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Recapitalizing Your Business to Maintain Control

Author: Ronald E. Lyons Date: 11/29/2011

Categories: Corporate and Business Law, Estate Planning and Administration

A major challenge for closely held family businesses is how to transfer ownership to the next generation without losing control. For some closely held family businesses, the owner will take whatever steps are necessary to maintain control over his business even if it means a viable succession plan is not put into place. Relatively few owners are willing to voluntarily cede control to the next generation. This is particularly true where the current owner is also the founder of the business.

One concept that is often embraced by even the owner of the family business involves recapitalizing the business into voting and non-voting ownership interests. This planning concept is available for corporations and limited liability companies, as well as partnerships. Contrary to popular belief, even S corporations are permitted to have voting and non-voting stock without violating the rule precluding S corporations from having two classes of stock.

To implement this planning concept, a sole owner seeking to initiate a succession plan could, for example, recapitalize the corporation into voting and non-voting shares. The voting shares would be allocated with a minority of the corporation’s value while the non-voting shares would be allocated with the remaining balance that equates to the majority of the value. The original owner retains all of the voting shares but is now free to gift or sell the non-voting shares to adult children as a means of implementing a succession plan and/or reducing estate taxes.

With the use of a certified valuation analyst, the gifted shares may be subject to a valuation discount since the owners of those shares lack voting and management rights. The original owner still retains the ability to exert the final element of control by directing the disposition of his voting shares via his testamentary will or trust. Other options include the ability to leave voting stock to children that are active in the business while leaving non-voting stock to other children that have little, if any, involvement in the business. While this may present a practical solution to the ownership, the family dynamic may be strained since the non-voting owners will likely desire cash distributions while the holders of the voting stock will be more likely to reinvest capital to grow the business. A key to resolving this type of problem lies in creating a comprehensive shareholders’ agreement that facilitates a buyout of the shareholders with non-voting stock at a fair price but with a deferred payout to help assure that the business in not unduly burdened over the short term.

For more information on this topic, please contact Ronald E. Lyons at (240) 778-2306 or rlyons@mcmillanmetro.com.