Successful Succession Planning, Part 3

In Part 1 of this series, we discussed your exit strategy and timetable, and Part 2 covered some options for choosing and preparing your successor. Now, let’s review some transfer strategies.

Begin with a current business valuation to establish the worth of your stock. Consult IRS Ruling 50-60 for a list of related factors, and refer to the financial column on page 166 for additional information on valuation. 

The selection of a transfer strategy depends on who will own and control the company and when you intend to transfer assets. The trick is to extract maximum equity while leaving enough value in the company to make it attractive to the future owners.

Stock transfers

Stock may be transferred through direct sale, gifting, bonus options or an employee stock option plan. A direct sale of stock to family members is the simplest transfer method. It bypasses the corporation, and the cost can be covered by the heir’s salary or insurance. The heir pays more income taxes, and you, the seller, will be taxed on your gain on the sale. You get cash flow, and your heir avoids gift taxes and enjoys the benefits of future growth and perhaps a flexible payment schedule. The gains to you are taxable annually, and there are limitations to how much “investment” interest can be deducted; also, any payments owed to you upon your death are included in your estate.

The corporation also can redeem stock under a repurchase agreement. If you have retired, the equivalent of your former salary may be used to fund the repurchase. There will be capital gains or dividend tax effects, depending on whether the transaction qualifies as a sale or exchange. “Family attribution rules” classify shares owned by certain relatives as if they are owned by the majority shareholder; to avoid this problem, you cannot retain an interest in the company (except as a creditor), or reacquire one, for at least 10 years after the sale.

Buy-sell agreements allow for stock to be transferred from those who either die or leave the company. The company uses redemption to repurchase stock from a person or an estate, while individuals within the company may use a cross-purchase to purchase shares directly. A hybrid arrangement allows for either, with shareholders deciding on the method at the time of the purchase.

Stockholders will demand returns on their investment, but not all stockholders control management decisions. Decide how your stock will be allocated, to whom and in what combination of voting and nonvoting shares. Beware of transferring too much control through stock options to managers and supervisors as a reward, or you can quickly dilute future control of the company.

Also, courts may attach a premium to the value of voting stock, if the ratio of nonvoting to voting stock is greater than 1 to 1. This can affect how your estate is probated or how transfer agreements are enforced.

Asset sale, joint venture or leveraged buyout

An asset saleis also called a “sidewise sale,” and your accountants or attorneys may consider it too complicated to recommend. The heirs form a new corporation and capitalize it, and that corporation forms a purchase agreement with your company. The new corporation may purchase equipment, inventory, the company name and similar assets. The original company keeps cash, receivables and real estate, and it may choose to lease the real estate to the heirs’ new company with a possible purchase option. The purchase may be financed by the original company or by lenders.

You may choose to work for the new company or receive an income to manage its property. Eventually, the original company is liquidated, and the income may be sheltered under a wealth accumulation trust. You will have to make decisions on how to convert real estate and how to shelter the income, as well as the time period for the conversion.

Specific arrangements, such as joint ventures and leveraged buyouts,may assist with the logistics of the transfer. Joint venture arrangements provide a bridge from the original to a new company, to allow for a gradual shift of risk and responsibility, in the same way that project joint ventures have provided opportunities for small businesses to partner with larger corporations. The appraisals needed for these contracts can provide protection from tax impacts, assist in negotiating profits and debt obligations, and allow you to gradually extract yourself from the existing company as the new one becomes more self-sufficient with each new project.

The leveraged buyoutuses debt financing based on collateral (corporate assets) or predicted cash flow and profitability, so buyers without substantial cash, such as family members or employees, can still make the deal. You will need advice on dividend and capital gains rules, and faith in the new management team’s ability to pay the debt if you are the lender or guarantor, so consider carefully whether you want to contribute the leverage.

Gifting, trusts and inheritance

Gifting is simple. You can vary the timing for different recipients, and the tax laws have restricted the maximum annual gift to each recipient but not the number of recipients. Advantages of making annual gifts include removing future appreciation in value from your estate, and allowing for an easy transfer of company assets. Instead of dividing up your equipment, you simply transfer an equivalent number of company shares.

Make sure any gift of stock is backed by a buy-sell or repurchase agreement, so divorce or death of a family member does not transfer ownership of stock to in-laws or strangers. If you understand the limitations and are careful not to place control into the wrong hands, then gifting is an easy way to gradually transfer assets.

Inheritance also is simple, if your will specifically designates ownership to your intended heirs, not to their spouses, stepchildren or debtors. Someone will eventually pay taxes on any appreciation in value of assets, and there are special stock redemption and tax rules that may apply if the business is more than about a third of the value of your estate.

Trusts provide an extra layer of asset protection. A charitable remainder trust allows you to receive income during your lifetime from a low basis asset and receive a tax deduction for donating it to a charity after your demise. A grantor retained annuity trust creates an S corporation to transfer nonvoting stock to heirs, enabling you to transfer significant share value while you maintain control and receive annuity interest with little or no tax effect. Think of it as a tax-free dividend.

Although you can never ultimately control the quality of decisions your heirs will make, trusts can provide certain buffers to ensure your wishes are honored. A poorly designed trust is worse than no trust, so use only attorneys who are experts in this specialty.

Family limited partnerships

The family limited partnership has become a popular structure for transferring family business control. As the managing partner, you retain cash and voting control with as little as 5 percent ownership interest, while the limited partners have few or no management duties. The partnership agreement can be amended, and money and property can be added or withdrawn without tax impacts, making this a more flexible and tax-efficient structure than a corporation.

Unrestricted ownership includes individuals, trusts and other business entities. The partnership may serve as a risk management device and protect assets from creditors, since limited partners are not responsible for partnership debts, nor is the partnership responsible for debts of the partners.

Bonuses and ESOPs

You may use stock options or bonuses with a vesting schedule designed to reward loyal or high-performing employees without a great impact on cash flow. The company gets an expense deduction and may pay the employee a cash bonus to cover taxes on the value of the stock. Be careful not to dilute control by awarding too many shares to employees, and don’t randomly award stock at all employment levels. Again, all employees holding stock should be subject to a repurchase agreement, so the company will be entitled to repurchase shares if the employee leaves or is terminated.

Employee stock option plans (ESOPs) are not as popular as they once were, but the ESOP still offers a way to raise capital and transfer ownership to an employee group. Nondiscrimination rules apply to ESOPs, and there are the usual administration costs as well as annual reappraisal of share values. Properly structured, this can be a way to build employee loyalty, but employee owners may demand a higher return on their equity investment than the company is prepared to provide. Consider all of the ramifications of placing ownership in the hands of a group of employees before you implement an ESOP.


Liquidation may be your choice if there are significant family conflicts, no qualified or willing successor, or you simply don’t want anyone else to run the company after you retire. The simple conversion of assets to cash is a straightforward way for you to extract your equity, and the company assets may be worth more than you thought.

Regardless of how you structure your final succession plan, make sure the steps in the chart above are included to ensure both a smooth transition of control and a proper transfer of ownership. You never can guarantee the future, but you will have done the best you could to ensure your intentions are honored. Now relax and let go. You deserve to enjoy the fruits of your labor.

About the Author

Denise Norberg-Johnson

Financial Columnist
Denise Norberg-Johnson is a former subcontractor and past president of two national construction associations. She may be reached at .

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