Tim McDaniel

How many times have you received a 500 percent increase on a tax exemption? The federal gift tax exemption did just that — going from $1 million to $5 million for an individual and from $2 million to $10 million for couples — but only for 2011 and 2012.

As a result, you have a unique opportunity to make a monetary gift or interest in your business over the next 20 months that could be tax-free now and shielded from future appreciation from taxes.

Taking advantage of this window of opportunity may require you to think about some thorny issues that you’ve been putting off — including establishing or finalizing the succession plan for your business, and your retirement and estate plan. It’s important to keep in mind that you can develop a succession or retirement plan without putting it fully into action. And it’s far better to have a plan in place that allows you and your family to take advantage of a more generous tax code while it lasts, than to have no plan in place and miss the opportunity to transfer more of your wealth now.

Taking the First Step

The first step in this process will be determining what you plan to do with your business. Has it always been your plan to gift your business to your family? Have you discussed it with them? Do they share your interest in continuing the business?  Will they be have the skills and knowledge to lead it, if not soon, in future years? You’ll also want to address how you can treat other family members who are not in the business equally and fairly in your estate and succession plan.

If you plan to transition your business to family members eventually, consider gifting at least a portion of stock now, while the gift tax ceiling is low and the value is depressed due to the recession, even if you aren’t ready to actually complete the transition. You can maintain control of the business by issuing non-voting stock or retaining a majority of shares in your company. Use this time to mentor family members so that they learn the skills they will need to successfully take over the business when the time comes.

When You’re Not Sure

If you are unsure whether you will transition your business to the next generation, it may still make sense to gift a portion of stock to your family now while the gift tax limits are more favorable. If you do eventually sell your business, your family will still benefit from the sale of their shares in the company.

If You Plan to Sell

When you are certain that you will eventually sell your business, you may still wish to gift a portion of stock in the business to family members. As noted above, your family would benefit from the eventual sale of their shares. Knowing that you plan to sell your business also sets up a different set of goals to grow its value. You’ll make management decisions that help you grow your biggest investment over time, just as you would grow the funds in your stock portfolio.

Knowing Your Business Value

No matter which path you choose regarding the future of your business, the most important step when preparing for gifting is determining the value of your business. It is easy for a business owner to develop an idea of what they think their business is worth. However a valuation that reviews financial statements and comparable businesses can result in a realistic, but totally different, number. You don’t want to be blindsided by unrealistic expectations.

A business valuation can help you make management decisions that will enhance the value of your business before and during the transition process. This “investor’s mindset” can help you identify potential risks and minimize them, look for sustainable growth in your product or service lines and keep a close eye on cash flow. Certainly the earlier and more frequently you conduct a valuation of your business, the better informed you’ll be when making management decisions that will impact your company’s value.

Ensuring Your Retirement

Along with determining what will happen to your business in the future, you’ll need to consider your retirement needs. Is your current nest egg enough to sustain you in retirement? You may have time to adjust your current company pension plan to help you better prepare for retirement. For example, you might consider a profit-sharing, defined-benefit plan or even staying on at your company as a consultant or salaried employee after the transition. Your financial advisor can assist you in developing ways to meet your retirement as well as your business goals.

Now is the Time

No matter which path you choose to take with your business, you’ll never have a better opportunity to transition wealth to your family that you have during 2011 and 2012. Because sorting through your professional and retirement goals takes time, begin by setting aside planning time to begin the process. Then you’ll be able to present your gifts to take advantage of today’s generous gift tax limits.

Tim McDaniel, CPA/ABV, ASA, CBA, is a principal with Rea & Associates, Inc., a regional accounting and business consulting firm. He specializes in business valuation and succession planning and also consults with family businesses regarding family integration and succession planning. He can be reached at (614) 889-8725 or tim.mcdaniel@reacpa.com.

How will you transition your business to the next generation when it’s time to leave? If you are like more than 70 percent of closely-held business owners, you’ve put off making this important decision. However, without preparation, most family-owned businesses are not successful in making the ownership change when the time comes. In fact, nearly 70 percent of all family firms do not reach the second generation, and 88 percent of family firms do not reach the third generation.

Much like a scheduling a routine physical or creating a will, succession planning is critical, but not urgent, so it continues to be pushed lower on your to-do list. Resist the urge to put off doing this crucial task. Just do it! Here’s how.

Step 1 - Making the Decision

Making the decision to create a succession plan is the first step in the process for transitioning your business. Set a deadline of nine months to one year to complete your succession plan. Schedule four to eight hours each month into your calendar to work on your succession plan and dive into the process.

Remember that establishing a succession plan won’t tie you to one solution for exiting your business. It is understood that the plan will be a “living document” that you will definitely revise as your life circumstances change and as the marketplace changes. Having this ‘roadmap’ in place will make it easier to react to these life changes — and choose which fork in the road will best meet your needs. It certainly beats being lost in the wilderness with no map or GPS to guide you.

Step 2 – Know the Value of Your Business

Will the business you’ve worked so hard to build help carry you to retirement? Typically 50-70 percent of a business owner’s net worth is tied up in the business. Having solid data on what your business is worth will help you make management decisions that help you grow your biggest investment — your business — over time, just as you would grow the funds in your stock portfolio.

This “investor’s mindset” might include identifying potential risks and minimizing them, looking for sustainable growth in your product or service lines and keeping a close eye on cash flow. Certainly the earlier and more frequently you conduct a valuation of your business, the better informed you’ll be when making management decisions that will impact your company’s value.

Your business value becomes even more important as you get closer to transitioning it. Having the valuation information will greatly help you and your financial team plan for tax implications and investment strategies as you go through the transition.

It is easy for a business owner to develop an idea of what they think their business is worth. However a valuation that reviews financial statements and comparable businesses can result in a realistic, but totally different, number. Don’t be blindsided by unrealistic expectations. Invest in a business valuation and use it to make management decisions that will enhance the value of your business before and during the transition process.

Step 3 – Know All the Options Available

The best option for transitioning your business will depend on your goals and what is most important to you when the transition is completed. The options can include:

Giving It Away

 

  • A popular option for business owners ensuring the continuation of the business through family members can include gifting all or part of the interest in the business to family members or employees, selling the company to family members or employees or a combination of both.
  • Advantage: The legacy of the business continues.
  • Disadvantage: Results in less cash, can be impeded by estate tax.

With today’s discounted business values, now is a great time to gift interest in the business. You’ll be able to gift a greater percentage of ownership (than during times when business values are higher), and the recipient will get a greater gift tax exemption through 2012.

Employee Purchase

 

  • Employee Stock Ownership Program (ESOP) — for businesses with no family to transition it to.
  • Advantage: Ensures the continuation of the business, provides employees with a greater interest in its success.
  • Disadvantage: Can be costly to implement.

Selling Out

  • Sell the business outright to either a financial or strategic buyer.
  • Advantage: Strategic buyer, so owner normally achieves the maximum price.
  • Disadvantage: Strategic buyer, so if purchased by a supplier, competitor or ancillary business in the marketplace, will often decrease duplication which may cut jobs, could be differences in culture for existing employees.

Stepping Away

  • Maintain interest in the business but walk away from the day-to-day duties.
  • Bring in a professional management team.
  • Allows owner to receive economic benefits while leaving the headaches to someone else.
  • Owners maintain ownership until return on their investment can improve.

No plan can mean liquidation. If you don’t have a plan for the transition of your business, the final result can mean liquidation of the business and its assets upon your death. This often results in the lowest value for the business and can have a devastating effect on employees.

Step 4 – Assessing Where You, Your Family and Your Business Are

When you own a family business, it can be easy to put off having those important, strategic discussions with your family about the future of your business. However, communication between you and your family becomes an essential ingredient of a successful business transition.

Begin by answering some very specific questions. Determine what the goals are for the business. If the goal is to transition the business to your children or other family members, ask them their goals and desires. If they share your interest in the business, begin to plan how they can participate, how they will be trained and how you can help them become successful. Develop policies and criteria for hiring family members into the business. Will they be required to go to college? Work outside the business for a few years? Address family members who do not wish to be involved in the business. How will they be treated fairly in the estate?

Laying every family member’s goals and desires out on the table is extremely important for the succession planning process and for the future of the business. But it’s not always an easy process. Often family relationships can bring sensitive issues to planning sessions. Using an outside advisor that you trust can help you facilitate this meeting and keep the discussion focused on the future of the business and working toward meeting everyone’s mutual goals.

By developing a well-defined family strategic plan that is interwoven into the business strategic plan, you can build communication and consensus on common goals. This can lead to increase productivity and better management decisions.

Step 5 - Setting a Course of Action Involves Communication, Timing

Communication is a key element of a successful business transition. The sooner you determine your course of action and share it with your family and key personnel, the more quickly everyone can work together toward the goals.

Each person involved in the business must understand the chosen plan of action and clearly understand the one thing he or she must do, above all else, to make the plan successfully hit its targets. Each key member of the team must be committed to the plan’s success.

Timing of the transition is a second crucial part of a successful business transition. If you intend to sell your business, the best time to do it is when the economy is in an up cycle. But if you want to gift your stock in the business to others, make your gift when the business value is at its lowest.

Analyze key indicators such as economic conditions, interest rates, industry trends, buyer activity and your company’s performance and overall organization — and take the appropriate action at the most opportune time.

The merger and acquisition market is depressed in the current economy and activity has remained low for an extended period of time. If your transition plan involves selling your business, allow enough lead time to enhance your profitability and make the business more attractive to a buyer now. Then, you’ll be prepared to sell when the tide rises on the next economic wave.

Step 6 – Executing and Reassessing Your Plan

Your succession plan is a fluid document. Things don’t always go as you planned. Economic conditions may change, new regulations may impact your products or services, key personnel or family members may leave or change their mind about their role.

The key is not to give up or retreat. If conditions change, reassess your plan and determine alternative ways to reach your goals. Hold quarterly meetings with key personnel and family members that focus only on succession issues. These meetings offer an opportunity to remind everyone what the plan entails and how each key person contributes to the success of the plan.

Determine if the plan still makes sense under current conditions and take the opportunity to change tactics if the situation warrants. For example, the tax package that Congress recently passed makes the next two years the perfect time to gift interest in your business if this is one of your transition goals.

You, as the business owner, must commit to the plan and schedule time to make sure it is executed properly. If you don’t believe in the plan or don’t take it seriously, it’s hard to expect the people around you to help you execute it.

Building and implementing a succession plan for your business isn’t easy. It takes a strong commitment and a lot of time and attention. However, the process pays off in several ways. You’ll have peace of mind that comes from determining a logical exit plan for yourself, and you’ll know that all those around you know and understand your plan and willingly work to help you succeed.

You’ll know that the future of the business you worked so hard to develop has been determined, and the tactics to help reach that future are in place. And you’ll be better able to make strategic decisions about your business that may impact both current and future plans.

As the old saying goes, failing to plan is planning to fail. Improve the chances that your business will be successful into its next generation by beginning the succession planning process.

Tim McDaniel, CPA/ABV, ASA, CBA, is a principal with Rea & Associates, Inc., a regional accounting and business consulting firm. He specializes in business valuation and succession planning and also consults with family businesses regarding family integration and succession planning. He can be reached at (614) 889-8725 or tim.mcdaniel@reacpa.com.