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Keeping The Business In The Family

By Tim Berry, JD - Email Editor

Date : August 13, 2009

In a few previous articles I have been harping that parents should not leave assets outright to their children. Instead the parents should leave the assets to the kids, in the form of a trust, and the kids could have some supervisory role with the trust.

Let’s go the next step.

 

The challenge with this is what if the kids are successful?

Example: Dad has a "tire company" worth $1,000,000. He wants to be able to retire in Fiji and learn bartending, but has put every dime back into the business. To that end he asks little Johnny if Johnny would be willing to purchase the business from Dad for $1,000,000 via an installment note. Johnny seems to believe that he can really make the business roll and agrees to purchase it from Dad via the installment note.

If Johnny gets involved in a lawsuit in the early years, no big deal; the installment note is a prior lien on the business and chances are the judgment creditors are only going to get the "center of the tire, which is nothing."

However, what if Johnny increases the value of the business to $3,000,000 in a fairly rapid time period? NOW what happens to the business? There’s a very good chance the judgment creditor is going to get a piece of it as the installment note will only encumber up to $1,000,000 of the biz, the rest is up for grabs.

Moving on from lawsuits, let's talk about some inevitables, death and possible divorce.

-If Johnny owns the biz outright is it going to be included inside his estate?

-If Johnny gets a divorce, is his future ex-spouse going to have a good shot at getting a portion of the business?

Better solution?

Why not have Dad establish a trust in the very beginning, an Asset Protection Trust. Dad names Johnny as the beneficiary of the trust, and Johnny has the right to remove the trustee if need be. Dad then sells the trust the business via the installment note.

Let’s go back to the prior scenarios. If Johnny helps build up the business owned by the trust to 3,000,000 and gets hit with a lawsuit, what does the judgment creditor get?

- How much of the biz value is included inside his estate?

- How much is his future ex-spouse likely to get?

Probably nothing.

Remember Dad set up a trust and sold the business to the trust. The trust owns the business. If the trust was drafted properly, Johnny could be involved in 93,000 lawsuits, lose them all, and yet the 93,000 judgment creditors probably cannot get a thing.

When the stress lawsuit and divorce causes Johnny's heart to explode in anguish, the business is probably not subject to millions in estate taxes and the conniving new spouse probably won't get anything either. Johnny's estate ended up with, Asset Protection, estate tax savings and keeping the assets in the family, just by being proactive and using a trust!

What is the moral to this story? Parents should not give assets outright to the kids, nor should they sell assets directly to the kids. The better way of doing things is to make sure a trust has ownership of the assets. The kids can still benefit from the assets of the trust, but the kid’s creditors cannot take away the assets from the trust.

By the way, this moral doesn’t just apply for parents either.

How are most buy/sell agreements structured? Let's take a person buying an existing business from a local family. If the Buyer gets sued by someone later down the road, is the business at risk of being taken away?

Yep.

Could you have a trust own a life insurance policy that is going to fund the buy out? Sure you could. (Insurance agents reading this, could this be a door opener for you with small business owners?)

If you did that, who now owns the portion of the business purchased upon the new buyer's demise? The trust, an Asset Protected Trust.

Years ago I heard a phrase that has stuck with me, “Don’t put your trust in money - put your money into a trust.” Trusts are very easy to establish and operate and provide fantastic Asset Protection, so long as you set one up before the rain falls.

A side note: We are entering into a world of have and have-not's.

What i mean by that is; have and have-nots of "knowledge". A full 90 percent of the world is going to be in the "have-not" category and a limited few are going to be the "haves" category of this "specialized knowledge". Now that you have joined the "haves," my question to you is what are you going to do with your new found knowledge!

If you would like to discuss the use of trust for you, your family, or even as a marketing tool for your business, give us a call we would love to talk with you about it. Please contact us at info@trustmakers.com

By Tim Berry, JD
TrustMakers.com

 

 

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