Weighing Company Sale Vs. Family Succession


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Scott Williams, age 58, has operated his own printing business, The Written Word, for more than 20 years. The business is operated as a limited liability company with Scott and his wife, Dana, as the only members. Scott has had several offers to purchase his business from publicly traded companies, but has resisted selling, partly because he still enjoys the work, and partly because he is unsure if either of his children are interested in continuing the business.

Recently, Scott hears the callings from his golf clubs and fly rod getting louder and is considering accepting a company’s offer to buy the business. At the same time, however, his 29-year-old daughter has expressed interest in becoming involved in the printing business.

If Scott accepts the company’s offer to purchase his business, he will receive a combination of cash and common stock in the purchasing company. By accepting this deal, Scott knows he will have a large portion of his wealth tied up in the purchasing company. Although the company has performed well and appears solid, Scott is concerned about keeping so many of his eggs in one basket. If Scott chooses, however, to retain the business and keep it in the family, he is unsure of what he needs to do in the interim before his daughter becomes comfortable in the day-to-day operations of the business. He has heard the phrase “business succession planning,” but isn’t exactly sure what that means. Although most of his wealth is wrapped up in The Written Word, Scott has $600,000 in a SEP IRA, and he maintains about $100,000 in a mixture of savings and investment accounts. His printing business was recently appraised at $1.8 million.

The following information includes each of Scott’s concerns regarding selling his company or using family succession followed by recommendations by Fifth Third Bank’s Private Client Group.

Scott’s first concern: If he is forced to take a large position of company stock as part of the sale, is there any way to protect his interest in the stock?

Scott’s acceptance of a buyout offer composed of XYZ stock will significantly change the allocation of his net worth. The XYZ stock received as compensation for The Written Word will now represent a disproportionate share of Scott’s investments, subjecting his net worth to undue exposure to the volatility of this one stock. An obvious answer would be to sell the stock. This selling strategy, however, is usually unattractive in a buyout situation because the owner’s cost basis in the stock is so low, resulting in a large capital gains tax bill. There are hedging methods available, however, with which Scott can protect against downward volatility in the share price of XYZ and postpone the capital gains tax until a later date. The most common forms of hedging transactions are “Cashless Collars” and “Variable Prepaid Forward” contracts.

Scott’s second concern: With such a large position held in one company’s stock, how should his other assets be invested in order to optimize the performance of his entire portfolio?

In order to maximize his investment return and protect against volatility in the markets, Scott should certainly evaluate his overall investment holdings, in light of the prospective sale of his business resulting in a large position in a single equity. This is necessary to ensure he has the proper asset allocation to suit his future retirement needs.

An individual’s optimal asset allocation depends on many factors, including the individual’s age, income needs, retirement goals and his or her risk tolerance level. A review may call for Scott to shift his other investment assets to income rather than equity investments in order to maintain an appropriate balance.

Scott’s third concern: If he decides to transfer the business to his daughter rather than sell, are there products and techniques he can employ to protect the business and ensure it is transferred appropriately?

There are many different products and techniques available to a small business owner that will protect a business and ensure that it is transferred appropriately to the next generation. One popular method is to use a Grantor Retained Annuity Trust (GRAT). A GRAT is generally a short-term trust that provides for an income stream to the grantor and an outright transfer of the trust assets (shares of The Written Word, in this case) to another individual upon the expiration of the GRAT term. With a GRAT, Scott’s interest in The Written Word would be purchased with cash flow from the business, while still retaining the ability to control the operations of the business during the term of the GRAT. Upon the expiration of the GRAT, the control and ownership of his interest in the business would pass to his daughter. In addition, all appreciation in the value of the business from the time he establishes the GRAT until it terminates will pass to his daughter tax free as long as he survives the term of the GRAT.

Another important element to business succession planning and protection is the proper use of life insurance on the lives of key members of the business’ management and ownership. For instance, “key person” insurance is advisable to ensure the business will have some liquidity after the death of a senior manager or majority owner. In addition to providing liquidity to the business, life insurance on Robert’s life, in this case, would provide funds to help pay any estate tax liability if he were to pass away during the term of the GRAT and if the value of the business was taxable in his estate.

Recommendations in this article and their results may vary with each client based on the client’s current financial picture and goals. There are no guarantees that any investment strategy described in this article will result in a profit. Investment results cannot be predicted or forecasted and will vary depending on market conditions.