The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. NOTE: If you are seeking CPE credit, you must listen via your computer — phone listening is no longer permitted. Drafting Tax-Effective Succession Plans for Closely-Held Businesses: Navigating Competing Concerns Ensuring Business Continuity, Preserving Owner Liquidity, and Minimizing Tax Liabilities Today’s faculty features: 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUESDAY, SEPTEMBER 8, 2015 Presenting a live 90-minute webinar with interactive Q&A Brian M. Annino, Member, Annino Law Firm, Atlanta Julius H. Giarmarco, Chair of Trusts and Estates Practice Group, Giarmarco Mullins & Horton, Troy, Mich. Martin S. Varon, Partner, IAG Forensics & Valuation, Marietta, Ga.
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The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
NOTE: If you are seeking CPE credit, you must listen via your computer — phone listening is no
longer permitted.
Drafting Tax-Effective Succession Plans for
Closely-Held Businesses: Navigating
Competing Concerns Ensuring Business Continuity, Preserving Owner Liquidity, and Minimizing Tax Liabilities
September 8, 2015 Considerations for Counsel in Designing
Succession Plans 5
Why be concerned about succession planning?
• Ensure continuity of a family-held or closely held business.
• Reward key employees for loyalty.
• Avoid family disputes or protracted litigation.
• Legacy and retirement planning.
• Ensure a market for purchase of business interests that otherwise would not exist.
• Ensure liquidity of a deceased shareholder’s estate.
• Insurance for a family business.
September 8, 2015 Considerations for Counsel in Designing
Succession Plans 6
Who is the client?
• Are you representing the business entity or a shareholder? – Review ABA Model Rules 1.7 and 1.13 (as may be
adopted in your jurisdiction) – Be wary of conflicts of interest. – When in doubt, ensure that shareholders with
competing interests are represented by independent counsel.
• Red Flags: When a shareholder asks you to keep a secret from other shareholders or seeks counsel as to what is in “their best interest.”
September 8, 2015 Considerations for Counsel in Designing
Succession Plans 7
Understand the client’s goals!
• Meet client and understand their goals and objectives. • It’s our job to listen to our client’s goals and advise of
how to accomplish them in a lawful tax-efficient manner.
• Example: Clients, a husband and wife, want to transfer business they wholly own to children. They are interested in making transfer during their lifetime but are concerned about unnecessarily paying taxes. – Clients’ goal is to transfer business to children. – Determine value of business and analyze if business can be
transferred during lifetime in tax-efficient manner and analyze benefits of same vs. waiting until the second spouse to pass away.
September 8, 2015 Considerations for Counsel in Designing
Succession Plans 8
Explore the Options (Today’s focus)
• Trusts and family-limited partnerships
• Buy-Sell Agreements
• Asset Purchase Agreements and Mergers
• Inter vivos transfers to family members
• Funding options for purchases, acquisitions, and mergers.
September 8, 2015 Considerations for Counsel in Designing
Succession Plans 9
Utilize a teamwork approach
• Quarterback the team as legal counsel.
• Engage tax counsel or a CPA (if nec.)
• Utilize a Certified Valuation Analyst – Too often overlooked, but a proper valuation is critical
and provides protection in the event of an audit.
• Understand client’s industry and get assistance from industry experts – Example: Consult with IT professional regarding
potential ramifications of patent application on future value of biz.
September 8, 2015 Considerations for Counsel in Designing
Succession Plans 10
Execute the Plan…but stay in touch.
• Work with client and the team to draft and implement plan.
• Our job is just starting. – Check in regularly with client.
– Does the plan still meet client’s needs?
– Has valuation changed?
– New shareholders?
– This is why we are better than online/self-help legal solutions.
September 8, 2015 Considerations for Counsel in Designing
“the price, expressed in cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in a open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”
Rev. Ruling 59-60, SAS #1
Entity and Valuation and the Impact of Valuations 16
Fair Value
• Value of corporation’s shares immediately before the effectuation of the corporate action to which the shareholder objects
• Using normal and current valuation concepts and techniques AND
• Without discounting for lack of marketability or minority status
1999 Revised Model Business Corporation Act
17
Investment Value
• The value to a SPECIFIC owner or investor
• This is the value to the specific individual or entity’s motivation, their perception, their situation
Entity and Valuation 18
Intrinsic or Fundamental Value
• Value based upon perceived judgment of the financial analyst observing the investment characteristics of the subject entity
• Does not look to the specific investor’s circumstances
19
Book Value
• Accounting term, not valuation term
• Equals Total Assets (net of depreciation)
• Less Total Liabilities
• GAAP
Entity and Valuation 20
Strategic or Synergistic Value
• Value to a Specific Buyer because of added benefits
– Reduction of costs
– Economies of Scale
– Addition strategic alliances
– Eliminating Competition
– Market Share Enhancement
Entity and Valuation 21
Approaches to Valuation
• M – Market Approach
• I – Income Approach
• A – Asset Approach
22
Market Approach
• Guideline Public Companies
• Guideline Transaction Method
• Past Transactions Method
• Buy-Sell Agreements
• “Rules of Thumb”
Entity and Valuation 23
Income Approach
• Discounted Cash Flow (DCF)- projecting future cash flows into perpetuity and discounting it back to present value using a rate of return
• Capitalization-estimating a single period’s cash flow dividing it by a rate of return adjusted for the expected growth
Entity and Valuation 24
Asset Approach
• Adjust Assets and Liabilities to fair market value
• Subtract fair market value of liabilities from fair market value of assets
• Remove Non-Operating Assets and Liabilities
25
Levels of VALUE
Entity and Valuation 26
Asset Transfer Vehicles
Presented by:
Julius H. Giarmarco, J.D., LL.M. Giarmarco, Mullins & Horton, P.C.
September 8, 2015 Overview of Buy-Sell Agreements 79
What is a Buy-Sell Agreement?
• A binding executory agreement amongst co-owners requiring a departing owner to sell his interests in a business and the remaining owner to buy the departing owner’s interests.
• Analogies: Premarital Agreement; Estate Planning for Business.
– Corporation or LLC purchases shares or membership interests from departing owner.
• Hybrid
– Agreement includes provisions for different triggering events.
September 8, 2015 Overview of Buy-Sell Agreements 81
• Buy-Sell Agreements should be drafted by counsel in coordination with a CPA or tax counsel.
• Shareholders should negotiate key terms at the earliest possible stage, preferably before the business is incorporated or organized.
• Importance of Business Valuations.
• Ensure that there is a funding mechanism to fulfill the purpose of the Agreement!
September 8, 2015 Overview of Buy-Sell Agreements 82
What Triggers Action in a Buy-Sell Agreement?
• Whenever a co-owner departs the business.
• Examples: – Withdrawal of a co-owner at a time before
retirement.
– Retirement
– Disability
– Death
– Bankruptcy
– Divorce or Familial Separation
– Loss of necessary license
September 8, 2015 Overview of Buy-Sell Agreements 83
• Fundamentals of Buy-Sell Agreements:
– HOW will the shares or membership interests be sold?
– What is a triggering EVENT under the Buy-Sell Agreement?
– What is the VALUE of the ownership interest?
– How will parties FUND the Buy-Sell Agreement?
September 8, 2015 Overview of Buy-Sell Agreements 84
Importance of Funding Sources for Various Contingencies
• At a fundamental level, a Buy-Sell Agreement is inherently useless if there is no available method for the remaining owner to purchase the departing owner’s interest.
• A business owner should consider various sources of funding for the various contingencies that could trigger action under a Buy-Sell Agreement.
September 8, 2015 Overview of Buy-Sell Agreements 85
Funding Sources
• Savings – “Cash is King.” – Best source of funding because it can cover all triggering
events.
• Life Insurance Policies – Generally, each co-owner will own policy and pay
premiums. – Payable upon death, therefore is intended to assist with
only one of the triggering events. – Benefits may be distributed free from income tax. – Certain types of policies may generate cash-value, which
could be utilized for other triggering events.
September 8, 2015 Overview of Buy-Sell Agreements 86
Funding Sources
• Disability Insurance
– Generally, each co-owner will own policy and pay premiums.
– Payable upon occurrence of disability.
• Ensure that covered disabilities match definition in Buy-Sell Agreement.
September 8, 2015 Overview of Buy-Sell Agreements 87
Funding Sources
• Bank Loans – If co-owner is credit worthy, bank loans provide
flexibility to fund all triggering events.
– More difficult to obtain than in the past.
– Will likely require securitization of business and perhaps personal assets.
– A co-owner needs to re-visit his ability to obtain a bank loan on a yearly basis to ensure ability to obtain, or otherwise obtain and maintain a revolving line of credit.
September 8, 2015 Overview of Buy-Sell Agreements 88
Funding Sources
• Promissory Note/Installment Payments
– If allowed, terms should be set forth in the Buy-Sell Agreement.
– Beneficial to the remaining owner.
– May not be beneficial to remaining owner or remaining owner’s estate.
– Promissory Note should be secured with business and/or personal assets of remaining owner.
September 8, 2015 Overview of Buy-Sell Agreements 89
Federal Tax Considerations
• Buy-Sell Agreements requiring stock redemption – If transaction fails to qualify as IRC § 302 or 303
exemption (and treated as a non-liquidating corporate distribution, purchasing shareholder could be deemed to have received a taxable dividend.
– Ensure that FMV is paid for withdrawing shareholder’s stock.
• If too high, withdrawing shareholder may have received a gift from remaining shareholders.
• If too low, remaining shareholders may have received a gift.
• Importance of valuations!
September 8, 2015 Overview of Buy-Sell Agreements 90
Federal Tax Considerations
• Cross-Purchase or Hybrid Buy-Sell Agreements
– Be careful of potential constructive dividend issues.
• If remaining shareholders are required to purchase shares but purchase is made by corporation, IRS may determine existence of taxable constructive dividend.
• Possible solution: Shareholders have the option, but not obligation to purchase shares. This provides flexibility for corporation to redeem stock without constructive dividend issue.
September 8, 2015 Overview of Buy-Sell Agreements 91
What is a Business Valuation?
• A process by which the value of a business is determined.
• The concept of fair market value (FMV) is central to the process.
• A business valuation utilizes different and additional methodology than a financial statement in order to determine FMV.
• What will my business sell for in the market?
September 8, 2015 Overview of Buy-Sell Agreements 92
Why Conduct a Business Valuation?
• To prepare for a sale or transfer of business assets. – Asset Purchase Agreements – Mergers and Acquisitions
• To prepare for selling shares or membership interests in the business and drafting Buy-Sell Agreements.
• To prepare for retirement and/or winding down and dissolving the business.
• To plan and prepare for current and future income, gift, and estate tax.
September 8, 2015 Overview of Buy-Sell Agreements 93
Why Conduct a Business Valuation?
• To prepare for the future development of your business by tracking market value over time.
• To adequately determine insurance needs.
• To prepare for offering employee stock plans.
• To prepare for divorce.
• To prepare for litigation.
– External and Internal
• To prepare for compliance reporting.
September 8, 2015 Overview of Buy-Sell Agreements 94
Why Conduct a Business Valuation?
• What is common to all of these circumstances:
– Business valuations are utilized in the course of preparation and planning for the future of a business.
– Business valuations are in indispensable tool in planning the fundamental development of a business and preparing for key events, such as interest transfers and sales.
September 8, 2015 Overview of Buy-Sell Agreements 95
Methodologies of Business Valuations
Three Primary Approaches:
• Asset Approach
• Market Approach
• Income Approach
September 8, 2015 Overview of Buy-Sell Agreements 96
Asset Approach
• Adjusts assets and liabilities to FMV.
• Assets – Liabilities = Net Asset Value.
• Include all assets in determination. – Not just assets on financial statement.
– However, calculation of intangible assets is difficult.
• Perhaps not the best method for calculating going business concerns (value of business looking forward).
September 8, 2015 Overview of Buy-Sell Agreements 97
Market Approach
• Seeks to establish value of business by utilizing market comparisons.
• What have similar businesses sold for relative to a comparable variable (sales, net income, earnings, etc.)
• Requires the existence of other like-kind business for proper comparative calculations.
• Utilize database and trade organization information.
September 8, 2015 Overview of Buy-Sell Agreements 98
Income Approach
• Values company by estimating future earnings and converting the estimate into a present value. – Based upon investor’s required rate of return and
risk of investment.
– Net cash flow is typical measure of earning power.
• Attempts to quantify the concept that the true value of a business lies in part upon future earnings and wealth.
September 8, 2015 Overview of Buy-Sell Agreements 99
Preparing for a Business Valuation
• Allocate sufficient time prior to the need of the business valuation.
• Locate a certified and accredited professional. – Attorney – CPA – Certified Valuation Analyst
• Bookkeeping and accounting should be in order. • Be prepared to educate the professional regarding the
unique characteristics of the business. • Work with your professional in a transparent and
forthright manner.
September 8, 2015 Overview of Buy-Sell Agreements 100
Thank you. Please feel free to contact me if I can
assist you further. Brian M. Annino, Esq. Annino Law Firm, LLC