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Family Business Consulting 5 09

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A presentation I recently shared with a family owned business ready to explore sucession planning.

A presentation I recently shared with a family owned business ready to explore sucession planning.


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  • 1. Succession Planning for the Family Business: Understanding the Process and the Strategies May 26, 2009
  • 2. Why Most “Great” Plans Fail: 1. They ignore family dynamics. 2. They ignore basic business issues. 3. They are tax-driven. 4. They don’t involve “the next generation”. 5. Everyone wants to avoid confrontation.
  • 3. Five puzzle pieces that drive the keep or sell decision Governance of Family Leadership Wealth Succession is how the family develops its human is about who will run the company and intellectual capital in addition to its in the future. Should non-family be non- financial assets. Philanthropy can be brought in, or the company sold? used as a “learning lab.” lab.” Ownership Succession is about who will own the company in the future. Those who own the company may not be the same as those who run the company. Business Opportunities, Risks, Family & Market Value Cohesion means understanding enterprise value, how the family will function need for future capital, industry issues during and after a transition of and other factors that influence its future ownership and management
  • 4. Planning solutions (and governance) tend to be generation specific Governance ) Owner- Rotating Board Members with Go ce Investors staggered terms and outside an ve members rn ern G3 an ov c e( sg Family Trustees, Company les Hybrid Model s Officers, and a few outside (le sh Family Shareholders members On an Some Not Active ds s nd G2 on Ha ) Owner-Managers Advisory Board Entrepreneur or Sibling Partners All Active G1
  • 5. Owner-Manager Model Issues Typical Solutions Who decides who can and cannot Installment sale to next work in the company? generation (or redemption Will daughters have the same agreement) – during lifetime. opportunities as sons? Non-qualified retirement plans for What to do for “non-actives”? senior generation. Business valuation issues. For S corporations, distribute AAA to manage value. Financial burdens on the business Equalization for non-active family – to support growth and fund members. senior generation’s retirement Gift and then buy-back of non- needs. voting shares Who will be CEO among siblings? Other assets (non-operating real estate) Life insurance
  • 6. Owner-Investor Model Issues Typical Solutions Where to draw “the line” between Voting Trusts (for S Corps), Family family and business? Partnerships (for C Corps), and Generation-Skipping Trusts with How to educate uninvolved owners? investment committees empowered Time involved in managing to vote family business stock shareholder relationships Sale of stock to defective trusts; life Fair compensation for family (and insurance purchased for estate non-family) executives liquidity Family councils and family Family perceptions regarding risk committees for policy decisions and strategic growth Compensation agreements for key Cash flow needed for distributions people – phantom stock and SAR vs. retained for growth plans Benchmark company performance – enterprise level business valuations Experienced outsiders on board of directors
  • 7. Hybrid Model Issues Typical Solutions How to give non-actives some Recapitalizations and creation of “voice” … but not too much? new non-voting shares Compensation and perks for Voting rights (on major decisions) actives may become a source of for non-voting shareholders contention Shareholder Agreements with What if actives feel it’s “their” puts and calls business? Can checks and balances be Provisions if the company is sold placed on those running the to a third party company? Voting shares gifted, or sold, to How to avoid freeze-outs and family in key positions shareholder conflict? Will shareholder agreements create forced sale scenarios?
  • 8. Hurdle: Evolving from an Entrepreneurial to a Professionally-Managed Business Organizational Culture and Values Profit Orientation and Accountabilities Key Focus Leadership and Management Development Areas Budgeting Innovation Information and Communication
  • 9. Using a Leveraged ESOP • To business owners the ESOP is … a buyer of stock and/or a means to start succession planning. • To employees the ESOP is … a company funded retirement plan and an incentive to act like owners. • To companies the ESOP is … a technique of corporate finance, a tool to increase productivity and provide a qualified retirement plan.
  • 10. Leveraged ESOP Bank 3 Loan Corporation 2 Contributions 15% of covered payroll Escrowed shares ESOP 1 Sells shares Financial Institution Cash 4 Tax-free rollover Qualifying replacement securities (1) Bank lends money to ESOP with company guarantee. (2) ESOP buys stock from existing shareholders. (3) Company makes annual tax-deductible contributions to ESOP which in turn repays bank. (4) Stock is held in suspense account and released as loan is repaid. (5) Employees collect stock or cash when they retire.
  • 11. Why ESOPS are Popular – Business Succession Strategy • Management changes only if shareholder/manager chooses to leave • If done in stages – less leverage, less interest expense than an MBO or LBO • Board of Directors retains control of company • Not an all-or-nothing alternative
  • 12. Why ESOPS are Popular – Liquidity • Owners can sell all or part of their shares • Can spread sale of shares over years • No change of control • No third-party participation • No uncertainty of outcome
  • 13. Why ESOPS are Popular – Defer Gains on Stock Sold • Pay capital gains now (only on shares sold) and reinvest anywhere or spend the money, OR • C corporation owners – can elect §1042 rollover and defer capital gains tax (restrictions apply) • S corporation owners – can defer capital gains by receiving seller note instead of cash – pay tax as principal is paid back
  • 14. §1042 Tax-Deferred Rollover • C corporations only • Privately-held companies only • ESOP must acquire 30% or more of the stock (cumulative) • Seller must reinvest the proceeds within 12 months • Reinvested funds must be Qualified Replacement Property or “QRP” • Tax-deferred continues as long as seller holds QRP • Shareholder must have owned shares for at least 3 years
  • 15. Benefits of S Corp ESOPs • ESOP’s share of S corporation earnings is exempt from unrelated business income tax (UBIT) • Taxation is delayed until distributions are made to ESOP participants • Thus, a 100% ESOP-owned S corp would NEVER pay income taxes
  • 16. Limitations of S Corp ESOPs • No tax-deferred treatment on owner’s sale of stock to the ESOP • Interest and forfeitures are included in 25% of the company contribution limit • Must meet “broadly based” test (§409p) – in general, need more than 10 employees
  • 17. Voting Rights of ESOP Trust • On ordinary issues – ESOP Trustee(s) • On special issues – ESOP Participants Vote as a group On merger, consolidation, recapitalization, liquidation or sale of substantially all corporate assets No voting rights on sale of stock for cash Employees only vote allocated shares
  • 18. ESOPs Require Ongoing Planning • ESOP exploratory committee to be formed Hire legal counsel and appraiser Fairness Opinion - separate from appraisal • Borrowing rate determined (if ESOP is leveraged) • Trustees Administrative Committee • Voting of shares (as trust fiduciary) Voting reserved to committee • Repurchase liabilities projected • Contribution limits determined Example: $7,000,000 covered payroll x 15% = $1,050,000 of eligible contribution deduction $1,050,000 will amortize a $4,600,000 ESOP loan Assume loan term of 5 years at 7%
  • 19. In summary, the right ownership structure should align family and business interests • Agreement on goals and objectives for the business Growth rates Tolerable risk levels Expected returns Non-financial benchmarks • Timely and accurate information • Leadership consciously cultivated/CEO succession • Competent, empowered management team Performance-based compensation • Formalize family ownership Linkage between company and family, roles and responsibilities, role of the Board Managing tension: leadership, politics, expectations Liquidity for shareholders and capital for growth
  • 20. Succession Planning for the Family Business: Understanding the Process and the Strategies We are Brown, Edwards & Company, L.L.P., a regional accounting and consulting firm, serving our clients’ needs since 1967. Our mission is to provide business management and tax saving solutions as a necessary extension to traditional accounting and tax compliance services. Notification as required by the Standards of Tax Practice: Tax information contained in this document is a discussion of relevant issues and is not rendered as a covered or reliance opinion. Therefore it is not intended or written to be used (and cannot be used) for the purpose of avoiding penalties that may be imposed by any tax authority.

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