Keeping the Family Business Together
Multifamily investors should engage in succession planning early in order to ensure the health of family-owned real estate.
By Allen J. Popowitz, Esq. and Samantha A. Karni, Esq., Brach Eichler LLC
Two young working class men in 1950 decided to pool their income and buy a modest multifamily apartment building as a way to supplement their families’ wages with passive income. Before long, their holdings were several buildings, their factory jobs were in the past and the families were moving up the socioeconomic ladder with each new acquisition. American success story? Yes. Happily ever after for their descendants? Not necessarily.
This was the humble beginning for many successful real estate empires, large and small. The original investors may have been brothers or friends, each with equal consent rights and ownership and each taking on an active role in the day-to-day management of the properties, with the corporate governing documents requiring unanimous consent for all actions. However, two 20-something friends or siblings eventually marry and have children and then grandchildren, and before you know it, the simple organizational chart for the property owning entity could morph into a situation where what began as two or three friends or siblings through inheritance is now owned by fifteen or twenty partners, many of whom are strangers to each other and only a few of which continue to play an active role in the family business. However, the governing documents of the property owning entities were never updated by the first or second generations and continue to require consent from all beneficial owners for all decisions, leading to an enormous logistical headache for those who actively manage the business at every turn. Alternatively, when the original partners become incapacitated or pass away, the families may be forced to liquidate an otherwise healthy business because of a lack of consensus of the descendants on how to manage the real estate portfolio.
Succession planning is a process of identifying and developing internal people with the potential to fill key management positions in a company as they become available and is critical to successfully and efficiently continuing the seamless management of any business, large or small. A small family-run real estate business is no exception. In the real estate industry, succession planning should include (1) a written succession plan incorporated into the governing legal documents of the holding companies and their subsidiaries identifying those representatives of the various branches of the descendants who will be the managing members of the companies and their successors; (2) the reach of authority of such representatives; and (3) the list of “major decisions” which require such representatives to seek the consent of a certain majority of the beneficial owners.
There are a number or ways to provide for adequate succession planning for the family-owned real estate businesses. However, the more removed the businesses become from the first generation of owners, the more difficult it becomes to adequately separate the roles of the various members in the management of the business. Whether management is controlled by one or more individual managers or another family-run entity formed solely for the purpose of serving as manager of the property-owning entities, the families need to make some tough decisions early on as to who will be the designated individuals to run the family business and who their successors will be or what mechanism will be set up to select these successor individuals.
Once succession planning is established, the family also must to decide whether the designated manager(s) should either have unlimited power for all decision rendering the other beneficial owners as economic interest holders only, or be subject to “major decision” consent rights of the other beneficial owners for issues such as purchase of additional properties, sale of properties, financing, bankruptcy and more. The list of “major decisions” can be narrowly or broadly drawn, keeping in mind that as those owners expand in numbers it becomes more and more difficult to collect consent and signatures from multiple owners.
Private, family-owned real estate businesses have the potential to be lucrative, long-term investments, serving as a rewarding career for the day-to-day managing family member(s) and a prolific source of passive income for the uninvolved family members. However, without some prudent succession planning, the family business may not be able to survive the growing family tree. The earlier the families are able to sit down and work out a plan for succession of the management for the business, the healthier the family business will be in the long run.
Allen J. Popowitz is the chair, and Samantha A. Karni is an associate, in the Real Estate Practice Group at the law firm of Brach Eichler LLC in Roseland, N.J.