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Business Succession Planning


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An introduction to the tools and strategies for business succession planning

An introduction to the tools and strategies for business succession planning

Published in: Economy & Finance, Business

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  • 1. Business Succession Planning Karen L. Brady, J.D. Karen Brady & Associates, P.C. (303)420-2863
  • 2. What is Exit Planning? A systematized process, a customized approach resulting in an owner’s transition out of the business
  • 3. Why Exit Planning? Every owner leaves his or her business – voluntarily or otherwise. At that time, every owner wants to receive maximum value for his or her business.
  • 4. Recipe for Successful Exit Plan
    • A written plan developed from client’s objectives
    • Experienced to to design and implement the plan
    • Optimum cash flow to fund the plan
    • Management team to succeed owner
    • Time to implement the plan
  • 5. Why Time is Important
    • Allow next generation of owners to earn way into business
    • Create liquid market for company stock while retaining control
    • Provide for owner’s retirement income
    • Provide for children not in business
    • Protect assets from potential creditors
  • 6. What Owners Often Want
    • Shift wealth to next generation
    • Reward loyal employees
    • Receive maximum value
    • Take business to next level
    • Maintain ownership indefinitely
  • 7. The Team
    • Financial/Insurance Advisor
    • Attorney(s) – Business Planning/Estate Planning
    • CPA
    • Transaction Intermediary (Broker or Investment Banker)
    • Banker
    • Business Consultant
  • 8. Timing of Transfer
    • During Life
    • At Death
  • 9. Challenges
    • During Life
    • - Capital Gains Tax for Owner
      • Gift Tax for Owner
      • Funding the Transfer
    • At Death
    • - Estate Tax
    • - Funding the Transfer
  • 10. Internal Planning
    • Identify successor management
    • Provide opportunity to learn
    • Establish strong financial controls
    • Develop culture of ownership
    • Develop relationship between new management and advisor team
  • 11. Some Techniques
    • Buy/Sell Agreements
    • Family Limited Partnerships
    • Charitable Remainder Trusts/Private Annuity Trusts
    • Nonqualified Deferred Compensation, including:
    • ESOPs
    • 412i
  • 12. Buy/Sell Agreements
    • Agreement between owners
    • Binding agreement on the triggers and pricing of transfer when one owner leaves/is pushed
    • Typical Triggers:
    • Death
    • Disability
    • Divorce/Bankruptcy
    • Retirement (including R.I.P. – retired in place)
    • Termination
  • 13. Buy/Sell Challenges
    • Pricing, which can raise IRS flags
    • Funding
    • Minimal wealth transfer/estate planning accomplished
  • 14. Family Limited Partnership/FLLC
    • Divide ownership from use, benefit, and control
    • Discounts are a “bonus”
    • Allows inclusion of children not in the business
    • Some asset protection for owner and next generation
  • 15. Disadvantages of FLP/FLLC
    • Complexity of separate entities
    • Fiduciary duty of General Partner
    • IRS scrutiny
    • Loss of step-up in basis at death
  • 16. Split Interest Trusts
    • Charitable Remainder Trusts
    • Private Annuity Trusts
    • Defer capital gain tax (sometimes indefinitely for CRTs)
    • Charitable Deduction offset other tax bite, as in use of retirement funds
  • 17. Disadvantages
    • In PATs, can’t benefit from up market
    • In CRTs, nothing for kids to inherit
    • In PATs – trust’s “real basis” can be less than anticipated basis if owner dies early
    • If owner lives past life expectancy, trust may not be able to pay as promised
  • 18. Nonqualified Deferred Compensation
    • Promise to pay later for services performed now
    • Deferral must be agreed to before services are performed
    • If compensation plan is funded (with trust, insurance, etc.) – must be substantial risk of forfeiture to the employee, otherwise constructive receipt
  • 19. When can pay out
    • Separation from Service
    • Disability
    • Death
    • Specified time pursuant to pre-arranged schedule
    • Change in ownership
    • Unforeseeable emergency
  • 20. NQDC – Employee’s Perspective
    • No income tax until compensation received
    • Appreciation depends on contract
    • Risk of Loss to Creditors of Employer
    • Risk of Loss Because Employer Lacks Resources/Liquidity
    • Part of Estate and is IRD
  • 21. NQDC – Employer’s Perspective
    • Keep Good Employees
    • Fund Owner’s Buyout
    • Can’t deduct as expense until compensation is paid
    • Shows up on balance sheet
    • Costs of Administration
  • 22. Common NQDC
    • Direct Agreement – no funding, just a promise to pay later (minimum wage must still be paid now)
    • Rabbi Trust – Employer funds trust but trust subject to employer’s creditors (no income tax paid by employee until accesses trust)
    • Secular Trust – Employer funds trust which isn’t subject to creditors (employee pays income tax as trust is funded, but appreciation is tax-deferred)
  • 23. Other NQDC Ideas/Names
    • Phantom Stock
    • Incentive Stock Options
    • Nonqualified Stock Options
    • Top Hat Plans
    • Excess Benefit Plans
    • Insurance Arrangements
  • 24. Employee Stock Ownership Plan (ESOP)
    • Company establishes ESOP
    • ESOP borrows funds to purchase stock – from company, owner, or bank
    • ESOP purchases stock from owner
    • Owner who sells can reinvest in “qualifying replacement securities” and defer capital gain – like a 1031 exchange
  • 25. ESOP Advantages
    • For Owner
    • Creates liquidity
    • Diversify investments without paying immediate tax
    • Creates market for company stock
    • Removes cash from company value
  • 26. ESOP Advantages
    • For Employees
    • Become owners/vested in company
    • Fund retirement
  • 27. ESOP Disadvantages
    • Complexity
    • Still need individuals who can manage business after owner leaves
  • 28. 412i Plans
    • Still a good idea in a narrow set of facts
    • Defined benefit pension plan
    • Promise to employee specific amount of retirement benefit based on compensation, years of service, or both, funded exclusively by life insurance or annuity contracts
  • 29. Reasons to Consider 412i
    • Employer can place large amount of cash all at once and take immediate deduction
    • Exempt from usual minimum funding standards for defined benefit plans
    • Conservative assumptions of investment growth
    • Insurance removes risk of employer guaranty of funds in plan
  • 30. 412i Disadvantages
    • Investments may be more conservative than would otherwise make
    • Lack of flexibility
    • No loans to participants
    • Business must have cash flow to assure funding
    • Initial setup can be relatively high
    • Requirements to provide for other employees often makes 412i best for cos. where owners are only employees
  • 31. 412i Requirements
    • Funded exclusively by life insurance or annuity contract(s) and guaranteed by those contracts
    • Insurance contracts must provide level annual premium payments beginning date participant is part of plan and not going beyond participant’s retirement age
    • Benefits of plan must be equal to benefits provided by insurance contract
  • 32. Business Succession Planning Karen L. Brady, J.D. Karen Brady & Associates, P.C. (303)420-2863