Financial Considerations of a Succession Plan
One should seek the help of a CPA when evaluating the financial considerations of a succession plan.
Succession Plan Must Address Financial and Tax Issues
Without a funded succession plan any approach can be tenuous.
Three Basic Approaches
- 1. Sale
- 2. Gift/Will
- 3. Liquidation
Liquidation is Least Advantageous
q Business being dissolved, fewer dollars received than from the business as a going concern.
q Dollars come from the value of tangible assets.
q Nothing is received for the value of the ongoing enterprise.
q Usually only taken where there is little likelihood of sale/no heirs to take over the business.
q Wherever possible, owner should have alternative resources for retirement as the liquidation value may prove insufficient.
Potential Buyers of the Business
q Family members (who also might receive shares as gifts).
q Third party/competitors.
Methods Used to Sell the Business
q One time payment or installments;
q Generally, dollars come from the business or from buyer’s assets or salary.
q Borrowed funds.
- 1. effect same as cash to seller;
- 2. buyer must pay interest to a lender (as opposed to interest to the seller under an installment sale).
q Sinking fund.
- 1. dollars set aside in investment account, allowed to grow.
- 2. avoids interest payments with borrowed funds or installment sale.
- 3. asset growth taxable/may be insufficient in the event of a premature sale (due to death, disability, etc.).
- 1. premium payments can take the place of a sinking fund;
- 2. can be permanent or term insurance;
- 3. permanent insurance provides tax deferred cash value growth
- 4. cash value can be used for a down payment;
- 5. “self completing” in the event of a premature death;
- 6. disability income buyout can handle disability issues.
Buy Sell Agreements Take Two Basic Approaches
q Cross Purchase
q Redemption Choosing correct approach involves:
- 1. specific company/owner needs/goals;
- 2. income tax consequences;
- 3. gift/estate tax consequences;
- 4. alternative minimum tax.
Gifting/Willing a Business in Family Situations
q Relative may need to buy out parent to ensure parent retirement funds.
q When parents can afford to gift/will the business to their child they must consider several items:
- 1. the parent will often try to balance inheritance received by children not involved in the business;
- 2. are there sufficient assets to do so;
- 3. is there a need to “create” an estate to will to those children;
- 4. often done with insurance options.
q Businesses often large illiquid assets/difficult to sell before estate taxes are due.
q Insurance can handle estate taxes/allow less pressured sale.
q Option to wait until death and will the business.
q Raises issues related to retaining control (and management) if the older generation keeps control of the business interest.