Ownership Transfers of Closely Held Businesses
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Right time to sell and why Planning for the exit – personal and corporate Tax ramifications Types of ownership transfers Assembling the deal team early Sale process overview Types of buyers Maximizing incentives Making sure no hidden assets are overlooked Common mistakes
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Ownership Transfers of Closely Held Businesses
- 1. Moderator: Alexander B. Kasdan, Senior Managing Director, DelMorgan & Co. Panel: • Louis Vlahos, Partner, Farrell Fritz, P.C. • Doug Himmel, Co-Founder and Managing Director, Melville Capital • Michael L. Evans, Northern California Managing Director, Newport Board Group LLC • Neil Morganbesser, President & CEO, DelMorgan & Co. © Copyright 2017 Expert Webcast – All Rights Reserved OWNERSHIP TRANSFERS OF CLOSELY HELD BUSINESSES June 22, 2017
- 2. 1 Expert Webcast is a sophisticated source of expertise for the professional and the business communities locally, nationally and cross-border. Producing the industry’s leading webcast panels covering corporate, M&A, restructuring and finance topics, Expert Webcast features foremost experts in law accounting and finance, and addresses timely and relevant issues faced by general counsel, C-level executives, boards of directors, business owners and their advisors, as well as institutional investors. We welcome you to join our upcoming video webcasts or visit our on- demand library to access recorded programs: www.expertwebcast.com.
- 3. 2 MODERATOR: Alexander B. Kasdan, Senior Managing Director, DelMorgan & Co., brings more than twenty years of senior-level Wall Street advice to middle market companies, entrepreneurs and institutional investors. He has extensive experience in investment banking, corporate law and restructuring at world’s leading firms, including Credit Suisse First Boston, O’Sullivan Graev & Karabell LLP (now O'Melveny & Myers LLP), Battle Fowler LLP (now Paul Hastings LLP) and Schlumberger Ltd., and as a founding partner of Convergence Capital Partners. Alex has worked on more than 100 domestic and cross-border transactions in North America, Europe and Africa. Alex is a Senior Advisor to Governance and Transactions LLC, an advisory firm established in 2003 by Mr. James L. Gunderson, former Secretary and General Counsel of Schlumberger Limited, to assist boards, management and owners with corporate governance, compliance, structuring and strategic transactions. Alex is a frequent moderator and an interviewer at Expert Webcast roundtable discussions attracting business leaders and leading professionals from around the world. Alex graduated magna cum laude from Middlebury College with a B.A. degree in Economics and Italian and was elected to Phi Beta Kappa during his junior year. In addition, he holds a J.D. degree from Columbia University Law School and has studied at the University of Florence in Italy. 100 Wilshire Blvd. Suite 750 Santa Monica, CA 90401 +1 310 980 1718 mobile +1 310 935 3826 office ak@delmorganco.com www.delmorganco.com
- 4. 3 Speaker: Louis Vlahos is a Partner at Farrell Fritz. As Farrell Fritz’s lead tax attorney, he has extensive experience in corporate, partnership and individual income taxation, and in estate and gift taxation, including tax planning, ruling requests, and tax controversy. Louis advises clients in connection with corporate and partnership organizations, operations and reorganizations; capital raises and debt restructurings; sales and acquisitions of businesses; distributions, redemptions, liquidations and spin-offs; S corporation issues; buy- sell agreements; real estate sales and like-kind exchanges; executive nonqualified deferred compensation arrangements; taxation of foreigners; state and local income, sales and transfer taxes; estate, gift and succession planning, including the transfer of business interests, family limited partnerships, transactions with trusts, and estate and gift tax audits; charitable giving; private foundations, tax exemption applications, not-for-profit restructuring, and excess benefit issues. Louis holds an undergraduate degree from Columbia College, a J.D. from Harvard Law School and an LL.M. from New York University School of Law. 400 RXR Plaza Uniondale, NY 11556 516-227-0639 lvlahos@farrellfritz.com www.farrellfritz.com
- 5. 4 Speaker: Doug Himmel is a Co-Founder and Managing Director of Melville Capital in Los Angeles and President of Melville Capital Structured Products Group, LLC (“MCSPG”) overseeing the Firm’s Business Development, Marketing, Brand Building and PR focus. For almost 25 years, Doug has been involved in the financial services, lending and life insurance. An active member of several professional organizations including the American Bankruptcy Institute, Turnaround Management Association, Association for Corporate Growth and the Financial Planners Association, National Association of Insurance and Financial Advisors, he is sought out as a contributor, speaking at conferences, writing articles or for market related quotes. Through overseeing Melville Capital’s marketing efforts to individuals, companies and their advisors, Doug has focused on helping to change policy owners’ view of life insurance as a saleable asset and not just an expense. Doug earned a B.A. in Political Science and Finance from the University of Arizona. 310.943.5370 dhimmel@melvillecapital.com www.melvillecapital.com The Life Settlement Advisors
- 6. 5 Panelist: Michael L. Evans is a member of the Board of Directors and Managing Director at Newport Board Group, a unique national professional services firm whose partners are CEOs and senior executives. Exclusively dedicated to Newport, they work together through the Newport Expert Network™ to guide companies through No Man’s Land transitions and assist private equity to acquire and grow these companies. Prior to joining Newport, Mike was a senior partner with Ernst & Young, where he led growth in a number of practices including corporate restructuring, risk management and strategy. Mike is a CPA and attorney. He serves on several corporate for profit and non- profit boards. 1 Market Plaza, 36th Floor San Francisco, CA 415-990-1844 Michael.Evans@NewportBoard Group.com www.NewportBoardGroup.com
- 7. 6 Panelist: Neil Morganbesser is co-Founder and President & CEO of DelMorgan & Co. where he provides senior leadership within the firm and helps oversee all client engagements. Mr. Morganbesser is also CEO of Globalist Capital LLC, DelMorgan’s broker-dealer affiliate. Mr. Morganbesser has over 25 years of experience providing financial and strategic advice to a full range of clients, including entrepreneurs, large corporations, governments, family businesses, private equity funds, and special committees of public companies. Mr. Morganbesser has been affiliated with some of the leading institutions in the world, and his experience ranges from representing the offshore owners in the sale of a small, private U.S. company for $10 million to representing the special committee of a large, public company in a $9 billion negotiated management buyout with a highly complex financial structure. Mr. Morganbesser has truly global experience with the most sophisticated transactions, across a broad range of industries and in a large number of jurisdictions, as the lead banker on a wide variety of transactional and other advisory assignments, including domestic and cross-border mergers, acquisitions, joint ventures, sales and divestitures, restructurings, special committee assignments, unsolicited acquisitions and hostile defense. With transactional experience in over 30 countries, Mr. Morganbesser has successfully advised on over 100 transactions. Until May 2008, Mr. Morganbesser was the head of West Coast and Asia Mergers & Acquisitions at Bear Stearns & Co., as a Senior Managing Director based in Los Angeles. Prior to joining Bear Stearns in May 2001, Mr. Morganbesser was an investment banker in the Mergers, Acquisitions and Restructuring Department at Morgan Stanley (in New York and Los Angeles). From 1990-1993, Mr. Morganbesser was a corporate and M&A attorney at Wachtell, Lipton, Rosen & Katz. Mr. Morganbesser graduated with an A.B. magna cum laude in Applied Mathematics / Economics from Harvard University (Phi Beta Kappa) in 1986 and received his J.D. and M.B.A. degrees (Order of the Coif, with honors) from Stanford University in 1990. 100 Wilshire Blvd. Suite 750 Santa Monica, CA 90401 (310) 319-2000 nm@delmorganco.com www.delmorganco.com
- 8. 7 MAJOR TOPICS: • Right time to sell and why • Planning for the exit – personal and corporate • Tax ramifications • Types of ownership transfers • Assembling the deal team early • Sale process overview • Types of buyers • Making sure no hidden assets are overlooked • Common mistakes
- 9. 8
- 10. 9 2 This session is designed to provide you with an awareness of issues, strategy and considerations related to the sale or succession of your company and help you to: • Establish a future state model of the company at a point in time in the future. • Create a timeline includes the remedies necessary to be ready for the transition. • Prepare your company before you execute your exit strategy which will maximize value and minimize risk to you, your successors and your family. • Minimize tax consequences on sale or succession. • Create an appropriate capital structure that promotes a smooth transition of your business. • Establish a realistic valuation of your company. • Help you to assess the readiness of remaining family members and how they will work with non-family members. • Provide input with respect to available capital market strategies. GOALS FOR THIS SESSION
- 11. 10 3 • How healthy is your operation? • Are you living off installed base or adding net new customers? Do you have more customers today than you did a few years ago? • Is your company dependent upon a few large customers? • Are you current in the technology you are promoting and servicing to your customers? • Maintaining great customer service is a key point in revenue and profit stability. How do you stress test your readiness in service? • What are you good at that allows you to be competitive in the marketplace? • Are you organized as a business a homegrown operation? • Depending on your exit plan, you may need a strong organization to perform during your buyout timeline. Is your company ready? EXIT READY? QUESTIONS TO ASK YOURSELF
- 12. 11 4 I. Succession Planning Overview II. Key Issues III. Governance IV. Senior Management: Key Steps V. Board of Directors: Key Steps VI. Funding Your Exit VII. Legal Agreements and Documentation VIII. Conclusions and Questions AGENDA
- 13. 12 5 RISKS OF FAMILY BUSINESSES Family businesses have an opportunity to sustain a legacy and get the benefits of customer and community goodwill. But: • 2/3 to 3/4 collapse or are sold by the founders • 95% do not survive third generation ownership • Simple planning and action can double the chances for success
- 14. 13 6 RISKS OF FAMILY BUSINESSES Reasons: • Inadequate management • Insufficient cash to fund growth • Non-alignment of incentives among family members • Lack of clearly defined practices and procedures • Taxes • Lack of a succession or exit plan
- 15. 14 7 CHALLENGES & OPPORTUNITIES What Makes Family Companies Different? Families Are Changing • Changes from the traditional family (e.g. divorce/remarriage; unmarried partners) may complicate issue of who should participate in the business and how they should benefit (salary, capital appreciation, retirement income etc.). • Need well thought out Board governance and management processes that are fair and consistent for all family (and non-family) stakeholders. • Well run family business can earn tremendous market advantages in goodwill with customers and communities, employee loyalty. • Family companies have significant presence in segments and niches in industries across the economy • Family companies include first generation companies hoping to transition the company to younger generation. • Family businesses have issues and transitions, which may require consideration of family values alongside strictly bottom line thinking.
- 16. 15 STAGES OF COMMON ISSUES STAGE 1 The Founder(s) STAGE 2 The Sibling Partnership STAGE 3 The Cousin Confederation Leadership transition -Aspiration to transmit the business -Succession -Estate planning - Maintaining teamwork and harmony - Sustaining family ownership - Succession - Allocation of corporate capital: dividends, debt, and profit - Shareholder liquidity - Family conflict resolution, participation, and role - Family vision, mission and linkage with the business
- 20. 19 12 III. GOVERNANCE • Get consensus on and communicate the values, mission, and long-term vision for the family business--to family and non- family stakeholders. • Keep family members (especially non- executives) informed about major business accomplishments, challenges, and options. • Communicate the rules and decisions that affect family members employment, dividends, and other benefits they get from the business. WELL-FUNCTIONING GOVERNANCE STRUCTURES AIM TO:
- 21. 20 13 III. GOVERNANCE • Establish formal communication mechanisms that allow family members to share their aspirations, ideas and issues. • Facilitate building of consensus around key decisions. • Avoid or minimize family disputes as to value, succession and fairness. They will happen! WELL-FUNCTIONING GOVERNANCE STRUCTURES AIM TO:
- 24. 23 1 Analyze talent implication of the business strategy • Where are we taking the business? • What type of leaders do we need? 2Define talent standards • What does best-in-industry talent look like? • What are the critical experiences, skill set and behaviors required for leadership roles? 3 Analyze individual & pool strengths & weaknesses • Who are our stars? Blockers? • Where do we have issues in our overall leadership talent portfolio? 4Conduct regular talent reviews • What actions are necessary to address talent gaps? • Who owns what actions? 5 Execute talent plans & measure impact • What actions are necessary to implement plan? • Are we getting the results wanted? If not, why? 5 STEP EVALUATION PROCESS
- 25. 24 17 FAMILY FIRST VS BUSINESS FIRST KEY ISSUE FAMILY FIRST BUSINESS FIRST FAMILY EMPLOYMENT Open-Door Policy for all family members; qualifications less stringent for family members Qualification-Based Employment, as for any other new hire COMPENSATION Equal pay for all, regardless of their experience or performance Merit-Based pay, based on experience, performance LEADERSHIP Leadership based on Seniority in Family—assuming basic qualifications are met Leadership granted to the right person (family or non-family), based on merit and qualifications RESOURCE ALLOCATION Business Resources used for personal needs (e.g., loans, grants) Business resources only used for business purposes – separate family reserve fund utilized for family needs DECISION- MAKING Unilateral & Concentrated with Senior Family Member (e.g., Chairman/CEO) Multi-lateral, based on Defined Governance Structure (e.g., Executive Committee)
- 26. 25 18 BUILD CONSENSUS ON FOUNDATIONAL ISSUES • Principles for best short- and long-term outcome for the business, the family and other stakeholders. • Prospects for the business, its viability in the market; its capital needs. • The role of the family in company ownership and management, including personal and business goals of the next generation. • Whether to bring in non-family professional management. • How to grow the company while serving family interests
- 27. 26 19 STEPS TO FORMAL SUCCESSION PLAN 1. START EARLY • To ensure continuity of business, plan to identify next CEO should begin as soon as CEO is appointed. 2. CAREER DEVELOPMENT PROCESSES • Consider strategic direction of company and what executive skills will be needed • Create development systems to help family and non-family executives fill skills gaps. 3. SEEK ADVICE • Get objective advice from independent directors or non-family executives.
- 29. 28 21 BENEFIT FROM OBJECTIVE ADVICE • Identify and address tensions between family-based values and the performance culture that a business needs to survive in today s competitive environment. • Balance long-term and short-term financial and family interests. Issues on which family businesses often seek advice from outside experts: • Get beyond the personalities and family dynamics that can impede successful decision-making. • Ensure that shareholder agreements, by-laws and other structures do not prevent the company from raising money, selling shares and otherwise conducting itself in the market as a non-family company would. • Get expert tax, legal and estate planning advice.
- 30. 29 22 IV. SENIOR MANAGEMENT – KEY STEPS • Formalize a strong senior management team, composed of family and non- family members. • To manage day-to-day operations of the business and the direction that is set out by the board of directors. • Consider establishing Executive Committee. • Remuneration based on performance (subject to family versus business values). • Performance evaluations conducted fairly and objectively.
- 31. 30 23 SENIOR MANAGEMENT SUCCESSION PLAN • This is most important issue for family- owned business. • Succession problems are the main reason family businesses fail to reach the third generation. • Formal succession plan should allow selection of clearly competent person (whether it is a family member or not). • Family members, the board, key senior managers, and other stakeholders must be involved.
- 32. 31 24 IDENTIFY AND PREPARE SUCCESSORS • Determine policy regarding whether successor will be from family. • Evaluate readiness and capabilities of candidates among family, non- family (depending on policy) owners and managers of the company. • Define ongoing role in the business of the retiring owner, if any. • Identify active and non-active roles of family members going forward. • Identify support for the successor that is expected from family members. • Help prepare the next generation for leadership roles. • Provide counsel and support to successors.
- 33. 32 25 • The Board of Directors is central to governance of family-owned business. • Initial role: comply with legal requirements and agreements. • Role becomes more complex as the business grows. (As interim step, many family companies add an Advisory Board to complement skills of current directors). Ultimately, the Board must mature to be a platform for long-term sustainability. For example: ü Include outside, independent members. ü Delineate roles of the Board and role/responsibilities of family and senior management. ü Ensure Board has ultimate authority to direct and control the organization, separate from family influence. V. BOARD OF DIRECTORS – KEY STEPS
- 34. 33 26 INDEPENDENT DIRECTORS • Normally, a board consists initially of family members and a few trusted non-family members. • Independent directors: ü Bring outside perspective on strategy and control. ü Add new skills and market knowledge to the firm. ü Help to approve important hires. ü Bring objectivity to resolving disagreements in the among family-member managers. ü Can use their connections to the advantage of the business.
- 35. 34 27 VI. FUNDING YOUR EXIT – EXTERNAL SALE • Senior Debt – generally term debt with a low rate of interest available from banks and often secured by company assets or company cash flow. (5-10%) • Mezzanine – available as subordinated debt (behind in priority to senior debt but above equity) from lenders or PE firms, often with a warrant or other equity kicker. ( 10-16%) Today, companies have a range of different types of capital available to create liquidity to buy out retiring owners: • Equity – Often issued in the form of stock together with options. If new investor is PE firm or strategic buyer, will usually want control of the company. • Subordinated Debt Restructurings – gaining importance as way to get capital and maintain control of the company as long as cash flow covers interest and any payment of principal.
- 36. 35 28 TRANSFER OBJECTIVES Objective 1 business owner’s objective to retain control of the business for some period of time – just in case! Objective 2 lower the gift/estate tax value due to valuation discounts for lack of control and marketability. Objective 3 assure a smooth transition of the business and consider non-participating family members. Objective 4 avoid and shift as much tax as possible. Objective 5 create retirement income.
- 37. 36 29 FORM OF SALE – FAMILY MEMBERS Installment Sales - An installment sale is an excellent way to provide a steady stream of cash flow (and retirement income) to the business owner while transitioning ownership of the business to the active children. The installment sale must bear interest at not less than the applicable federal rate published monthly by the IRS. (Caution - bargain sale rules). Private Annuities - With a private annuity, the business owner (the annuitant) sells the business interest to the active children (the purchasers) for an unsecured promise to make periodic payments to the annuitant for the remainder of the annuitant’s life. Family ESOP – essentially an installment sale but to a family Employee Stock Ownership Plan.
- 38. 37 30 VII. LEGAL AGREEMENTS & DOCUMENTATION • Review current buy sell agreement as to whether it achieves the goals of all owners and future management. • Assess full range of potential transaction options such as sale to a third party, debt-financed sale to next generation owner, capital structure alternatives such as preferred/common stock restructuring. • Identify a team of professional advisors (attorney, CPA, bankers, financial advisors). • Document the succession plan (including emergency plans) in writing. • Communicate the succession plan to family and stakeholders. • Establish a timeline for implementation of the succession plan. • Always consider tax implications – Estate, Gift and Income and liquidity needs to pay taxes.
- 39. 38 31 INCOME TAX CONSIDERATIONS • Transfer of business interests between family members –(IRC 2701-2704). Business interests transferred between family members must be FMV and conditions should be arm’s length. • Corporation redeems its stock and the withdrawing shareholder remains with the corporation as a director, officer or employee, the purchase price is treated as a dividend rather than a capital gain. (302,303 and 318). • This means the entire purchase price will be subject to tax, rather than the amount in excess of basis.
- 40. 39 32 TRANSFER TAX CONSIDERATIONS Annual Exclusion Gifts - Gifts of business interests up to $14,000 ($28,000 for married couples) in 2015 can be made annually to as many donees as the business owner desires. Gift Tax Exemption - $14,000 gift tax annual exclusion ($28,000 for a married couple), indexed for inflation, the business owner can gift $5.43 million unified credit (dollar for dollar) the estate tax exemption at death - such gifts remove the income and future appreciation on the gifted property from the business owner’s estate. Family limited liability company (FLLC) - LLC that only includes family members. It can be a valuable tool to transfer a business or business real estate to children at a discount from the value of the underlying assets owned by the FLLC – Single member manager or collective management?
- 41. 40 33 BUY/SELL AGREEMENTS – YOU NEED ONE NOW! A Buy-Sell Agreement is an agreement among business owners to: • Provide a mechanism to limit who can become a new co-owner. • Define approach to creating a market for the sale or transfer of ownership interests. • Specify the mechanism for determining a purchase price and how purchase price will be paid. (Warning: beware of book value-based formulas.) • Provides funding for purchase of a deceased owner s interest. ü Owners typically required to purchase life insurance on each other. ü In some situations, remaining owners may pay over a period of time on an installment basis.
- 42. 41 34 SHAREHOLDER WILLS AND TRUSTS – CRITICAL! • Create Revocable Trust to hold stock – avoids delays on ownership transfers and reduces costs. • Consider gifting of stock to transfer ownership under the Uniform Gift and Estate exemption. • Have clear provisions as to whom the stock will pass to upon death – family management versus heirs. • Consider the spousal effect of the ownership passing to offspring in case of death, divorce. • Establish equalization provisions to reflect rising stock values passing to selected beneficiaries. • Avoids probate and time delays upon death, both first and second. • You will have done your family a great disservice without making your clear intentions known – and why.
- 44. 43 36 VIII. CONCLUSIONS & FURTHER DISCUSSION • A sound governance structure— between Board, owners and senior management--can mitigate many challenges of family businesses and provide the right foundation for succession planning. • Governance structure must clearly define the roles, responsibilities, rights and interaction between the company’s main governing bodies. • A clear governance structure will make it easier to maintain family cohesion and attract capable non-family employees, to help provide long-term sustainability. • A fair buy/sell arrangement and well designed wills and trusts for owners will avoid disputes on death and retirement.
- 45. 44 37 SUMMARY TAKEAWAYS • Every business has succession issues – create a succession plan now. • Establish buy/sell agreements that reflect the true value of the business. • Consider multiple classes of ownership of your business (common/preferred). • Draft wills and revocable trusts. • Begin gifting program to utilize tax credits. • Review company structure to make sure to avoid double layers of tax.