Business Succession Planning 04 2009

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Business Succession Planning 04 2009

  1. 1. Business Succession Planning Vincent J Gallo CLU ChFC AEP Vincent J Gallo & Associates, Inc. Winston-Salem, NC
  2. 2. Agenda • Overview of business succession planning • Estate planning fundamentals • Business succession planning techniques
  3. 3. Overview of business succession planning • More than 80% of businesses in the U.S. are private and/or family dominated • Businesses owned or dominated by the members of a single family make up 175 of the Fortune 500 • International Family Business Program Association estimated that family firms contribute 60%-75% of the U.S. G.D.P.
  4. 4. Overview of business succession planning • Closely held businesses have an extraordinary failure rate: – 70% do not survive to the second generation – 85% do not survive to the third generation – The average family owned business lasts only 24 years
  5. 5. Estate planning fundamentals • General Rule - All asset transfers are taxable – Exceptions • Marital transfers • Annual gifts • Tuition or medical expenses • Charitable gifts • Unified credit (or “lifetime exemption”)
  6. 6. Estate planning fundamentals • Qualified Family Owned Business Exclusion – Additional exclusion is available for qualified family owned business interests (QFOBI) – Can increase overall exclusion amount to $1,300,000 – In order to qualify • QFOBIs must exceed 50% of the gross estate • Decedent or member of family must have “materially participated” in business for at least 5 of last 8 years • Situated in U.S. • Other qualification requirements
  7. 7. Minimizing Estate Taxation • Best way to reduce overall estate taxation is through “Estate Reduction” • Reduce the value of the taxable estate – without losing control – while retaining cash flow – paying minimum transfer taxes
  8. 8. Wealth transfer techniques • Five techniques for business succession planning – Buy/Sell Agreements – Family Limited Partnerships – S Corp Recapitalizations – Employee Stock Ownership Plans – Intentionally Defective Grantor Trusts
  9. 9. Wealth transfer techniques • Technique #1: Buy/Sell Agreements – Agreement among Company and Shareholders to buy stock from shareholders upon certain events: • Disability • Retirement • Death • Divorce
  10. 10. Wealth transfer techniques • Technique #1: Buy/Sell Agreements – Two Types of Agreements • Stock Redemption - Company buys stock from shareholder • Cross Purchase - Other shareholder(s) buy stock from shareholder • Common to use insurance or borrowing to provide funding – How it works • Company and shareholders enter into agreement • Upon specified event, affected shareholder must sell stock to company and/or other shareholders
  11. 11. Wealth transfer techniques • Technique #1: Buy/Sell Agreements – Price is either set annually, or more likely, an appraisal process is outlined in the agreement – Advantages • Provides protection to the company and shareholders • Provides liquidity to shareholders – Disadvantages • Accomplishes only minimal estate planning • No wealth transfer achieved
  12. 12. Wealth transfer techniques • Technique #2: Family Limited Partnerships – Family Limited Partnership (“FLP”) is a limited partnership established under state law – There are 2 classes of partners: • General Partner - Very little economic interest (typically 1%) but virtually all management control • Limited Partner - Virtually all of the economic interest, but very little management control – Donor contributes assets to the FLP in exchange for both general and limited partnership interests
  13. 13. Wealth transfer techniques • Technique #2: Family Limited Partnerships – Donor makes gifts of limited partnership interests to next generation. • Annual exclusion • Unified credit – Valuation discounts are often taken. The two types: • Lack of marketability • Lack of management control (minority interest) – Retention of general partnership interest allows senior generation to retain control while transferring value out of taxable estate.
  14. 14. Wealth transfer techniques • Technique #2: Family Limited Partnerships – Advantages • Discounts • Separation between ownership and control • Consolidated management of assets • Potential asset protection – Disadvantages • Separate entity which requires administration and tax returns • General partner has fiduciary duty to limited partners • IRS scrutiny
  15. 15. Wealth transfer techniques • Technique #3: “S” Corp. Recapitalization – What is it? • FLP-type technique for “S” Corporations – “S” Corporation • Cannot be owned by a partnership (FLP not available) • Cannot have more than one class of stock – However, “S” corporation can have more than one kind of stock (voting vs. non-voting)
  16. 16. Wealth transfer techniques • Technique #3: “S” Corp. Recapitalization – “S” Corporation is recapitalized to have: • Voting common stock • Non-voting common stock – Gifts of non-voting common stock are then made to the next generation – Discounting available: • Lack of Control • Lack of Marketability
  17. 17. Wealth transfer techniques • Technique #3: “S” Corp. Recapitalization – Advantages • Discounts • Separation of ownership and control – Disadvantages • Potential premium placed on the voting stock • Wealth transfer is not accomplished without additional gifting or other transfer techniques
  18. 18. Wealth transfer techniques • Technique #4: Employee Stock Ownership Plan – Closely-held company establishes an employee stock ownership plan (“ESOP”) – ESOP borrows funds to finance purchase – ESOP purchases stock from principal owner(s) – Selling shareholders may elect to reinvest the proceeds in “qualifying replacement securities” in order to defer capital gains tax – May leverage against bonds to finance diversification – Capital gains are deferred until replacement securities are sold, or eliminated entirely if held until death or donated to charity
  19. 19. Wealth transfer techniques • Technique #4: Employee Stock Ownership Plan – Advantages • Owners/Sellers – Provides liquidity – Diversification without paying current taxes – Beneficial scenarios • Retiring shareholder • Creation of a market for company stock • Relieve company of cash surplus • Employees – Become owners of corporation (motivation) – Retirement benefit
  20. 20. Wealth transfer techniques • Technique #4: Employee Stock Ownership Plan – Disadvantages • Must have individual(s) who are willing and able to continue business after current owners have sold • ESOPs are effective but are subject to many rules and regulations and should be considered only after a thorough examination of all factors involved
  21. 21. Wealth transfer techniques • Technique #5: Intentionally Defective Grantor Trust – Accomplished by selling asset (stock) to trust in exchange for a small cash down-payment and a long-term installment note – “Freezing” Technique • Freeze value of an asset • Freeze return on an asset
  22. 22. Wealth transfer techniques • Technique #5: Intentionally Defective Grantor Trust – Trust • Usually children are beneficiaries • Defective - income taxes are paid by grantor • Income taxes paid on trust income are not additional gift – Sale to trust • Business owner receives cash and installment note for balance • No capital gain on sale • Installment obligation is paid through income received by trust
  23. 23. Wealth transfer techniques • Technique #5: Intentionally Defective Grantor Trust – Advantages • No income taxes on sale to trust • Payment of income taxes on trust does not create additional gift • Trust can control timing and amount of distributions to beneficiaries – Disadvantages • Cash flow may be insufficient to pay installment obligation • Seller’s estate will include balance of outstanding note • Undistributed trust income is subject to higher trust tax rates
  24. 24. Business succession planning • Summary – A number of techniques exist to minimize estate tax exposure while achieving owner’s wishes – A number of factors influence the choice of which technique(s) is appropriate – Whichever technique is used, should be part of a comprehensive financial and estate plan
  25. 25. Wealth transfer techniques • Technique #2: Family Limited Partnerships Parents transfer Family Limited assets to partnership Partnership in tax-free exchange Gifts 99% Limited 1% General Children Partners Partner Grandchildren
  26. 26. Wealth transfer techniques • Technique #4: Employee Stock Ownership Plan Cash Qualified Business Replacement Owner(s) Securities Stock Cash “C” corporation Retirement Contributions Employee Stock Ownership Plan Cash (must own 30% Bank of company) Interest & Principal Payments on Note
  27. 27. Wealth transfer techniques • Technique #5: Intentionally Defective Grantor Trust Cash (gift) Parents Grantor Trust Company Stock Grantor Trust Cash and Parents Company Cash and Stock Note Receivable Beneficiaries
  28. 28. Final Thought • Having a Good Estate Plan Will Not Accelerate the Date of Death
  29. 29. Overview of business succession planning • Private companies have key advantages vs. public ownership – Typically, no separation between ownership and control – Investors have longer term perspective – Management invests less personal and financial capital in managing investor expectations – Flexible organizational structures
  30. 30. Overview of business succession planning • Objective forward planning is critical • Advance planning permits balancing of income, charitable and family wealth issues • Estate taxes are confiscatory yet elective
  31. 31. Overview of business succession planning • Effect of Estate Taxes Without Planning Your Family's Share of Your Estate The Government's Share of Your Estate
  32. 32. Overview of business succession planning • Effect of Estate Taxes With Planning Your Family's Share of Your Estate The Government's Share of Your Estate Estate Tax Savings???
  33. 33. Marketing Strategy • Review All Succession Alternatives • Don’t show bias to one technique • Optimize transfer transaction • Control • Valuation • Identify Liquidity Need • Cost Out Alternatives • Installment Sale at Death • Loans • Life Insurance • Identify Funding Alternatives • Term of payment • Leverage
  34. 34. Questions or Free initial Consultation Please contact: vincegallo@vincegallo.com Or 336.765.0122

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