Is Equal Fair?
From a definitional perspective, the term “equal” is a numerical calculation. Things are equal if they are of the same quantity, size, degree or value. With respect to the division of assets, equal would then simply mean that you take the total value of the assets, and divide it among the group you identify as your beneficiaries (whether that group consists of family members or employees).
However, it’s certainly not that simple in a business. For instance, the value of assets is seldom fixed and determinable. Almost every asset you own will either increase or decrease in value over time. Another thing to consider is that how and when you decide to determine the value of a business can also produce different results. Some assets will be more liquid than others. Some assets will have more tax and carrying costs associated with them. For example, would you rather receive an Individual Retirement Account (IRA) valued at $1,000,000, or an apartment building valued at $1,000,000? You might prefer the real estate due to the fact that, if you were a beneficiary of the IRA, you’d be required to withdraw the IRA over a 10-year period and report the entire amount as taxable income. However, the real estate can be held for years without recognizing any income. Conversely, depending on the location of the real estate, you might prefer to own the IRA because you want the liquidity associated with it.
Many years ago, an elderly client asked if I would act as the executor of his estate when he passed away. The client had three adult sons who did not get along and whom the client did not trust to handle his estate. The client wanted to divide his assets equally among his three sons. Besides a number of other assets, the client owned several residential apartment buildings. While I felt it was a compliment to be asked by my client to act as his executor, at the time, I did not realize what I was getting myself into.
When the client passed away, I discovered the rental properties were in severe disrepair, under-insured and potential fire hazards. As the executor, I was personally liable to secure the assets of the estate. I was incredibly nervous that an accident might occur on the property. Frankly, I suppose this is a perfect example of the old saying, “Be careful what you wish for.”
The three sons knew about the status of the real estate, and none of them wanted the assets transferred to them. Rather, each one wanted the other assets in the estate transferred to them. As a result, I liquidated the rental property (at a discounted value) as quickly as possible due to the potential liability associated with it. This story illustrates quite clearly how difficult it can be to determine asset value when trying to divide assets equally.
To put it bluntly: trying to be fair is a difficult task when you own a closely-held business. Even if you agree that fair does not mean equal, then how can you still be fair? When determining the value of your business and how to distribute it fairly, how do you consider the contributions made by a family member who has worked in the business? I have heard many next-generation family members argue that they helped grow the business. However, in some of those same situations, the senior generation will respond, “so did a bunch of other folks, and you don’t see them getting any ownership.”
The good news is that while trying to be fair may be difficult, there are a number of steps you can follow to help. This chapter will explain these steps so you and other important stakeholders can develop a decision-making process that everyone believes has treated them fairly.
Creating A Fair Decision-Making Process In 5 Steps
When we make decisions on difficult business issues, the goal should be a result that does the following: (i) best serves the needs of the business (ii) aligns with the business’s core principles or values, and (iii) does not harm anyone.
Next, you need to understand that decisions about what is fair can only be made with the available data. Accordingly, don’t think you will ever have everything you need to make the decision. After all, business owners make business decisions every day with the available data. You should not delay the process worrying about what the IRS, Congress or the next pandemic may bring. As the saying goes, “You can’t wait for all the lights to turn green before you start driving.”
Decisions about what is fair should also be made in an environment of honest and open dialogue, and with an attempt to remove bias. It is vital to understand and appreciate the real value of fairness is in the process of decision making, not in the outcome.