Advanced Strategic Planning for the Family Owned Retail Business

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Harris Wealth Management

• Advanced Strategic Planning for the Family Owned
  Retail Business
• Presented to
• National Grocers Association
• Presented by
• Frederick Jolly, Senior Vice President
• Michael Levin, VP, Senior Trust Administrator
  Senior Financial Planner

February, 2005
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American saying from 1870/1880s

• From Shirtsleeves To Shirtsleeves In Three
  Generations

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Ongoing Enterprises How do businesses fare?
1st Generation G2 lt 30 Survive G3 lt 10 Survive
G3 gt 90 Fail G2 gt 70 Fail 1st Generation
Source John Ward, PhD, Loyola University,
Chicago, IL
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Why Do Closely Held Businesses Fail

• Business Risk
• Lack of Effective Succession Planning
• Death (Estate) Taxes

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Will Estate Taxes Really Go Away?

• Who Pays Estate Taxes
• Less Than 2 Percent Of All Estates Have An Estate
  Tax Liability
• 32,000 Taxable Estates In 1995 (600,000 Credit
  Equivalent)
• 6,000 Taxable Estates In 1995 Paid 70 Percent Of
  The Total Estate Taxes

Joint Committee On Taxation, Present Law and
Background on Federal Provisions Relating To
Retirement Savings Incentives, Health and
Long-Term Care, and Estate Taxes (JCX-29-99),
June 15, 1999
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Common Issues For Closely Held Businesses
Succession Planning
Entity Choice
Retention of Key Employees
Family Issues
Estate Planning
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Succession Planning

• Ownership Issues
• Business Arrangements
• Management Succession Issues

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Ownership Issues
Personal Exit Strategy Issues
Keep
Not Sure
Sell
Family Members (Discounted Value)
Third Parties (Fair Market Value)
Gifts
Gifts/Sale
Sale
Financial Buyer
Strategic Buyer
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Cause of Intra-Family Transfer Dilemma

• Insufficient Assets to Sustain Lifestyle
• Loss Of Control Of The Business
• Inability Of Next Generation To Manage Wealth
• Not Willing To Let Go

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Strategies That Address The Intra-Family Transfer
Dilemma

• Continuing Income Stream To Senior Generation
• Retaining Control Even After Business Transfer
• Employing Trust and Other Devices To Restrict The
  Next Generations Access To Underlying Assets

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Developing A Successful Business Transition
Strategy
Control
Ownership
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Ownership Transition Quandary

• Lifetime or at Death
• Equal or Unequal
• If During Lifetime When And
• Sale
• Gift
• Combination Of the Above
• If at Death
• Sale
• Bequest

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Control

• Where Should Control Eventually Reside If An
  Intra-family Transfer Occurs?
• Stakeholders Consistent With Prorata Interest
• Only Stakeholders Active In The Business
• What Is The Exit Strategy For Non-controlling
  Family Stakeholders?

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Other Business Succession Planning Issues

• Business Arrangements
• Shareholder
• Buy/Sell
• Employment Agreement
• Management Succession Issues
• When
• To Whom (Key Employees, Family)

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Retention of Key Employees

• Non-Qualified Compensation Agreement
• Employment Agreement

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Non-Qualified Deferred Compensation Illustration
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Family Issues
Business
Ownership
Family
From Craig A. Ardnoff and John L. Ward, Family
Business Governance. Maximizing Family and
Business Potential _at_ 1996 Business Owner
Resources.
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Family Issues

• Active Participants
• Passive Participants
• Conflicting Interests of Family Members

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Choice of Entity

• Types of Entity
• S Corp vs. C Corp
• Limited Liability Company (LLC)
• Family Limited Partnership (FLP)
• Advantages vs. Disadvantages
• Succession Planning Implications
• Tax Implications

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Estate Planning

• Disposition of Assets
• Outright
• In Trust
• Minimizing Estate Tax Liability
• Quantifying and Funding For Liability
• Liquidity
• Insurance

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Transfer Taxes

• Gift Tax Considerations
• Applicable Exclusion Amount for Gifting --
  1,000,000
• Annual Exclusion Gifts
• 11,000 per Year per Donee (2004)
• Exclusion Amount Indexed for Inflation
• Gifts in Excess of These Amounts Subject to
  Current Taxation

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Transfer Taxes

• Applicable Exclusion (Amount Reduced by
  Applicable Exclusion Gifting)
• 1,500,000 in 2004 2005
• 2,000,000 in 2006, 2007 2008
• 3,500,000 in 2009
• Repeal of estate tax 2010 (one year only)
• 1,000,000 in 2011 thereafter
• Highest Estate Tax Rates
• 2004 48
• 2005 47
• 2006 46
• 2007 45
• 2008 45
• 2009 45
• 2010 (Gift tax rate equal to highest
  individual rate)
• 2011 55

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Example 1 Pass Business Ownership To Child
Active In The Business While Providing
Appropriately For Other Children

• Facts
• Dad and Mom would like to pass ownership of their
  business to their one child who actively
  contributes to the business.
• They would like to also leave meaningful wealth
  to their other three children.
• Dad and Mom have an independent asset base
  outside their business, but
• want to retain control of the business even
  after the transfer to their son.
• Dad and Mom believe the business is worth at
  least 30,000,000 to a strategic buyer, or
  15,000,000 to a financial buyer.
• Company is an S Corporation.
• Dads salary from S Corp is 350,000
• Sons salary from S Corp is 300,000
• S earnings have ranged over the past several
  years between 800,000 and 1,200,000

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Example 1 Action Steps

• Step 1
• Recapitalize stock
• 90 non-voting
• 10 voting
• Shareholder Agreement (Rules of and
  Responsibility of Ownership)
• Who Can Be a Shareholder
• Control Mechanism
• Disposition During Life or at Death
• Employment Agreement for Dad
• Assures Continuing Income Stream
• Provides Retirement Benefit
• Further Depresses Value of Business for Transfer
  Purposes

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Example 1 Action Steps

• Step 2
• Valuation of Business For Intra-Family
  Transfer Purposes
• Step 3
• Sell 49 of Stock (all non-voting) to Son
• 10 down payment
• Balance-Interest only note with 15-year balloon
  payment
• Revise Mom and Dads Estate Plan
• Leave balance of the business to son
• Leave bulk of assets to other children (use
  insurance to partially implement)

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Example 1 Perceived Benefits

• Transferred 49 of Value for Approximately
  5,000,000. (Perceived Value at least 14,700,000
  based on strategic sale.)
• Purchase Funded with Future Earnings of Company
• Tax Efficient Way of Keeping Business in Family
• Provide for Other Family Members

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Example 2 Shifting Value To The Next Generation
In Anticipation of a Liquidity Event

• Facts
• Family business is a C Corporation
• Dad, age 60, believes business will be purchased
  at a substantial premium within two years.
  (Current enterprise value is 15,000,000,
  strategic value 45,000,000)
• Dad owns 100 of the stock
• In anticipation of a liquidity event, Dad would
  like to transfer 49 of his equity in the
  business to his children while retaining control.
• Company has never paid a dividend. Money is
  plowed back into business.

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Example 2 Action Steps

• Step 1
• Recapitalize stock
• - 90 non-voting
• - 10 voting
• Shareholder Agreement (Rules and Responsibility
  of Ownership)
• - Who can be a shareholder
• - Control mechanism
• - Disposition during life or at death
• Employment Agreement
• - Assures continuing income stream
• - Provides retirement benefit for Dad
• - Further depresses value of business for
  transfer purposes

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Example 2 Action Steps

• Step 2 Valuation of Business for Intra-Family
  Transfer Purposes
• Step 3
• Dad transfers 49 (All non-voting stock to a
  grantor retained annuity trust (GRAT)
• - Term of GRAT is 10 years
• - Annual GRAT payment funded by return of stock
  or cash from sale

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Example 2 Perceived Benefits

• Transferred 49 of value for approximately
  5,000,000. (Perceived Value at least 22,000,000
  based on a strategic sale.)
• Purchase funded with future earnings of the
  company and tendering back appreciated stock.
• Tax efficient way of transferring wealth to the
  next generation in anticipation of a sale.