Preparing for the inevitable Featured

7:00pm EDT December 26, 2007

With recent activity in the private equity arena, business owners have been placing considerable emphasis on structuring their companies to maximize the price of an ultimate sale. However, smart business owners should begin to position themselves before reaching the top of their game so as to structure their companies for sale from an estate-planning perspective. Tax law developments in recent years, including capital gains and dividend rate reductions, make it imperative for business owners to examine current estate planning so as to minimize the tax cost of transferring the business and maximize its value to the retiring owner or the next generation.

Smart Business asked John Brentin, a partner at Porter & Hedges LLP, how business owners can leverage their wealth, retain their monetary gains and prepare their companies for sale.

Why should business owners be concerned early on with transition planning?

It is inevitable that for every business owner, at some point a transition will occur — by sale, incapacity or death. If there is no heir-apparent, it is then necessary to put in place a mechanism to allow the most appropriate person to carry forward the vision of the founder. Likewise, if there is no one of the next generation capable or with a desire to carry forward the business, a lack of early planning can lead to significant tax liability should a transition be forced upon business owners. In those unfortunate circumstances where there is a death of the owner, without advanced planning, the business can be adversely affected, both operationally and from a cash flow perspective.

How can business owners minimize estate and gift taxes?

The current reality is that there is no repeal of the death tax forthcoming. At rates approaching 50 percent and a current exemption of only $2 million, planning is critical. Since the estate and gift tax is applied to the value of assets being transferred, successful planning seeks ways to transfer wealth while minimizing the valuation of retained assets that will be included in the estate. For those business owners who desire to minimize estate taxes there are several available options. Currently, the annual gift tax exclusion amount is $12,000. This means that a husband and wife can now give $24,000 to as many individuals they care to benefit every year. If they transfer interests in the family business, they can leverage the gift using a qualified appraisal of the interest that is appropriately discounted for lack of control and marketability. Another option is to transfer those interests into a trust established for family members to keep the business within the family for succeeding generations. If large transfers are desired, using a grantor trust may allow them to sell up to their entire business interest in exchange for a promissory note without paying any income tax on the sale.

Why are control, timing and form of business so important to transfer planning?

Control of a business has a great deal to do with the concept of valuation. Further, since our entire transfer tax system is based on value, timing also plays an integral role. Finally, not all forms of doing business are created equal. Today’s business owner has a wide array of choices, and some structures are better suited than others to facilitate a transition of ownership.

From a timing perspective, the ideal times to begin a transfer of ownership process are at the initial start-up or during an economic downturn. The value of the company is lower, which is a benefit for valuation purposes in tax planning. Based on the options available to minimize estate taxes during such a period, an owner has the ability to retain control while putting in place a mechanism to facilitate the transfer of the value to the next generation.

Finally, formulating a succession plan often reveals that the original structure of the business entity may no longer be appropriate. Recent amendments to Texas statutes and changes in federal tax law make it easy to convert from one form of business to another. A successful plan will always assess and isolate risks and potential liabilities. If a particular facet of the business operation produces a greater risk, it may be appropriate to form an additional entity to conduct that part of the business operation.

How flexible should you be with your transition plan?

It is wise to plan for all contingencies and allow for flexibility in your transition plan, knowing that every circumstance planned for will not actually happen. Building in flexibility allows those left in charge to react to unforeseen conditions. A transfer plan that reacts to the ebb and flow of the business world can help alleviate the worries and assure the continued success of the enterprise.

JOHN BRENTIN, a partner at Porter & Hedges LLP, is in charge of the firm’s wealth preservation practice. Reach him at (713) 226-6663 or