SUCCESSION PLANNING. Business Succession Planning

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1 SUCCESSION PLANNING Marty Roos Laura C. Mason John Willding Business Succession Planning The average business must reinvent itself every ten to fifteen years to consider the following: Market changes; age; and demographics Technological changes Competition Complacence Most family businesses survive only one generation Failure of family relationships Failure to prepare the next generation to lead the business Tax Symposium 1

2 Need for Business Succession Planning Succession Planning needs to be thought through five to seven years before succession event, whether that be to pass the property to the next generation or to sell the business. The size of the of the business is not relevant: if the owner and/or children depend on the business for their livelihood, succession planning is necessary. 3 Need for Business Succession Planning Whether the business is sold or passes to children, the business owner needs to consider: Is this business my retirement? Are their children involved in the business? Likewise are there some children not involved in the business? Can family members work together? Is there a family member or key employee that could run the business? Estate planning and estate taxes play an essential part in the business succession process. Estate planning documents and business documents need to consistent with business disposition planning Tax Symposium 2

3 American Taxpayer Relief Act of 2012 Extends many of the Bush tax cuts of 2001 and Other relevant provisions: Top rate of 39.6% (up from 35%) will be imposed on individuals with taxable income of more than $400,000 a year ($450,000 for married couple). Imposes a 20% tax rate on capital gains and qualified dividends that would otherwise fall in the 39.6% tax bracket. Below that level, the lower 2012 rates remain in effect. The 3.8% Medicare tax on investment income went into effect 1/1/13. 5 Limited Partnerships Limited partnerships can be a good vehicle for succession planning, gifting, and estate planning, as discussed above. Note: IRS may in near future issue regulations regarding discounts on intra-family transfers. Isolation of control in a separate general partner entity (often an LLC). Economic interests through limited partnership interests Tax Symposium 3

4 Structure of Texas Limited Partnership Husband 50% Member Wife 50% Member XYZ, LLC (Texas Limited Liability Company) 1% General Partner Husband 49.5% Limited Partner ABC, Ltd. (Texas Limited Partnership) 100% Property or other Assets Bar Business 100% Wife 49.5% Limited Partner 7 Limited Partnerships/Limited Liability Companies LPs and LLCs provide potential to transfer by gift or bequest limited partnership interest with little control element. Can be effective in succession planning. Use of LPs and LLCs can minimize estate taxes otherwise payable. Protection of Assets Charging Orders Avoid contribution of personal assets Consider what it means to be partners or co-owners with family members, including pro rata distributions. Transfer of interests and limitations to incorporate into governing agreement (spouses, in-laws, etc.) Tax Symposium 4

5 Three Strategies for Succession Planning Shelve It: The generation operating the family business desires to maintain control for the time being. A succession plan is not actually developed. An estate plan is put in place for the controlling generation. Value of business may be lost. Sell It: The operating generation wants to shift appreciation and control, but there is no one in the family to take on the business; or everyone agrees it s time to sell. Decide whether to sell to a competitor, take the business public. Decide whether use proceeds of the sale or public offering to start a new business or retire. Pass It Down: The younger generation is capable and ready to operate the business. Shifting of either, or both, of business appreciation and control. Business continues, but there are questions: Who gets control? Who gets ownership? Who gets employment? Value for Older Generation? 9 Shelve It Two Friends and Our Wives, LLC Business was owned by two members, one of whom died. Deceased member was the sole manager and majority owner. No buy-sell in place. Poor governing documents lead to confusion over disposition of ownership interests. Minority member assumed management responsibility. No succession plan was ever put in place. Deceased member wanted to keep majority interest and management control during his lifetime Tax Symposium 5

6 Shelve It Two Friends and Our Wives, LLC Parties headed towards litigation and hired separate legal counsel. Lawyers were unable to resolve differences, but all parties wanted to continue the business. The surviving member and the spouse of the deceased member worked out agreement to continue business and sell at a later date. Deceased member s spouse transferred some ownership to the surviving member, providing incentive to keep the business going and growing. Deceased member s spouse, surviving member, and his spouse, are all involved in management. All three now realize the importance of putting a buy-sell agreement in place within their LLC Company Agreement. They are also looking at implementing employment agreements with non-compete provisions for key personnel to make the business more attractive to potential buyers. 11 Sell It Buy, Sell, or Litigate, Incorporated. The family (parents and three of the four children) own a chain of convenience stores as well as real estate holdings. Parents were the initial owners, but through gifts and stock purchases, the children became owners as well. Parents are now divorced. Mom is not active in the business, but Dad remains active. One of the children passes away unexpectedly, leaving her interest to her sister, the one child not involved in the business. Dad and the two children continue to own and operate the business. Grandchildren are now involved in the business as well Tax Symposium 6

7 Sell It Buy, Sell, or Litigate, Incorporated. The family business was highly successful, but the family lacked a clear vision for succession or sale. One of the children desired to sell the business, the other child wanted the business to pass to the next generation (grandchildren). We were initially brought in to update the buy/sell agreement between the two children in the business, which was ten years old at the time. Under the agreement, the surviving spouse of a child was to receive $1 million. The Company s interest was in fact worth close to $50 million, so $1 million was far less than pro rata value. Out-laws do not get along. One spouse refused to sign the original buy/sell or any revised agreement. Litigation waiting to happen? The child not involved in the business lived outside of the state, and had no desire to be involved in the operations of the business. This lead to resentment from the other living siblings, who are actively involved in operations (and dealing with mom and dad). 13 Sell It Buy, Sell, or Litigate, Incorporated. Should Mom s interest be bought back by the company, now that she is no longer active? How should the parents address these issues in their estate planning documents? Should the child not involved in the business receive an ownership interest in the business upon death of the parents? If not, how can they equalize the gifts between the children? Proceeds from life insurance? How do the owners prepare the business for sale or succession where one family member has no desire to be involved and there is disagreement as to how to proceed? What are the best ways to make a family business appealing to potential buyers? Tax Symposium 7

8 Pass It Down Texas Tea, Inc. The patriarch groomed his son to take over the oil company he founded, and carefully drafted an estate plan to provide for his daughter, who did not want to be involved in day-to-day activities. Patriarch died unexpectedly, and the next generation had to scramble to implement the succession plan perhaps before they were ready. Estate planning was clear and complete. There was an attempt to equalize value of the estate between the heirs, whether involved in the business or not. Extensive charitable planning was incorporated to minimize tax at death. During life, Patriarch had transferred interests in various business entities to next generation to begin implementation of succession planning. Unique assets to dispose of as part of estate administration aircraft. 15 Pass It Down Texas Tea, Inc. Patriarch retained control of the main operating entity. At his death, the heirs were in agreement as to how this entity was to be run. We were able to implement corporate documents to elect managers and officers and delegate responsibilities to keep the business active. Without cooperation between the heirs, this would not have been possible. Poor family relations are the main cause of the failure of family businesses to survive from one generation to the next. Texas Tea, Inc. also had an established stable of professional advisers: attorneys, CPAs, and the permanent employees of the operating company all knew what had to be done to implement a successful transition. Despite the sudden transition, good facts and good relations between the heirs allowed for a successful transition Tax Symposium 8

9 Pass It Down Or Not? I Hate You, Too, Inc. Husband and wife had built a successful staffing business, but the husband died, leaving the wife in complete control. She was also the face of the business and had managed it for years. The couple s two daughters were already involved in management, and had been gifted ownership interests in the business before the husband died. The wife wanted the two daughters to each have an equal opportunity to take over the business. Though both excellent in their positions, they did not get along. 17 Pass It Down Or Not? I Hate You, Too, Inc. Husband s will did not make specific elections to allows the trusts it created to hold S-Corp. shares. This proved a costly mistake, but it was curable. The estate plan should address the business. The wife involved the daughters in the plan for business succession and the drafting of a new shareholders agreement. Emotional confrontations in an attorney s conference room are not uncommon in business succession planning. Daughters were able to work for a period of time together in effort to keep business alive Tax Symposium 9

10 Pass It Down Or Not? Family breakdown happened again, resulting in one daughter no longer being involved in the day to day business operations, but remains an owner. shareholders agreement incorporates a push-pull provision, assuring that if one daughter wants out of the business, the other will get the opportunity to be the sole owner, and the departing daughter will get a fair price. The wife s estate plan equalizes the balance of the estate between the daughters. Good idea? If the one daughter remains in the business, but splits any profit equally with her sister, may lead to resentment. 19 Question & Answer Segment Tax Symposium 10