Creating a Successful Transition

Strategies for Family-Owned Businesses
by Michael Bass

Just as every business is unique, business owners, too, have an endless variety of needs, objectives and hopes for the future of their companies. You may be wondering how and when you can step back from the business some day.

Getting a grasp on your business transition needs—and the many alternative strategies available to you—will provide a framework for achieving your goals.

Transition planning begins with analyzing the complexities of your business—including family and employee stakeholder interests, management succession needs, shareholder expectations and potential tax liabilities—to develop a complete picture of your current situation.

Stepping Down, Cutting Back or Moving On
There are many reasons you may be considering a transition. You may be eager for a well-deserved retirement. You may be ready to move on to another endeavor or feel it is time to hand over the business to the next generation. Perhaps you simply want to step back from day-to-day operations or think this is an optimal time to sell, merge or spin off the company. Whatever the reason, there are things you can do now to ensure a successful transition.

Discovering the Right Transition Strategies for You
Whatever you’re envisioning for the future of your business, chances are you can make it happen. But you’ll need to begin by plotting your course and identifying and removing potential obstacles.

Charting Your Course
The most critical undertaking as you begin this process is to identify and develop goals and objectives for your business, your family and yourself. This is a course that will become more refined as the future converts unknown factors into actual conditions. It is important that the plan has been established and developed as fully as possible, so that over time it can be implemented quickly and alternatives considered where appropriate.

Once your goals and objectives have been identified and delineated in as much detail as is practical, the next step is to examine your business and all of its characteristics, attributes and challenges. This phase identifies modifications that can be made to various aspects of the business (management, ownership, tax structure, governance, etc.) to more closely align with and meet your business objectives.

Perhaps your personal mission is to retire in great health at 55 years old with financial independence and a strong management team in place. And the mission of your company may be to exceed your customers’ expectations and industry norms for profitability while being a good corporate citizen and rewarding your employees.

To achieve your personal and business goals, your succession plan and strategic business plan must be coordinated and managed around these objectives. This will require careful selection of your successors and others who will carry out your plans as you begin the process of stepping back.

Developing Your Process
Devise a timeline for the transition process that will allow your successor to assume leadership gradually. Allow yourself plenty of time to prepare for departure, while making yourself available to lend professional advice to your successor.

Transition Strategies and Techniques
There are many strategies available to make your transition easier, reduce unnecessary tax erosion, and accomplish your goals in the most effective manner possible. Components of this plan may include the following:

  • Gifts of interests in the business. If the plan calls for family members to own interests in the business, a variety of structures are available to make transferring that interest more tax efficient. Variations of the transfer structures can segregate the control and value aspects of the business into separate interests that can be transferred to different family members. This can better reflect the family members’ proper relationship with the business and other family members. Transfers such as these can be designed to affect a systematic transfer mechanism over a period of years, or actually postpone the recipient’s beneficial ownership and control of the business interest being transferred.
  • Conversion of value to cash. A number of options exist to convert a portion of your interest in the business to cash. This can accomplish a variety of goals, including diversification of your wealth, increasing cash flow and reducing your ownership of the business for tax planning purposes.

Among the techniques to accomplish some of these goals are: (1) restructuring of the business entity itself so that it is more tax efficient, such as an S Corporation election, (2) spinning off a division into a separate entity that can be dealt with independently from the original business, or (3) repurchasing some (but not all) of your interests in the business.

  • Payments of phantom stock, stock appreciation rights, stock option and other equity participation plans. These arrangements can be designed to motivate and retain key employees, make them think and act like owners, and give them an equity position in the company that is protected by a buy-back program. If the optimum plan is to continue to operate the business for the benefit of the family, the successor management needs the incentive to continue with the company. They also need the assurance that their interests are protected and are consistent with those of the controlling owners. These arrangements require employees to pay taxes only, rather than the actual cost of purchasing ownership.
  • Employee stock ownership plan (ESOP). An ESOP can be a means of motivating employees through a long-term ownership position in the company. Where this tool aligns with your goals, it can provide a very effective method of motivating and rewarding employees who have helped you achieve success in the business. An ESOP can be a very tax-efficient way to provide investment diversification for you and tax benefits for the business.
  • Sale of the business. In some cases, the analysis of the business in relationship to your goals will lead to a conclusion that the business should be sold. Some business owners will want to embrace this option only after a thorough analysis and investigation of all other options. For others, it may be their first choice. In either case, substantially better results can be achieved by long-range planning and preparation to take full advantage of various structures and tax benefits in completing the sale. Timing is crucial, and a longer period for preparation provides opportunities to benefit all stakeholders in the business and, potentially, charitable organizations and initiatives whose goals and vision you share.

Contact your tax advisor for more information on transition strategies and their potential tax impact including:

  • Developing your unique transition plan
  • Reducing future transfer costs and estate taxes
  • Enhancing the benefit of any life insurance assets
  • Business control agreements
  • Family partnerships
  • Business entity structures
  • Compensation devices. iBi

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