More Private Businesses Are Being Run by Minority Stockholders*
There are two appropriate uses for minority stock, but it is not what is described here.
Today my owner sits in his office for the last time. From an idea on the back of a restaurant napkin, 30 years ago, to me today, as a billion-dollar business, I am considered “too big to fail”.
It’s been a few years since he read the article about minority stockholders running more private businesses, like me. Was it the answer to his prayers about ‘stepping down’?
Minority stock is non-voting stock. This means minority stockholders can run the business but can’t vote or participate in decisions. Increasingly, more business founders and owners are not completing the step- down from their business. Holding their voting stock means the owner STILL OWNS THE BUSINESS! At first this may sound like an ideal solution but.
What this arrangement looks like in 5 years…
The owner has enjoyed more freedom and his accustomed income from his business. His three adult children have been running the business and call on the owner for decisions, meetings, or votes. The detail of what to do with his stock had faded away. ‘Should he transfer it to the kids?
Will they stick with the business? Should I seek a new CEO?’ Then, one day his attorney approaches the owner about doing a wealth transfer plan for his business stock.
Ready or not the owner had not addressed his choices, and neither had his family. Thus, the voting stock was sold into an Intentionally Defective Income Trust at the recommendation of his lawyer. The kids were the income beneficiaries and remainder interests. The term of the trust was a typical 10-years. A Trustee was selected for the trust. As you will see, one “simple” decision has profound impact for years to come!
Why Has Control Shifted Here?
While the Trustee worked in the business, this did not equip the Trustee to make key decisions about the business, as the primary asset of the trust.
When the former owner left his business, he held onto his voting stock. When that voting stock was gifted or sold to a trust, the Trustee became responsible for voting the shares of stock. Yet Trustees are trained in more traditional trust investments. Far fewer have in-depth knowledge of businesses or real estate holdings. The former owner could no longer vote because he was no longer the owner. When a trustee votes, and there is no language adopted in the trust agreement to outline the duties for a business asset, the trustee votes on behalf of the beneficial interests in the trust. This is the income beneficiaries and remainder interests, who receive the balance of the trust when it terminates. Voting on the beneficial interests is DIFFERENT from voting on behalf of the business.
This uneasy relationship between owner and the trustee begins. An owner wants to participate in decisions about the business, but he cannot vote. Trustees are very uncertain of when or what to vote on or what outside skills are needed. After a period of 3 years, revenues begin to sag, the business is worth less, or the annual installment payments to the former owner are overlooked.
Ten years later, the former owner is now in his early 70s.
The former owner was driving home one late winter evening. In his rush to get home, he went through an intersection on the change of the traffic light, from yellow to red. Suddenly the driver’s side of the car was hit by an oncoming vehicle that had jumped the traffic light on his side, as it turned green. The former owner was mortally injured and rushed to a local hospital. He passed away a few hours later, with his family by his side.
As to the business
There was no leadership/succession plan in place in the business. A buy-sell agreement was never executed and sat unsigned in drawer of the owner’s desk. The voting stock had been placed in trust and the installment pays had five years to go. The voting stock in the trust was not available to the children who were still running the business on nonvoting stock. Bankers did not see the minority stockholders as legitimate business owners, so lines of credit were called. Revenues began to dry up.
The moral of this story is this, when you decide to step down from your business, make sure there is a finite time for completing the process. Even better, decide sooner not later what you want for your business; a 2-step monetization, a sale to a third party, an M&A event.
Make sure key documents are duly signed and executed and compatible with your will and funded trusts.
IF you understand the need for assistance with this, it becomes clear why business groups need to modify their services and a trust company needs to modernize for the needs of ultra-affluent business families.
