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Internal Transfers

Internal Transfers. Convert ownership into financial independence … an inside view. Business Transfer Spectrum. Owner Transfer Motives. Private owners want to:. ● Create a f amily legacy ● Change lifestyle ● Empower employees ● Diversify estate and “equalize heirs”

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Internal Transfers

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  1. Internal Transfers Convert ownership into financial independence … an inside view INTERNAL● TRANSFERS

  2. Business Transfer Spectrum INTERNAL● TRANSFERS

  3. Owner Transfer Motives Private owners want to: ● Create a family legacy ● Change lifestyle ● Empower employees ● Diversify estate and “equalize heirs” ● Give to charity ● Use transfer to create liquidity ● Leave door open to possible future external transfer INTERNAL● TRANSFERS

  4. Transfer Market Timing Ten Year Transfer Cycle Deal RecessionPrime Selling TimeAlmost Recession (Buyer’s Market) (Seller’s Market) (Neutral Market) 1 3 8 10 INTERNAL● TRANSFERS

  5. The Choice of Transfer Method Matters ●Employee Stock Ownership Plans (ESOPs) and most estate planning methods select fair market value ● Management Buyouts select investment value ● Phantom stock and co-owner transfers select whatever the creators dictate INTERNAL● TRANSFERS

  6. ESOPs ● Employee Stock Ownership Plans are defined- contribution, tax-qualified plans ● ESOPs can borrow money to buy stock of a private company. (P&I on loan is tax deductible to company) ● Owners can sell part or all of the stock to an ESOP on a tax-deductible basis (no capital gains if > 30% for a C corporation) ● Can be sold in stages (multiple transactions) INTERNAL● TRANSFERS

  7. ESOPs (Cont’) ● C or S corporation ● S corporation must be > 50% but no income tax on profit going forward. (Trust is a non-taxing entity) ● Combined with executive compensation plan allows management to earn stock outside the plan ● Owners can sell 100% of their stock in stages ● Owner remains in control and takes a salary until retirement ● Value world: Fair market value INTERNAL● TRANSFERS

  8. ESOPs – Points to Consider The Good: Tax deferral to the Seller; Chips off the table; Minority can get out; Cash flow of company increases; Empowers employees; Remain in control; Investment income replaces salary; Acquire competition tax advantaged To Consider: Dilution to owner outside the ESOP; Disclosure to employees; Annual valuations; Repurchase obligation; Added leverage; Added complexity INTERNAL● TRANSFERS

  9. Management Transfers ( MBOs/MBIs) ● Management Buyouts (MBOs) – existing management team acquires ● Management Buyins (MBIs) – outside team acquires ● Engineering the deal (capital structure is key) Senior; Junior; Notes; Warrants; Factoring; Deferred Compensation ● Value World: Investment value (Owner value would be nice) INTERNAL● TRANSFERS

  10. Mgt. Trans.– Points to Consider The Good: Management is knowledgeable of the business; empowers employees; informs them of your intent; you can remain on the BOD To Consider: Owner loss of effective control; dependent on future corporate cash flow; subject to market interest rates; business is bought with “after tax dollars”; added leverage; financial ties to the company INTERNAL● TRANSFERS

  11. Phantom Stock ● Focus management on value growth ● Create “golden handcuffs” for qualified management ● Used to attract and retain quality management ● Retain ownership of stock ● Change in control provision (pays management on sale) ● You control vesting schedule for each individual ● Value world must be consistently applied INTERNAL● TRANSFERS

  12. Phantom Stock– Points to Consider The Good: Retain ownership of stock; Motivates management; Based on incremental future value growth; Attract and retain quality management; To Consider: Creates an unrecorded & unfunded future liability; Goes not solve your transfer issues; Share future profits; Management takes no financial risk; Periodic valuations required; Management may not respond; Limits on deductibility to the company INTERNAL● TRANSFERS

  13. Charitable Remainder Trusts ● Donor gifts C corporation shares to a CRT (some or all of the stock – no prearranged sales) ● Gifting generates a charitable gift deduction ● The trust is a non-taxpaying entity (no capital gains on sale – math on Page 361 of Private Capital Markets) ● Donor lives off of distributions; can use a wealth replacement trust to take care of kids; upon death the principal reverts to one or more charities ● Value World: Fair market value INTERNAL● TRANSFERS

  14. CRT– Points to Consider The Good: Receive income tax deduction subject to limitations; Removes future appreciation from estate; Deduction based on current stock value; Can be less than 100% of your ownership To Consider: Only works for C corporations; Does not solve your transfer issues; Asset in the trust is not liquid; Dividends outside the trust are subject to double taxation; Charity may receive stock in your company INTERNAL● TRANSFERS

  15. Family Transfers ● There are a large number of ways to transfer the business to family members ● Acronym soup: SCINs, GRATs, FLPs, IDGTs, etc. ● Or you can just give stock away ● Realizing your dreams: perhaps one part family transfer; one part market transfer ● Value World: Fair market value INTERNAL● TRANSFERS

  16. Combination Strategies Using more than one approach to realize your motives! INTERNAL● TRANSFERS

  17. Combination Strategies Phantom Stock Options & Acronym soup CRT & MBO/MBI S Corp. Equity Recap & Dynasty -QSSTrust Executive Compensation & ESOP CRT & ESOP (remember, no prearranged sales; internal or external) INTERNAL● TRANSFERS

  18. Combination Strategy– Points to Consider The Good: Begins the Process of equity transfer; Does not preclude the business from external transfer; Provides asset protection; Can motivate management To Consider: All the “to consider” items previously discussed; Adds complexity to your life; Advisory team must understand your motives; Difficult to coordinate advisory team INTERNAL● TRANSFERS

  19. Owner Motives Matter Most ● Don’t let your advisors promote their motives or belief systems ● It’s your goals that need to be met! INTERNAL● TRANSFERS

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