Owners of privately held businesses often have competing concerns when designing their own exit plans. Especially if there are family members involved in the business, the owner may be conflicted as to what to do with the firm. Should the owner sell to children involved in the business, thus assuring those children act as owners, not just as heirs?
Or, to avoid exerting cash flow pressure on the children, should the business interest be gifted to them? Further, few business owners want to give up control. Should the owner stay in the business, making sure it is well run? In sum, should the owner sell, gift, or stay?
Using a combo approach
In some cases, the business owner can do all three. As will be shown, a carefully crafted combination of all 3 exit strategies can help to assure a successful exit by the owner and a profitable transition to the children. Assume, for example, the case of Brandon.
? Brandon is the owner of a $10 million S corporation, is 55 years old and wants to retire at 65.
? Brandon wants his children in the business to start acting like owners, not heirs.
? The company yields, on average, a 6% after-tax rate of return.
Brandon’s primary exit planning goals are to maximize the value going to the children, minimize the taxes incurred, continue to maintain control until retirement, and assure his exit plan is adequately funded.
Working with his exit planning team, Brandon can accomplish his goals. The following exit plan involves a sale of the business and a gift of assets to the children while allowing the owner to stay in control. The exit plan involves the following steps:
(1) Value the business. It is important that Brandon determine the true value of the business (i.e., what a reasonable buyer would pay to a reasonable seller). The transaction must be based on a value that will pass muster for tax purposes.
(2) Apply for life insurance. Funding the buyout with life insurance is a key aspect of the transaction, and it is important to determine Brandon’s insurability upfront. Once the trust is created, the insurance will be issued to the trust.
(3) Create and seed a grantor trust. A grantor trust, otherwise known as an Intentionally defective irrevocable trust (“IDIT”) is drafted by counsel to place the assets of the trust outside of the estate for federal estate tax purposes while assuring the income from the assets is paid to the grantor. The attribution of income to the grantor is intentional, and must be carefully designed. To assure legitimacy from a tax perspective, it is often suggested that the trust be seeded with some gifted assets (probably at least 10%). Brandon could gift stock or other discounted assets.
(4) Create voting and nonvoting stock. This will assure that Brandon maintains control of the business because he will continue to own the voting stock in the business.