Acknowledge The Different Lens Of Fairness
Anytime you involve other important stakeholders in a process to determine what is fair, keep in mind that there will always be some individuals who interpret the situation differently, despite looking at the same situation with the same facts. Don’t view this as something negative, but try to embrace it as part of the process.
Like beauty, fairness is in the eye of the beholder. Depending on who you ask, you may get different answers.
For example, just imagine the wide range of answers you’d get about what would be fair with respect to transferring a closely held business interest if you were to ask each of the following:
a. The business owner
b. The business owner’s spouse
c. The next generation currently working in the business
d. The spouse of the next generation currently working in the business
e. The next generation not currently working in the business
f. The key employee in the business
Although you are likely to get many different answers, none of them are necessarily wrong. It’s important to appreciate that fairness is not solely objective, but can include subjective or qualitative elements that are hard to quantify.
This same issue may arise when you employ your child in the business—or if you have another child who is not in the business. Both children may want to follow a process that differs from each other or everyone else to arrive at a decision. Understand that this is not uncommon. However, it is important for the group, rather than a single person, to arrive at a process. When differences occur (and they will occur), I often suggest business owners go back to their determined values and principles and work from there.
One example I recently encountered dealt with the distribution policy of a very successful construction company. This company was an S corporation, so all of their net income was reported and tax was paid by the shareholder owners instead of the company. As a result, whether the company made a dividend distribution or not, the shareholders still had to report income and personally pay taxes on the income allocated to them.
As you can imagine, this could create potential problems for a shareholder who must pay tax on income they did not receive. As a result, this company agreed on a dividend distribution policy of 40% of the income. In other words, if the company made any income, it was required to distribute a minimum of 40% of its income to the shareholders regardless of the needs of the company.
As a shareholder who is not active in the business, your fairness lens may be set directly on the tax liability you might incur from the income of a business. In other words, you are likely to feel such a policy is fair because no shareholder should have to pay tax on the income they never receive.
However, in this situation, the non-shareholder CFO was concerned that the company ought not to be forced to make such a distribution. The company may encounter a need for liquidity, or a bank may try to restrict distribution due to certain bank covenants. The CFO felt a better process was to avoid forcing a set percentage of cash from the company to be in the form of a dividend. Rather, the CFO felt the decision should be made by the board on an annual basis after taking into consideration all the facts and circumstances the business is facing at that time.