(Illustration by Jean FranÇois Martin.)

During their weeklong divorce trial in March, Witte’s husband laid claim to income she was receiving from stock she owned in the family business. “He claimed in court that my parents had intended for him to have shares,” says Witte’s brother, Kevin Grace, CEO and principal of SEI MetalTek. Because John Grace, the family patriarch who founded the company in 1966, is alive and could testify otherwise, the claim seemed easily disproved. However, as many who have lost family holdings to outsiders have painfully learned, stated intentions are not always enough to prevail in a case such as this.

Fortunately, the Grace family had also taken legal steps to ensure that MetalTek stock stayed exclusively in family hands. In 1998, when John and his late wife, Diane, transferred ownership of the company to their three children, they created a shareholder agreement that stipulated who could own stock, how it could be transferred and what would happen to that stock in the event of a shareholder’s death. All family members and their spouses signed the document. The spouses further attested that the family stock was separate property, not joint marital property, in case of divorce.

TOP VIEW  Families that wish to keep their businesses in the hands of immediate family members must undertake careful and thorough stock succession planning. Legal mechanisms can protect family shareholders from losing their positions to divorce or lawsuits; others can prevent estranged family members from gifting and selling stock, thereby diluting the family’s control. While building these legal bulwarks can strain family ties, they are often the only way to maintain a hard-won legacy.

Owners of a family business can, like the Graces, keep stock shares strictly within the immediate family by creating legal stock ownership succession plans. These plans include not only shareholder agreements, but also buy-sell agreements, voting trusts and prenuptial agreements, all of which govern who can and cannot own stock in family companies. While erecting these legal barricades around marriages and other interpersonal relationships can sometimes strain family ties, creating and implementing them, however emotionally difficult, are essential to effective estate planning.

Divisive Dilution
Divorce represents a formidable threat to ownership continuity, but it is hardly the only one. Sometimes, particularly within large companies, family members who experience cash flow challenges or wish to support a charity may sell or give away stock to other people or entities. The greater the number of family owners, the harder it is to prevent these transaction. Such was the case with Benjamin Moore & Co., a paint manufacturer founded more than 100 years ago in New York. At the time of its sale to Warren Buffet’s Berkshire Hathaway in 2000, the founding family owned less than 60 percent of company stock, largely because there were no restrictions on who could own it. According to Jack Moore, a fourth-generation owner, the company had used stock as executive compensation, and some family members had begun to contribute it to favorite charities. Control of stock became so loose that three years before the sale, some family members actually began selling their shares over the counter.

“We didn’t have any stock sale policy that I know of,” says Moore, who is retired from EDS and founded the family business initiative for the National Association of Corporate Directors, a corporate governance organization in Washington, D.C. “We were discouraged from dispersion of stock outside the family, but it was up to the individuals as to how they disposed of shares.” He believes that there were more than 1,800 shareholders at the time of the sale.

While those who study family businesses concede that ex-spouses or other outsiders rarely hold a substantial portion of equity against the family’s will, they point out that it is not uncommon for an outsider to acquire just enough voting stock to complicate family business decisions. Furthermore, a nonfamily shareholder who is forced to sell his stake could cause expensive problems by fighting the method the company uses to value his stake in the company as part of a settlement offer.