BUSINESS SUCCESSION PLANS & TECHNIQUES
A problem with most successful closely held businesses is that they can have a large value for transfer tax purposes, but it can often be rather difficult to turn this “paper value” into cold, hard cash if necessary. There is no established market for the sale of closely held business interests. This is what prudentbusiness succession planning is designed to accomplish.
Sooner or later everyone wants to retire, or there is a desire to "cash out." But, if one is in a partnership or a solely-held business, retirement isn't just a matter of deciding not to go into the office any more. Besides ensuring that you can extract built-up cash value and have enough money to retire on, the whole question of what happens to the business becomes paramount. Who's going to take over your role in a multiple ownership? Who's going to manage the business when you no longer work? How will full or partial ownership be transferred? Will your business even carry on or will you sell it outright?
Business succession planning techniquesseek to manage these issues, setting up a smooth transition between you and the future owners of your business. With family businesses, succession planning can be especially complicated because of the relationships and emotions involved - and because most people are not that comfortable discussing topics such as aging, death and their financial affairs.
Perhaps this is why more than 70 percent of family-owned businesses do not survive the transition from founder to second generation. In most cases, the "killer" is taxes or family discord, both issues that a good business succession plan will cover.
A change in business entity form may be necessary to allow multiple owners, if the original was a sole-proprietorship. Techniques or strategies that might be used to continue the business in the family include converting to an S corporation or a family partnership, doing a preferred stock recapitalization, a partnership capital freeze, an installment sale, a self-canceling installment note, and a private annuity. Different classes of ownership interest may be necessary to allow the owner to achieve multiple objectives in the transaction.
Some of the techniques we may use:
The first term obviously would apply only when the entity involved is a Corporation, and the 2nd when the entity is a Partnership (general or limited.) These techniques can be performed while maintaining control and payment of income from the business. To achieve the goal of limiting or freezing the value of the business in the owner's estate, the owner retains a type of ownership interest that has a fixed liquidation value. This feature puts a cap on the value of the interest regardless of the growth of equity in the business later on. Also, once the recapitalization is finished the owner is in the position to gift or sell the appropriate ownership classes to family members.
A slight variation of the normal installment sale occurs (see above) when the installment note contains provisions that the purchaser's obligation to pay the note will be canceled if the seller dies prior to the node being paid in full. Various estate /income taxation issues usually apply.
When an installment sale occurs, instead of paying the unpaid purchase price in a fixed number of installments, it can be paid over a period of time that is determined by one or more (usually not more than two, e.g. a husband and wife) person's lifetime(s). The amount of each payment is determined by dividing the fair market value of the property by the annuity factor shown in the government actuarial table.
If an installment sale as outlined above is not feasible, or if no purchaser can be found, a sale of the business to an employee stock ownership plan (ESOP) may be a possibility. While an ESOP is most often used as a corporate financing tool, and a deferred compensation plan to motivate company employees, it can also be used as a business succession device. A leveraged version of this plan is called a LESOP for "Leveraged Employee Stock Ownership Plan." In the case of a LESOP the funds to purchase stock from the owner(s) on behalf of the employees are borrowed from a bank. This comes with tax advantages to the business.
A business reclassification will be required for unincorporated closely-held businesses in order to issue company stock.
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