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Business Succession & Continuation

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  • Business Succession and Business Continuation Planning
    According to the Small Business Administration Office of Advocacy, there are approximately 28 million small businesses in the U.S. The owners of these businesses will at some point have to decide when they will leave their companies, who they will leave their companies to, and how they will be paid a fair value for their share of these businesses. Easier said than done!

    Too many business owners assume that their businesses—which they typically have much of their net worth tied up in—will be their retirement plan. The problem is the vast majority fail to consider how their businesses will succeed them and how they will be able to unlock their investment in the company to pay for their retirement.

    An Orderly Transition When The Time Comes To Leave Your Company
    A company owner may wish to continue working but on a dramatically reduced schedule. She or he may want to transfer complete ownership of the company and move on to retirement or to pursue other endeavors. Or, they may want to structure a buyout with one or more partners or family members, often one of the most difficult maneuvers (proper planning at the start of a partnership is perhaps the most important step a business owner will make). Of course there are a number of additional unique circumstances, each requiring careful planning and consideration if the owner hopes to maximize the return on their investment, preserve wealth, limit the impact of taxes, and manage assets wisely. BCG has vast experience in business succession and continuation strategies. We can help you whether your need is simple or highly complex in nature.

    There are a variety of business succession strategies including: Planning for Death
    A final, but all important consideration is what would happen to the business if the owner were to die? All too often business owners neglect to consider the consequences of not planning for this unfortunate outcome, potentially ending the company’s life as well or leaving partner or heirs with enormous financial obligations. Consider these scenarios:

    When a business owner dies, surviving owners want:
    • Total control of the business without interference from the deceased owner’s heirs
    • A prompt transfer to the surviving owner(s) of the deceased owner’s interest in the company at a fair price
    • The loyalty and support of employees, customers and creditors during and after the transition of ownership
    When a business owner dies, the deceased owner’s heirs want:
    • Ongoing financial security after the loss of the deceased owner’s salary and benefits
    • Prompt settlement of the deceased owner’s estate including proper tax valuation of the business interest
    • Retention of the business interest by family members or a prompt sale of the interest at a fair price
    The existence of a written Shareholder’s Agreement, also called a Buy-Sell Agreement among the business owners will help achieve these outcomes and avoid unhappy consequences.

    Funding Your Business Succession and Continuation Plan
    Of the many business owners who do prepare a formal Buy-Sell Agreement to facilitate the transfer of their business, many forget one very important item: How will the transfer of ownership be paid for?

    Transferring business assets while securing the continuation of your business and the financial security of your heirs in the event of your death, disability or retirement can be hugely challenging and expensive to the company. The choices for funding typically include:
    • Insurance Policies (Buy-Sell Agreements, trusts)
    • External Lines of Credit
    • Internal Sinking Funds
    • Employee Stock Ownership Plan (ESOP)
    Most business owners find that insurance offers a versatile means of offsetting both the risk and expense of a sudden or planned buyout.

    Planning now to fund the transition will maximize your return on your investment and will minimize the succession costs. To minimize the impact on estate and gift taxes and to take full advantage of capital gains benefits, your BCG business succession and continuation consultant can help you put together a smart plan and help you stick to it.
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    Sell Your Business Outright
    There are unique business succession and continuation considerations when you plan to sell your business outright. First, if you sell your business, you will also want to consider the tax ramifications as well as the best ways to invest the proceeds to ensure that you will have a comfortable retirement or that your heirs are well provided for. If the continuing business will be paying a portion of the sale price to you over time, you will certainly want to be sure the company remains healthy and vibrant, and that you are legally protected from financial loss.

    If you are a sole owner, you will want to have the company pay your heirs the fair market value of the business, which would not be subject to gift tax or estate tax. A BCG business succession and continuation expert can provide you with innovative solutions to reducing the impact of taxes and help you build a sound plan to maximize the return on your business investment when the time comes. [back to top]

    Transfer Ownership Through a Buy-Sell Agreement A Buy-Sell Agreement is a legal contract that spells out the details of the transaction between the buyer and seller of a business. A Buy-Sell Agreement puts into writing an understanding of the owner’s or owners’ desires at the time of specific events such as retirement, disability, death, or divorce that could impact the continuation of the business.

    Since a Buy-Sell Agreement binds the owner and any partners to immediately take action based on a triggering event, plans for paying all money due must be in place to prevent the company from having to liquidate part or all of its assets to pay for the buyout. It is advisable to carefully coordinate your estate planning with the terms of your Buy-Sell Agreement. Your BCG business succession and continuation consultant can walk you through the many options. [back to top]

    Form a Family Limited Partnership
    If it is your intention as the owner of a business to leave your business to family members, you will want to give serious consideration to using strategies that will limit any inheritance tax. In some cases where owners had failed to properly plan for business succession and continuation, their companies were forced to liquidate to pay estate taxes.

    By creating a Family Limited Partnership, you effectively transfer the company into a new company. You remain in control of your business and over time gift the partnership to your family members, potentially transferring the business to your heirs at significant transfer tax savings. You will want to consult your legal and tax advisors. Your BCG business succession and continuation consultant will work closely with your advisors to ensure that you are able to maximize your return on your business investment. [back to top]

    Establish a Private Annuity
    This impressive sounding option is actually little more than a formal agreement whereby the buyer, whether a family member or an outside buyer, takes complete ownership of the business in return for regular payments to the owner. The owner, or annuitant, receives the entire principal and accrued interest over his or her lifetime based on fair market value of the business. Therefore, the property that transfer to a trust is not a gift and is not subject to gift tax, and when the annuitant dies, there are no estate taxes because the property was sold.

    Payment structures can also include continuing payments to the owner’s spouse or heirs. A private annuity is an unsecured promise to make these payments and relies on the healthy continuation of the business. Because payments are privately arranged, the transaction is considered a sale versus a gift, allowing the seller to avoid incurring estate or gift tax. You should consult your tax and legal advisors. BCG’s business succession and continuation experts can help you understand the many options that are available to you. [back to top]

    Create an Irrevocable Trust
    An irrevocable trust is a sophisticated business succession and continuation tool that allows a business owner to transfer ownership of appreciating assets including a business, investments, cash and life insurance into another legal entity in exchange for income payments over a specified period of time.

    Also known as a grantor retained unitrust (GRUT) or grantor retained annuity trust (GRAT), the trust effectively removes the assets from the grantor's taxable estate. The grantor is also relieved of the tax liability on the income generated by the assets. Another benefit to the business owner of an irrevocable trust is that it allows him or her to give money and assets away while they are alive without steep tax consequences. While you will want to consult with your tax and legal advisors, a BCG business succession and continuation expert can help you understand the many options available to you. [back to top]

    Use a Charitable Remainder Trust
    Are you interested in a steady income stream, lower income tax and a smaller taxable estate? Would you like to benefit a charity? If so, a charitable remainder trust may be just what you need.

    When you create a charitable remainder trust, you donate an asset, such as stock or real estate, to a trust which you create. A low basis asset is ideal; if you sell it in the trust, you pay no immediate income tax on the gain. The trust document specifies the amount of annual income you receive, which must be between 5 - 50% of the trust value. This income can be a fixed dollar amount or a fixed percentage of the annual value---you decide. It doesn't matter if the trust earns this amount of money---it will come from trust principal if the income is not sufficient. As the income is received by the donor, it is taxable, based on the character of the income in the trust---either ordinary income, capital gain, tax-exempt income or return of principal.

    You receive an immediate income tax deduction in the year the trust is funded, equal to the net present value of the actuarial benefit to the charity at the end of the trust term. This charitable deduction may offset up to 30% of your adjusted gross income and be carried forward for up to five years. You also lower your taxable estate because the asset is no longer included in your estate, since it passes to charity. The trust term can be for one or more lives, or for a period of up to 20 years, as long as actuarially the charity receives at least 10% at the end. The actual amount the charity receives doesn't matter; this is a calculation that is performed when the trust is created. The trust must be irrevocable, and you must give up the right to receive the asset at the end of the trust term.

    Does it bother you that your family will receive less when you die? If so, you can buy life insurance in an irrevocable life insurance trust to replace the after-tax value, perhaps using some of the income stream from the charitable remainder trust. This insurance can be free of probate, income tax and estate tax, leaving even more for your family.

    Here are some examples to illustrate how this technique actually works. The results will vary based on IRS interest rates; these examples are based on current rates available April 2010. They also assume a marginal income tax rate of 28% federal and 7% New York State.
    1. A person age 65 donates land with a fair market value of $300,000 and a cost basis of $100,000 to a charitable trust. She retains an 8% income interest for life, based on the annual value of the trust assets. The assets are put into the trust and then sold, saving income tax of $70,000 on the sale ($200,000 gain x 35%). The donor also receives a charitable deduction of $89,904 in the year the trust is funded, saving additional income tax of $31,467.
    2. A husband and wife both age 70 donate stock with a fair market value of $1,000,000 and a cost basis of $100,000 to a charitable trust. (If you have one stock that is a large part of your overall investments, it may be prudent to diversify, but selling the stock may result in costly income taxes.) They retain a 10% income interest for 20 years, based on the annual value of the trust assets. (They chose a 20-year time period because of their age, worrying that they could lose the benefit if they passed away within the next few years. If they die before the term ends, their beneficiaries will receive the remaining income.) The stock is put into the trust and then sold, saving income tax of $315,000 on the sale ($900,000 x 35%). The donors also receive a charitable deduction of $125,771 in the year the trust is funded, saving additional income tax of $44,010.
    3. A husband and wife both age 60 donate real estate with a fair market value of $500,000 and a cost basis of $350,000 to a charitable trust. They retain a 7% income interest for both their lives, based on the annual value of the trust assets. The assets are put into the trust and then sold, saving income tax of $52,500 on the sale ($150,000 x 35%). The donors also receive a charitable deduction of $84,490 in the year the trust is funded, saving additional income tax of $29,572.
    Sound too good to be true? It's not! Please speak to one of our financial professionals to find out more information about this strategy. Do not act based on this analysis, since there are many rules to follow, they are not all shown here, and you need to retain the services of an attorney to create the trust and advise you on legal matters.


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