It’s Time for a Fire Drill. Sydney Commercial Plumbing Chapter 2
by John McAlister
Welcome back! This is the second chapter in our four-part series about Nancy Sydney, the president of Sydney Commercial Plumbing, and the coup she faced from their inactive shareholders. Frustrated with lack of dividends and perceived favoritism towards working family members, some of the inactive family members were being courted by George, an analyst at a national P.E. firm who saw an opportunity to make a name (a promotion and a small fortune) for himself with this deal.
Chapter Two:
Nancy’s attorney answered his phone. He listened as Nancy shared her concerns about George and the inactives. This was clearly beyond his expertise, but he knew precisely who to call. This was a job for the Beringer Group. TBG had helped several of his clients develop and implement succession plans for their family enterprises, and he was confident they could help Nancy. They made the call together, and a meeting was set for early the following week.
Our first meeting with Nancy was a long one. Family business negotiations are often complex and filled with a mixture of business and emotion. Clearly, this would be no exception. She was confident but anxious, frustrated but hopeful… but above all, she was determined to find a solution that would hold together her family and her business.
The Beringer Group has a proven, battle-tested process to help our clients identify and address their ownership and succession-related concerns.
During the Introductory Meeting, we get to know you and your concerns and what makes your family enterprise unique. Nancy talked about Sydney Commercial Plumbing and its history. “My Grandfather started this business almost 60 years ago and survived many challenging times,” she said. “I’ve worked here since I was 14 and I’ll be damned if it’s going to fall apart on my watch!”
In the Goal Analysis stage, we dug deep into Nancy’s objectives for this engagement. She made it clear that we needed a solution that satisfied the inactive shareholders and quell discussion of selling to George’s P.E. firm without hindering Sydney’s ability to operate and grow. She also cautioned me several times, “I am in charge of this business, but it is also my family’s. We need to resolve this, and we need to do so with love and respect.”
In the Document Review stage, we reviewed and abstracted every document and agreement related to Sydney Commercial Plumbing’s organization and its shareholders so we could map out how assets currently flow and how control is structured. We discovered some very eye-opening details at this stage - which is often the case when the “Fire Drill” is run:
Some documents were woefully out of date. For starters, Nancy’s will had been drafted ten years ago. As you can imagine, lots of things have changed in her life, especially her net worth. There was a prenuptial agreement in place, but some assets and control would not flow the way Nancy had intended.
There was a massive estate tax problem looming on the horizon. If Nancy passed away, her shares would pass to her children via a Trust, along with a huge estate tax! The life insurance policy she had purchased years ago would cover only about half of the current liability. Sydney Commercial Plumbing had doubled in size, but her insurance policy had remained stagnant. Her children could not possibly afford to pay the estate tax and might be forced to sell out. There was also some confusion as to where Voting Control would wind up.
Sydney Commercial Plumbing only issued one class of stock, so non-active shareholders had just as much of a vote as active shareholders. While this may seem fair at first blush, the working shareholders are investing both their talent AND their time, and they need to have full decision-making control over the direction of the company.
Nearly 40 years ago, Nancy’s father had the foresight to purchase about 50 acres of land that surrounds their facility for possible expansion because the current owner was in need of cash for an acquisition and he knew her dad could close quickly. The property has appreciated considerably and is now worth over $20 million. Unfortunately, he purchased it directly through Sydney Commercial Plumbing’s C-Corp., so it is trapped on the balance sheet at its original cost plus physical improvements. Whenever the property is sold, the gains will be treated as ordinary income and taxed at the highest corporate tax rate!
Finally, some family members felt that a high-paying position at the company was their birthright. Five 3rd and 4th -generation family members were currently in college, and only one of them was studying business. None of them were concerned about finding a job. They simply expected that Nancy would find a spot for them, creating one if it didn’t exist, regardless of their grades or skills.
We were brought in to find a solution for the inactive shareholders, but by following our process and reviewing all of their agreements, we had discovered potentially catastrophic problems that also needed to be immediately addressed. Now it was time to start working on solutions to fix them…
…. To be continued …
How much has changed in your life and your family’s lives since your documents were drafted?
Generally, Nancy’s problems were side effects of Sydney Commercial Plumbing’s long-term success and growth. Oftentimes, our clients are so busy growing their business that they don’t review their wills, life insurance, trust and buy-sell agreements, their corporate structure, etc. until after someone dies or a conflict arises, but there is a much better approach. Schools and offices are required to run periodic fire drills to test their systems. The fire department then issues a report that identifies the flaws that need to be fixed before an actual emergency. Your business and personal documents deserve the same level of scrutiny.
If your documents haven’t been reviewed and updated in the last 3-5 years, it’s time for the Beringer Group to run a fire drill on them and find their weaknesses before an actual emergency occurs.
About the Author
John R. McAlister
After working with CIGNA Financial Advisors, John co-founded an advisory firm in 2000, focussing on complex family transitions. He sold his practice in 2012 to become part of TBG. He is a graduate of the University of Georgia.