Most of us do not intend to leave our families a financial mess when we are gone.
In fact, many believe they have done all the required work to have their estate settled: They considered what was essential, gave away assets during their lifetime and documented thorough instructions for what to do after they passed.
But after decades as a CPA helping administrators and trustees, I am rarely surprised when an estate is a mess. Even the most conscientious decedent can leave behind confusion, bad tax planning, missing documents, a poorly drafted trust, outdated titles and promises no one wrote down.
However, sometimes clients can make planning decisions that can negatively affect them while they are still alive, and that is far worse. One particular choice a client made, done with the best intentions, created more confusion, cost and heartache than I can recall with any of the estates, and the lessons from that experience are worth sharing.
Gifting stock as a wedding present
Here’s how this mess began.
My clients wanted to help their daughter and her under-employed husband, so they gave them 40% of the stock in one of their operating companies as a wedding gift, outright (not in a trust or an LLC). The parents retained 40% of the stock, and a co-founder owned the remaining 20%.
The parents thought they had bought their son-in-law a job and financial stability for their daughter, but over the next few years, during annual board meetings, they began to notice red flags.
While competitors were growing, their sales went flat. Reported profits hovered exactly at 5% of gross revenue, well below the industry average. Unaudited financial reports were internally generated, and yet no one at the company could explain them. The shareholders of the S-Corp never received distributions. Depreciation reports showed old equipment that was not being replaced.
Hostile takeover by parents
After several years of tense, unproductive board meetings with no improvement, the parents finally decided to take the company back to straighten the ship. However, they could not do it alone because they only owned 40% of the shares.
If you own more than 50% of the stock in a company, you have the control to make management decisions. So, the parents convinced the 20% shareholder to side with them. The parents now controlled 60%, while their kids only had 40%.
Once the parents obtained access to the main office, what we found was shocking.
There were piles of past-due vendor invoices. There was not enough cash to cover payroll that week. The company’s antiquated accounting software, running on an expired license, was installed on a home-use PC, the only computer we found at the location.
Checks were handwritten, there were no vendor filing or inventory control systems, and the bank accounts had not been reconciled for over a year.
It was a mess to end all messes.
That same day, the dad wired a large cash infusion into the business, and I downloaded a basic bookkeeping program onto my own laptop so that we could print checks and start paying vendors. Well into the night, we worked in assembly-line style, finding and reviewing invoices, printing and signing checks, and filing everything.
To this day, it is one of my favorite memories with a client. They were not afraid to do the hard work.
Once the office was stabilized and we understood who needed to be paid and invoiced, the parents began working on personnel.
As is common when you first take over a business, the parents laid off and rehired the employees with new employment contracts. Most of the employees had been there for more than 20 years, with families with multiple generations working there.
They hired a seasoned manager from a much larger company back East, and he moved his entire family, including his elderly mom, who had never been to California. They wooed experienced financial, IT, and sales managers from successful firms, offering competitive pay and benefits. Within about a year, you could hear the hum of a functioning company again. It appeared that this mess had been successfully cleaned up.
How this mess could have been avoided
So, let’s pause and look at how this mess could have been avoided.
In some families, we allow members who own shares to sign checks or help with public relations, but we put professional management in place from day one to protect the business.
What if the board had hired a CPA firm to perform annual audits? Many of these problems could have been caught much earlier. What other steps would you have taken to avoid this mess?
I wish that this were the end of our story and that the company lived happily ever after. Unfortunately, not long after everything was finally stabilized, the father died.
Hostile takeover by the kids
Before the funeral even took place, the kids announced they were reclaiming control of the business. The 20% shareholder, feeling pushed out of the company, changed sides! He agreed to go along with the kids, so the kids now controlled the majority with 60%.
That same week, the daughter sent the general manager home, declared she was now the CEO, and proudly called the corporate attorney and me to announce that she had withdrawn $200,000 in corporate funds for personal use and that there was nothing anyone could do about it.
Mass firings by the daughter followed, primarily driven by her personal dislikes rather than any legitimate cause. Many were too old to find new employment easily, and under the son-in-law, there was no retirement plan. The company fell into chaos.
What happened next was inevitable. Control of the company was litigated. The mother made the wise decision to request a buyout, and I later heard that her children lost the company to the bank that financed the buyout.
How to prevent family business messes
Again, we can look at what could have prevented this mess. In this case, there was no reason to provide the kids with enough stock to outvote the parents. Imagine if the parents had only gifted 20% and retained 60%. They never would have lost control.
Another big mistake I see is giving assets outright to children, especially real estate or interests in a family business.
See a qualified tax attorney and talk with your CPA about how to structure gifts using trusts and LLCs so you minimize tax, transfer wealth appropriately, and still maintain control. Proper planning can also protect those gifts from creditors, lawsuits or a disgruntled spouse.
In one case, the mom gave away shares in a Family Member LLC until she retained only 5% of the stock, but the LLC agreement gave her shares the only voting rights.
Had my clients done this, the entire mess would have been avoided. The general manager would never have uprooted his family to move across the country for a job that evaporated. Dozens of long-term employees would not have lost their livelihoods. And the company, once stable and humming, would still be thriving under the same ownership today.
I sometimes wonder if, a few years later, my client and their kids sat down together at Thanksgiving and patched things up. Perhaps with a bit of planning, they could have protected the business and their family relationships.
Michelle C. Herting is a CPA, accredited in business valuations, and an accredited estate planner specializing in succession planning and estate, gift, and trust taxes.