Business Succession Planning Part II: Critical Tools
In Part I of business succession planning, the critical importance of business succession planning to the small or family-owned business was discussed. In Part II, some of the common tools used for transitioning a business to the next generation are introduced.
As an owner of a small or family-owned business, you can choose from many tools to transition your business to the next generation of leadership and maximize tax savings. It may simplify things to think of most business succession planning tools as falling into one of two categories: selling your business interest or other income-generating tools; and gifting your business interest.
Sales of Business Interest
If you are interested in selling your business to a family member, key employee or a third-party, you may want to consider a buy-sell agreement, a simple loan or, perhaps, even a Grantor Retained Annuity Trust (GRAT) or a Grantor Retained Unitrust (GRUT). The buy-sell agreement is a legal contract that dictates, in advance, the terms of sale of your business interest to a willing buyer. A buy-sell agreement allows you to remain in control of your business until a triggering event occurs, such as retirement, disability or death. Upon the triggering event, the buyer is obligated to purchase your business interest in accordance with the terms of the buy-sell agreement.
A second income-generating option is a simple loan. Consider lending funds to your successor, so he can purchase some or all of your business interest. As a lender, you receive payments plus interest from the promissory note for a definite period of time, while effectively transferring your interest in the business out of your taxable estate. This simple, less-costly alternative is especially appealing, since promissory notes offer flexibility and both parties can agree mutually upon the terms of repayment. A loan also works well within any estate plan, because a person can draft specific instructions into his Will or Trust Agreement directing that the Fiduciary extend the note for a certain additional term upon its expiration.
If the idea of receiving a regular stream of income appeals to you, consider a GRAT or a GRUT. It sounds more complex than it is. To use either, first, establish an irrevocable trust to hold appreciating assets (in this case, your business) and name a beneficiary to the trust (such as your children or other named successor). The goal of a GRAT or a GRUT is for the Grantor to pass interest in the business to the beneficiaries of the trust, and, in return, the trust pays the Grantor annuity income for a set term of years. A downside to using a GRAT or GRUT is that the funds may be included in the Grantor’s estate, if the Grantor does not outlive the GRAT/GRUT term.
Gifting Business Interest
If you are less concerned about income generation, consider gifting your business interest to your successor or creating a Family Limited Partnership (FLP) or Family Limited Liability Company (FLLC) and gifting your shares in either entity to a family member.
For 2011 and 2012, the annual exclusion for Federal gift taxes is $13,000, and the lifetime gift tax exemption is a generous $5 million. This presents a unique opportunity for succession planning. Under current federal laws, a person can gift up to $13,000 to any number of individuals per year and not pay any gift tax on those transfers. In addition, a person also may gift up to $5 million dollars during a lifetime (in addition to any annual exclusion gifts he may have made) without being subject to gift taxes. By establishing an annual gifting plan, you can gift some or all of your business to your successor over time, without paying federal gift taxes, while reducing the size of your taxable estate.
If your plan is to keep your business in your family, consider a FLP or a FLLC. First, you must form a business entity, known as a Limited Partnership or a Limited Liability Company. Next, you transfer your business interest into the partnership or LLC. As owner, you continue to hold a general partnership interest for yourself, or if you’re using an LLC, you hold your interest as a managing member of the LLC, and maintain control over the company. Once you have established the entity, you can begin gifting your limited partnership interest or your membership interest to a family member who is already involved in the day-to-day operations of the business. Through proper and appropriate planning, you can maximize the value of your gift by taking advantage of certain valuation discounts.
It is critical to bring your lawyer and accountant into this discussion early to develop the right plan for your business. Once you have developed your succession plan, remember to revisit it as time passes and circumstances may change; an outdated plan can be just as ineffective as no plan at all.
Tim Hughes is a shareholder in the law firm of Bean, Kinney & Korman in Arlington, Va., and lead editor of the firm’s blog at www.valanduseconstructionlaw.com. He can be reached at firstname.lastname@example.org.
Lauren Keenan is an associate in the law firm of Bean, Kinney & Korman, practicing in land use law and estate planning. She can be reached at email@example.com. You can also call 703-525-4000.
- 45May 2011 Business Building Thanks, but No Thanks! By George Hedley Over the last 25 years, our construction company has built more than 500 projects and hired at least 10,000 subcontractors. As I think back, I don’t recall receiving a thank you note from a subcontractor, ever, for any reason. It seems the art of…
- 43July 2010 Business Building 7 Steps To Business Failure By George Hedley Everything is changing in the business world today. The new reality of too much competition and too little profit has become an ongoing challenge. As you get tossed around on this sea of constant change, the basic business fundamentals remain the same. Here…
- 43October 2012 Business Building Profit Is Overrated By George Hedley Ask 50 construction company owners what a perfect business would be like for them. You’ll likely get 49 different answers. But, one common focus will stand out: Business owners want to create equity and build wealth. Equity and wealth are the outcome of consistently making…
- 39April 2013 Government Affairs Estate Tax Op-Ed Congressman Tom Rice (SC-07) Family business owners and entrepreneurs are all too familiar with our country’s onerous estate tax. The fiscal cliff negotiations at the end of last year halted the 55 percent estate tax rate from again taking effect, but the negotiated 40 percent rate and $5.12…
- 36September 2011 Legal Issues Succession Planning Failing to Plan is Planning to Fail By Timothy R. Hughes, Esq. and Lauren K. Keenan, Esq. Editor’s Note: This is part one of a two-part series. Most subcontracting firms are closely held businesses owned by either a family or a small cadre of owners. Running the business generally…