The Saslow succession plan took shape in 1989, the stock transfer occurred gradually between 1998 and 2002, and today it is complete. Ron is now Hu-Friedy’s president and CEO, and he is at work on his own business continuation plan, using the same type of trust structure to shepherd the business from his generation to the next. It is too early to tell whether his children, nieces or nephews will have an interest in taking control of Hu-Friedy—they are all still under the age of 10—but if something should happen to Ron or his siblings in the interim, the company will be handed down in trust, divided equally among the families of the three heirs. Ron’s voting shares will remain in trust, and, if he is unable to, a four- to five-member advisory board will make business decisions for the company until a successor comes of age.

Traditionally, family succession planning strategies have relied on wills, which convey assets at death, or buy-sell agreements, which specify how co-owners will sell business interests upon upheavals such as retirement, disability or death. While these tools attempt to smooth out the transition from one generation of leaders to another, they can leave successors floundering if this change happens abruptly, or if events force it upon a family. These unwelcome adjustments can trip up even the most venerable family firm. Without a nimble plan to hand over control of the helm, investor confidence, employee retention and, ultimately, the health of the business can quickly erode.

Families are increasingly turning to trusts to transfer ownership to limit much of this uncertainty, because trusts set specific instructions for managing, governing, even liquidating the business during, and sometimes beyond, the business transition. This approach is on the verge of becoming so popular that some family business advisors are now even labeling the concept “business continuation trust planning.” Despite the trendy moniker, this idea actually encompasses many of the same types of trusts that are already widely used in estate planning, including generation-skipping trusts, irrevocable life insurance trusts, grantor-retained annuity trusts and intentionally defective income trusts. Families can combine these tools to shield their businesses from uncertainty and help smooth the transition of ownership in the event of the founder’s untimely retirement, disability or death.

TOP VIEW Business continuation trusts can smooth thorny succession issues. They are typically constructed using estate planning tools such as grantor-retained annuity trusts, irrevocable life insurance trusts and intentionally defective income trusts, while voting trusts transfer legal title of shares to trustees granted corporate voting rights.

Indeed, a well-honed continuity trust plan can provide the founders of a family business with an integral device for choosing the next cadre of caretakers to carry the firm—and the family legacy—forward. While good parents may attempt to treat all children equally, savvy business owners must single out the best leaders. When a business is held in trust, such as a voting trust, founders can equitably divide shares among family members while keeping some of them locked out of important business decisions, as the Saslows did. This is particularly useful when children have little or no interest in, or aptitude for, taking charge. Trusts are also protective, shielding the business from future creditors, including current and future in-laws. Moreover, certain trusts, such as irrevocable life insurance trusts and intentionally defective income trusts, can be used to freeze or remove the value of the business from an estate, reducing—if not completely avoiding—estate and gift taxes when passing the business from one generation to the next.

“So many succession plans focus on leadership succession rather than ownership succession,” says Jennifer Pendergast, a senior associate with the Family Business Consulting Group in Atlanta and advisor to Saslow’s business. “If you do not have the right leaders, you can bring them in from the outside. If you don’t have the right owners, that’s tougher. Trusts can help families become good owners.”

CREATIVE LIQUIDITY
Along with resolving questions of ownership, voting trusts can be used as building blocks to transfer the legal title and voting rights to trustees for a set duration. While beneficiaries may own the trust’s business assets, trustees vote the stock and have decision-making control. Voting trusts simply transfer legal title of shares to the trustee or trustees granted corporate voting rights, and the trust can be appended onto other types of trust vehicles, such as generation skipping trusts, for estate planning purposes. These trusts also centralize votes regarding shares, says Holly Isdale, managing director and head of strategic wealth services at Lehman Brothers in New York. “Instead of having lots of disparate family members voting,” she says, “a representative from each part of the family can have a vote.” 

A lack of liquidity can lead to disaster when family members must exit a business. To solve this problem, many advisors recommend irrevocable life insurance trusts, or ILITs, which simultaneously provide substantial estate tax savings. Life insurance is often a crucial source of funding when a business does not generate enough liquidity to buy inherited stock from heirs after the death of a partner. ILIT grantors can also keep the death-benefit proceeds out of their estates (if an existing policy is transferred to a trust, grantors get the same benefit only after a period of three years), thereby avoiding any estate tax consequences. The ILIT becomes the beneficiary of the proceeds, and the terms of the trust specify that the money will be swapped out of the trust in exchange for stock. Keeping the proceeds in trust also keeps it out of the hands of company creditors.

Another tool, the intentionally defective income trust, or IDIT, is used to gift a business while also dramatically reducing estate and gift tax consequences. In this complex strategy, the grantor sells a portion of the family business stock to a trust at fair market value, meaning the owner takes a reasonable valuation discount for lack of marketability or minority interest in exchange for a promissory note for the purchase price that will last for a set duration, say 10 years. By exchanging the promissory note for the business assets, the grantor effectively freezes the value of the assets (at the discounted rate) at the time of the transfer.

The defective aspect of the trust simply means that it is not effective for income tax purposes. In other words, the trust is not required to pay them. The trust pays the grantor income distributions based on the promissory note, and the grantor pays tax on the distributions at ordinary income tax rates. In 10 years, if the value of the business has increased, the trust pays back the promissory note and distributes the rest to beneficiaries. The grantor has effectively shifted the growth of the business out of the estate and into his successor’s hands. Even if the grantor dies during the 10-year period, only the value of the promissory note remains in the estate. If the grantor prefers to keep control of the business, he can sell only nonvoting or minority shares to the trust.