Thinking about Transitioning your Business?

WithumSmith+Brown, PC | BE IN A POSITION OF STRENGTH
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Thinking about Transitioning
your Business?
January 28, 2020
Presented By

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Your Speakers
Hal Levenson
Founder and Chief Visionary
Officer
Trilogy Partners, LLC
Hal Terr, CPA, PFS, CFP®, AEP®
Partner, Co-Practice Leader of
Private Client Services Group
Withum
Jeanette Emmons, CPA, CM&AA
Senior Manager, Team Leader of
Transaction Advisory Services
Withum

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Thinking About Transitioning
Your Business?
 Why Transition?
 Options
 Process/Plan
 Overcoming Obstacles
 Success Stories

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What is Your WHY behind the
transition?
WHAT’S THE
MOTIVATION?
WHAT’S YOUR
PURPOSE POST-
TRANSITION?
WHAT MIGHT
STOP YOU?

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Options
Sell – Outside
Internal transfer
Annuity

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Process/Plan
Timeframe Post transition – 3 Year
Vision
Organizational Charts
Resources
People
Financial

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Questions To Ask
How to replace the owner?
People/skills required?
What financial resources are needed?
Competitive advantages/disadvantages?
Impact on culture?
How to promote innovation?
Stay in control & let go?
Start/Stop/Continue doing?

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Recap
 Define new purpose
 What’s the Organization
structure without you?
 Process:
Emotional/Business/Financial
 Ask for Help
 Take action today!

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The bottom line: transitions happen far more
often than the average business owner realizes.
According to a study by the National Center for the
Middle Market published early this year (2020):
77% of middle market
businesses have experienced
or expect to experience a
transition(*) in the past or next
five years.
The study suggests that more
than half of all MM Companies
can expect two transitions per
decade.
Current market conditions
could increase this number in
the coming years.
(*) for purposes of this study transitions include ownership, leadership and structuring changes

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Current favorable transition conditions include:
• Baby Boomers, who own an estimated 40% of MM
companies, are retiring
• There is a reported $2.1 trillion cache of capital (dry
power) to be deployed (source: Prequin)
• Low interest rates and easy access to capital
• High valuations enticing business owners to consider
selling NOW

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98% of companies that adequately prepare for
transition are highly satisfied with the results.
Among less prepared firms, just 33% report high
satisfaction with the transition.
Most companies begin preparing one to two
years in advance of a transition.
Transitions take
time, planning and
a skill set above
and beyond that
needed to run a
business. Not
surprisingly,
business that take
the time to plan for
transition report
significantly higher
satisfaction rates
post transition
than those that do
not plan ahead.

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Strong
Reporting
Functions and
Controls
Normalized
Earnings
Calculation
Personal
Goals and
Planning
Strength of
Management
Defined
Operational
Goals and
Procedures
Normalized
Balance Sheet
and Working
Capital
Preparedness on Every Front

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Building Value
 Value is often thought of as:
(frequently represented (middle market
by historical EBITDA) approx 4-8x)
Given this formula; theoretically, value can be driven by impacting either of these two
factors
 BENEFIT STREAM
 Increasing revenues or decreasing expenses will increase the projected future benefit stream (more
on this later) however,
 Unsustainable revenue spikes or expense cuts will improve EBITDA but generally do not add value.
You must be able to show sustainability.
 MULTIPLE
 Can be impacted by various factors including exit channel, industry and business strengths and
weaknesses.
Expected
Future
Benefit
Stream
Multiple
Enterprise
Value

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Building Value
Exit Channels can impact business value
Assess strengths and
weaknesses across the
organization
Focus on mitigating weaknesses to build
overall strength and value; enhancing
non-quantitative value factors
Most likely focus areas
include:
Reducing reliance on owner (building a
management team)
Formalizing operational and financial
reporting practices
Diversifying customer base (reducing
concentrations)
Building a strategic sales growth plan

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Business Strengths To Add Value
(Drive the Multiple)
Operational Financial
PLUS

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Future Benefit Stream –
Normalized Historical EBITDA
The deal multiple is typically
applied to the normalized trailing
twelve month EBITDA which is:
• Net Income
• Plus: Interest, net
• Plus: Taxes (based on income)
• Plus: Depreciation (non-maintenance)
• Plus: Amortization
• Plus: Non-recurring expenses
• Plus: Non-operating expenses
• Less: Non-recurring revenues
• Less: Non-operating revenues
When sufficient lead time is
available, consider implementing
practices to align actual historical
results to the projected normalized
results (i.e. remove personal
expenditures or excess
compensation / fringe to owners,
adjust rental agreements to fair
value, renegotiate major vendor
terms, reign in T&E expenditures,
right size headcount).

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Typical Normalization
Adjustments
 + Remove excess owner compensation
 + Remove excess fringe benefits
 +/- Adjust rents to fair market rates
 + Remove transaction related expenses
 - Adjust for management gaps
 + Adjust for one time professional fees
 + Discretionary charitable contributions
 - Remove gain on sale of assets
 - Remove casualty gain
 + New product launch expenses
 +/- Adjust related party transactions to fair value
 - Maintenance Cap Ex

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Normalized Balance Sheet and
Working Capital
Identification of assets and liabilities that will and will not be part of a transaction is critical.
Typically – non-operating assets are excluded and the seller retains all debt and debt like items (or
pays them off from proceeds at closing). Consider who got/gets the benefit of liabilities in
determine who maintains them.
In preparing for a transition clean up loose ends:
• Distribute personal assets out of the business
• Payout earned bonuses and commissions
• Formalize verbal agreements (bonuses, commissions, etc.)
• Buy-out minority owners
• Identify material contracts and outline assumption or change of control provisions
Working Capital
• To assure the buyer of a sustainable business on the closing date a working capital target is set and an adjustment to the
purchase price is made if working capital on the day of closing is above or below the target.
• Before setting the target, the parties must agree on the definition of working capital.

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Normalized Working Capital
 Current assets less current liabilities
 Typically excludes cash and debt
 Includes:
• Trade Receivables
• Prepaids (selectively)
• Inventory
• Other current assets (operating)
• Trade accounts payable
• Accrued expenses (selectively)
• Other current liabilities (operating)
 Inclusion or exclusion can be determined based on who receives
the benefit of the asset or liability the buyer or seller.
 Assets and liabilities should be adjusted to reflect the impact of
adjustments applied to normalize EBITDA

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Plan for the Impact of Your Tax
Structure
 Understand your tax structure and how deal proceeds would flow
through. How much Uncle Sam takes significantly impacts the sale price
needed to get you the desired proceeds.
• C Corporations face double taxation
• S Corporations must consider built in gains
• Partnerships show ordinary gains on hot assets
 Structuring the deal
• Weigh the legal and tax implications of a stock sale verses an asset sale
• Deal structuring can have a significant impact on the tax implications to the buyer and the seller
• In some cases purchase prices can be decreased with no impact to the cash received by the seller
by changing the structure of the deal.
 Compliance assessment – in a stock sale the liability for non-compliance
transfers to the buyer, thus buyers will perform tax diligence. Get ahead
of any issues by performing an internal assessment in advance of going
to market.
• Consider all types of taxes including income, franchise, sales and use and excise taxes.
• Consider unclaimed property rules
• Consider 1099 and other information return compliance – withholding requirements add up
quickly

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Estate & Gift Tax
Exemption
Estate, Gift and GST
exemption currently
$11.58 million per
person ($23.16 million
per couple)
Current sunset 2025
back to $5 million
indexed with inflation
Need to plan for
impact of 2020
election
IRS final regulation –
No Clawback of
utilization of increased
exemption

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State Estate Taxes
 No current New Jersey Estate Tax
 New Jersey Inheritance Tax applies to
transfers only to non-lineal descendants
 Pennsylvania Inheritance Tax
• 4.5% to lineal descendants
• 12% to siblings & 15% to others
 New York Estate Exemption currently
$5,850,000

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Portability - Deceased Spousal Unused
Exclusion (DSUE) amount
 TRA 2010 – for decedents dying on or after
1/1/2011
 Estate and gift tax exclusions were reunited at
the hip
(“use it now” or “use it later”)
 “Portability” became permanent with the 2012
Tax Act
 Final regulation became effective on June 12,
2015
IRC Section 2010(c)(4)

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DSUE = Lesser of
The basic exclusion amount, or
The excess of
• The applicable exclusion amount of the last such
deceased spouse of such surviving spouse, over
• The amount with respect to which the tentative
tax is determined under Section 2001(b)(1) on
the estate of such deceased spouse

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Advantages of DSUE Election
Get a second basis step-up at surviving spouse’s death
Ultimate Federal and State capital gains tax savings
Lower administrative expenses
Allows for spousal rollover of IRA/retirement plan assets
Control/GPA (limited for retirement plan assets)
Income subject to individual tax brackets, not condensed trust
brackets

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Portability • Simple and can be utilized even if there was no
estate planning prior to date of death
• No need to equalize estates
• Works especially well with certain types of
assets, such as IRAs and retirement plan assets
and residences
• Assets get a second step-up in basis on the death
of the surviving spouse
• Must file an estate tax return (Form 706). Although
there are some simplified procedures for filing just
for portability
• The spouses unused exclusion amount is fixed at the
first death and does not increase with inflation
• If you live in (or have assets in) a state with a state-
level estate tax, portability may not recognized
• Not recognized for GST purposes
• Appreciation of trust assets and undistributed
income will not be subject to federal or state
estate tax on the surviving spouse’s passing
• Asset and creditor protection of trusts
• Trustee can manage assets and financial matters
as the surviving spouse ages
• The first spouse to die will be able to control
ultimate disposition of the assets
• Protects assets from being squandered by
surviving spouse
• Undistributed income of trust can be subject to
higher income tax rates than individuals
• Annual expense of filing a trust tax return
• No step-up in basis of assets in the CST at death of
surviving spouse
• The couple may have to equalize their estates so that
the trust can be fully funded by the first estate
Credit
Shelter
Trusts
Advantages Disadvantages
No one solution is right for every client. In light of the unique nature of every client’s assets and family situation, it is difficult
to reach broad general conclusions with respect to the advisability of portability vs. Credit Shelter Trust. Make your estate
plan as flexible as possible – ex. Disclaimer Trusts
Portability versus Credit Shelter
Trust

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Gift Planning in Low Interest
Environment
Intra-Family Loans
• February 2020 Short-Term Rate: 1.59%
• February 2020 Mid-Term Rate: 1.75%
• February 2020 Long-Term Rate: 2.15%
Grantor Retained Annuity Trusts (GRATs)
Installment Sale to Defective Grantor Trusts

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Grantor Retained Annuity Trusts
(GRATs)
 Transfer wealth with potentially no gift tax cost.
 GRAT is an irrevocable trust to which the grantor transfer
property while retaining the right to receive annuity
interest.
 Zero-gift Walton GRAT
• If the value of the trust property appreciates at a rate greater
than the Code Section 7520 rate, the Walton GRAT will be a
success
• Designed to be of short duration with high annual payouts
• Concerns over rising interest rates
 Single-property GRAT
• Use several single property GRATs rather than diversified
property GRATs, since the single property GRATs that
“succeed” by appreciating will be beneficial, while the single
property GRATs that “fail” to appreciate will not be harmful

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Grantor Retained Annuity Trusts
(GRATs)
The grantor transfers property to the GRAT and pays gift taxes on the present value
of the remainder. In turn, the GRAT trustee(s) makes fixed annuity payments to the
grantor for a specified period. At the end of the trust term, if the grantor is living,
the remaining assets go to the remainder beneficiaries free of additional gift or
estate taxes.
Property
Fixed Annuity
At the end of the trust term, assets to heirs
pass free of additional gift or estate taxes
GRAT
Remainder flows
outright or in an
irrevocable trust
for children or other
beneficiaries at end of
the term
(Gift tax, unless zeroed out)

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Freeze Values at Current Levels for
Senior Generation Clients
Sale to an Intentionally Defective Grantor Trust (IDGT)
• The grantor creates a trust for the benefit of family members, and sells
assets to the trust in exchange for a long-term installment note. The
sale is made for fair market value per appraisals, etc., (including
valuation discounts) so that the sale by the grantor to the trust is not
treated as a gift to the trust beneficiaries.
• The trust is drafted to treat the grantor as the owner of the trust for
income tax purposes, but not for estate tax purposes. This is
accomplished by including certain grantor-retained administrative
powers in the trust.
• The trust is this “defective” for leaving the grantor subject to income
tax, but “intentionally” so, since this was done by design.
• Sale of assets to the trust avoid capital gains tax; note interest in not
subject to income tax.
• Seed money gift requirement.
• Have the grantor pay the income tax.

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Installment Sale To An IDGT
Overview Of Technique
Grantor IDGT
Gift & sale of highly
appreciating assets
Installment note(s)
Children,
Grandchildren
Great
Grandchildren &
Future
Generations
Discretionary
distributions of income
and principal during the
lifetime of the trust’s
beneficiaries
Assets outside of
the taxable
estates of
beneficiaries

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Leveraging Transfers Through
Valuation Discounts
 If the value of the transferred assets can be discounted by
application of well-established factors, the amount of assets
that can be transferred via the increased exemption
amount is substantially expanded
 Common discount factors include lack of marketability, lack
of control, restrictions on subsequent transfers, and
estimated income tax liability on “built-in gains”
 Despite repeated threats of “loophole closing”, valuation
discounts withstand IRS scrutiny

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Leveraging Transfers Through
Valuation Discounts
Transfers of undivided partial interests in real estate
Transfers of a partial interest in a family business
• Recapitalization to voting and non-voting stock
Transfers of a partial interest in a family holding company,
such as an LLC holding investment assets or a co-owned
family asset, such as a vacation home

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Adequate Disclosure
Statute of Limitations for Assessing Additional Gift
Tax
 Statute of limitations is ordinarily three years
after the later of:
• The date the return was filed OR
• The date the return was due
 Time period increases to six years after the
later of filing or due date if amounts
omitted from the return exceed 25% of the
amount reported

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Adequate Disclosure: Effects of
Running
of the Statute
IRS cannot increase the amount of the initial gift
IRS cannot increase the amount of a future gift
based on an increase in the amount of the initial gift
IRS cannot increase the amount of adjusted taxable
gift included in the estate as a result of the gift

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Requirements for Adequate
Disclosure
For gifts subject to §§ 2701 and 2702, a return
must provide the following information:
• A description of the transactions
• The identity of, and relationship between, the transferor,
transferee, and all other persons involved
• A detailed description of the method used to determine
the amount of the gift
• Treas. Reg. Sec. 301.6501(c)-1(e)(1)

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Questions? Thank you!
Hal Levenson
Founder and Chief Visionary Officer
Trilogy Partners, LLC
hlevenson@GetTrilogyPartners.com
(609) 688-0428 x12
Hal Terr, CPA, PFS, CFP®, AEP®
Partner, Co-Practice Leader of
Private Client Services Group
Withum
hterr@Withum.com
(609) 945-7946
Jeanette Emmons, CPA, CM&AA
Senior Manager, Team Leader of
Transaction Advisory Services
Withum
jemmons@Withum.com
(609) 429-5853

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