CLOSELY HELD BUSINESS SUCCESSION PLANNING

1. CLOSELY HELD BUSINESS SUCCESSION PLANNING October 8, 2019 Colorado Springs Estate Planning Council Presented by Constance D. Smith, Esq.

2. Family Business Succession Rates Only 30-33% transition to the second generation, though 70% of owners would like it to, and only 12-13% make it to the third generation 40-50% of owners plan to retire within 5 years, but less than half of them have any plan 80% of family owned businesses have no plan for owner’s unexpected death or disability Fewer businesses are staying in the family

3. SUCCESSION TRIGGERS • Loss of key person owner • Death • Incapacity • Retirement • b) Partner breakup • i) Dispute over operations, finances • Moving on, physically or ideologically • Health issues, retirement

4. 2) SUCCESSION TRIGGERS (cont.) c) Sale Can be planned sale or unexpected purchase offer Can sell to family, employees or third parties Merger with another company Death or incapacity Division of business activities into separate businesses

5. EVALUATE FAMILY AND BUSINESS NEEDS • 3) Family Considerations • Income continuation • Life insurance • Redemption of equity interest • Disability insurance • SSDI for disability

6. 3) Family Considerations (cont.) • Income continuation (cont.) • vi)Investment returns • vii) Annuity purchase • viii) Charitable Remainder unitrust payments

7. 3) Family Considerations (cont.) • Health insurance • COBRA • Use Spouse’s policy • Dependent coverage • Medicare plus for retirement, voluntary or poor health • Long term care insurance or Medicaid

8. 3) Family Considerations (cont.) • Separate control of business from economic benefit • Proceeds to Family, control to Managers

9. 3) Family Considerations (cont.) • Relational conflicts • Key employees/and family have different goals • Heirs apparent can't work together or don't have complimentary skills • Beware blended families and children from prior relationships

10. 4) BUSINESS CONSIDERATIONS • a) Employees security • Provide incentives to stay • Don't give stock ownership to non-key employees

11. 4) BUSINESS CONSIDERATIONS (cont.) • b) Lenders' and Suppliers' security • financial security at the entity level • insurance proceeds • Successor management authority

12. 4) BUSINESS CONSIDERATIONS (cont.) • c) Customer's work • Stabilize work force to get jobs completed • Accounts Receivable • d) Pipeline • Person or team to bring in new business • Younger employees ready to train and move up

13. 5) SUCCESSION OPTIONS • a) Continuation Of Business • Viability of business activity and profitability • Who will continue? • Where will funds come from to continue/grow?

14. 5) SUCCESSION OPTIONS (cont.) • Division of Business • Separate Business activities • Vertical division of business • Tax considerations

15. 5) SUCCESSION OPTIONS (cont.) • c) Sale of business • To Employees • To Family • To Third Parties • Merger with another business

16. 5) SUCCESSION OPTIONS (cont.) d) Termination of business i) No apparent successor or purchaser ii) Financial non-sustainability iii) Divorce

17. 6) UNPLANNED SUCCESSION • Passes under Estate Planning documents • All to spouse then to children • Common law Marriage • Separate personal financial control from business management

18. 6) UNPLANNED SUCCESSION (cont.) • Business documents • Specifies ownership, management, voting, contributions, distributions, etc. • Transfer restrictions • Successor Managers • Mandatory distributions • Buy-sell

19. 6) UNPLANNED SUCCESSION (cont.) • No formal organization • Sole Proprietor • Default general partnership • Passes under intestacy law • Children from prior relationships • Passes to parent(s) of unmarried owners with no children • If no spouse, children or parent, passes to siblings, then nieces and nephews

20. 7) RECOMMENDATIONS • Estate Planning • Divide business control (management) from economic benefits (ownership) • Different inheritances for family members working in the business and the non-participating heirs

21. 7) RECOMMENDATIONS (cont.) • Business Documents • Have Operating Agreements/ Bylaws that define ownership control and transfer provisions • Get a buy-sell early if there are multiple owners • Structure for Succession as well as startup • Consider creating voting/non-voting shares

22. 7) RECOMMENDATIONS (cont.) • c) Plan for transition before it's needed • Create a working team of advisors • Plan for personnel assumption of duties • Keep accounting and legal documentation ready for a sale • Identify potential Successors

23. 7) RECOMMENDATIONS (cont.) • Tax Planning Structures • i) Bequest at death gets stepped up basis • Outright lifetime gift • Gift to Grantor Retained Annuity Trust • Gift to Charitable Remainder Trust • Gift to Supporting Organization

24. 7) RECOMMENDATIONS (cont.) • Tax Planning Structures (cont.) • vi) Gift to public charity • vii) Recapitalization to get discounts of minority non-voting interests • viii) Installment sale • Sale to Employee Stock Option Plan

25. 7) RECOMMENDATIONS (cont.) • Tax Planning Structures (cont.) • xi) Sale to defective Grantor Trust • xii) C Corp capital Gain exemption §1202 • xiii) Avoiding state income tax

26. CLOSELY HELD BUSINESS SUCCESSION PLANNING October 8, 2019 Colorado Springs Estate Planning Council Presented by Constance D. Smith, Esq.