Business Succession Planning


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An introduction to the tools and strategies for business succession planning

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Business Succession Planning

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