessica and Fred may not support.

Fred and family’s risk:

  • Fred’s equity in the business was at risk because Jessica could legally demand the business be sold to support her income needs. Since Fred’s net worth is primarily tied to the business, he would lose tremendously.
  • Fred’s equity in the business was at risk because decision-rights were not clearly documented. Since Jessica did not want to work in the business, it would have been within her rights to appoint a new CEO, whether or not Fred agreed with this appointment. If the new CEO made poor decisions and the business lost value, Fred’s equity and net worth would also decline.

The business risks:

  • The business lacked formal, documented agreements about management roles, responsibilities and decision-rights. This put the business at risk due to uncertainties about what would happen under specific circumstances, such as Fred unexpectedly passing away. 
  • Without a clear succession plan for the future, the business’ long-term value was at risk.

After considering these scenarios and the clients’ goals, we developed a plan for moving forward.

 

Our Services For This Client

Our solution to this complex situation had two components: buy / sell agreements and life insurance plans for both Jessica and Fred. Working closely with legal partners and life insurance specialists, we were able to craft a custom plan for their unique situation.

The buy / sell agreement that we helped them negotiate with their legal partners determined what would happen to the equity of the business under specific circumstances. This protected Fred’s equity and his personal net worth. It also protected Jessica’s long-term income requirements.

As part of the buy / sell agreements, we also helped Fred and Jessica formalize the operating model of the business. This process helped determine specific roles and responsibilities and decision-rights under specific circumstances. This not only protected Fred and Jessica’s interests in the business, it also helped develop a succession plan to ensure the business had stable leadership for many years to come.

To ensure both Fred and Jessica’s family income needs were met, we helped select life insurance products that were appropriate to the situation. Working with a life insurance specialist, we were able to acquire insurance products that protected both parties from financial loss.

Fred was the beneficiary of Jessica’s policy and Jessica was the beneficiary of Fred’s policy. If Jessica were to pass away, Fred would have the capital necessary to buy out her equity. This would give Jessica’s family the full value of her estate and simultaneously protect Fred’s interests in the business.

If Fred were to pass away, Jessica would have the capital necessary to buy out his equity. This would give Fred’s family the full value of his estate and would prevent Jessica from having to perform a fire-sale of the business at a time when it would be without strong leadership.

 

The Client’s Results

At the conclusion of our engagement with this client, both Fred and Jessica had much greater peace of mind. Fred was able to go back into the office and focus on his new leadership role, which he enjoyed very much. Jessica was able to carry on her lifestyle without worrying about the need for income.

Steven’s legacy is honored by family, friends and employees of the business. His photo hangs in the lobby. Best of all, the two families remain very close, sharing holidays, birthday parties and wonderful memories.

 

The situation presented here is an illustration based on real life circumstances. It demonstrates the approach Whitnell might use to resolve a complex set of issues related to the transition of a privately owned business. Please note that we have changed the names and details of this client to protect their privacy.

The information contained in this case study is provided for informational purposes only. No illustration or content in it should be construed as a substitute for informed professional tax, legal, and/or financial advice.