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Overview
Scope of the chapter. A closely held operating business is the asset a family trust is least suited to hold and the one it is most often asked to hold. The business usually has no market, pays its owners irregularly, depends on a few people and carries risks that no amount of diversification inside the business can remove. It is also, very often, the source of the family's wealth and the thing the founder most wants to survive. This chapter examines how a trust can own such a business through a change of generations. It covers the objectives that a succession plan has to reconcile; the duties of a trustee who holds an operating business, including the duty to diversify and its waiver, the duty of loyalty when the trustee also serves the company and the decision in Matter of Hyde; the devices that separate control of the business from its economic value, including voting trusts and voting and nonvoting stock; the three ways a trust may hold stock of an S corporation; buy-sell agreements, the valuation rule of section 2703 and the decision of the Supreme Court in Connelly v. United States; the estate tax deferral and redemption rules that supply liquidity at the founder's death; lifetime transfers of the business into trust; provisions for management continuity, family disputes and exits, including sales to employees; and drafting.
Relation to other chapters. Several chapters treat parts of the subject in more general form. Chapter 30 examines entities owned by trusts, including the trustee's duties at the level of the trust and the level of the entity and the clauses that relieve a trustee of the duty to supervise an underlying company. Chapter 31 examines concentrated positions, retention clauses, Delaware's provisions for retained and specially held assets, including the excluded cotrustee of section 3313A, and the Virgin Islands Special Trusts Act. Chapters 6 through 10 examine directed trusts, which are the usual device for placing decisions about the business in family hands while a professional trustee holds title. Chapter 29 examines family governance and the family office. Chapter 23 examines the generation-skipping transfer tax, and chapter 40 examines grantor trusts and sales to them. This chapter draws on each and repeats none of them; its subject is the operating business and the particular problems its succession creates.
Why the problem is hard. Three features of a family business make its succession through trust difficult. The first is that the value of the business and the control of the business are both concentrated, and the persons best suited to receive one are often not the persons best suited to receive the other. The children who work in the business want control and the growth it can produce; the children who do not want income and the ability to sell. The second is that the business is illiquid. Its owners cannot sell part of it to pay estate tax, buy out a sibling or diversify a trust without selling or redeeming shares on terms that someone must set and someone must fund. The third is that the business depends on management, and the trust instrument, which may last for generations, must provide for the replacement of managers who have not yet been born by a process that the family will accept as legitimate.
The trust as the vehicle. A trust is well suited to some parts of the problem and poorly suited to others. It can hold the shares together when a founder's estate would otherwise divide them among heirs with different interests. It can place the vote in one set of hands and the dividends in another. It can survive the death of every person who signs it. It can protect the shares from the creditors and divorcing spouses of the beneficiaries (see infra chs. 36, 39). It can also, if badly drafted, place a trustee with no knowledge of the business in charge of a company it cannot sell, under a duty to diversify that it cannot perform and a duty of loyalty that the family's managers will regard as interference. The planner's task is to use the trust for what it does well and to relieve the trustee of what it cannot do.
Terms. In this chapter, the founder is the person who built or controls the business and creates the trust; the operating heirs are the descendants who work in the business; the nonoperating heirs are those who do not; the business is the operating company, whatever its form; and the buy-sell agreement is any agreement among owners, or between owners and the company, that restricts transfers of interests in the business or requires or permits their purchase at stated events. Chapter 30 uses underlying company for an entity held by a trust; the operating business of this chapter is one kind of underlying company.
Limits of the chapter. The chapter does not examine the corporate, partnership or limited liability company law of the business entity itself, the valuation of closely held interests as a discipline, or the income taxation of the business. The companion volume, Lighthouse on Limited Liability Companies, treats buy-sell agreements, transfers of interests and their tax consequences in the context of the limited liability company in detail, and this chapter cites it where the analysis is the same. Figures given for exemption amounts and rates are those in force for 2026 and should be confirmed for the year of any transaction.