Business Owners
Beware
Are you a business owner? Are you the first one to arrive in the morning, as
well as the last one to leave in the evening? Have your employees ever
taken home paychecks while you sacrificed your paycheck to the
bottomless pit called accounts payable? Have you ever paid your
mortgage on a credit card? Over the years, you have no doubt worked
through physical, mental and financial pain that would have caused other
folks to close shop and look for a job elsewhere. No doubt, as a
business owner you have survived untold challenges. If your business is
a family business, then you may face some unique challenges to
protect and preserve your business...and your family.
Some
Numbers
It would be an understatement to say that
family businesses are the backbone of the American economy. Some 90
percent of all businesses in this country are either family-owned or
family-controlled. They come in all shapes, sizes and colors,
representing all sectors of our economy. From agriculture, to services,
to technology, to manufacturing, family businesses generate an estimated
one-half of the U.S. Gross National Product and pay half of all wages
earned in this country. Not all family businesses are traditional small
businesses either. In fact, about one-third of all businesses included
in the Fortune 500 are family businesses. But not all of the family
business statistics are rosy.
Tragic
Transitions
Family businesses do not tend to outlive their
founders. At any given moment, 40 percent of family businesses are in
the process of transferring their ownership. Unfortunately, two-thirds
of all initial transfers fail. Of the one-third that survives an initial
transfer, only one-half will survive a second transfer. Why such a
dismal success rate? The reasons are as varied and unique as the
businesses and business owners themselves. Nevertheless, many of the
failed transfers can be traced to three causes: people, taxes and cash.
People
Planning
The family element in every family
business can mean the difference between its success or failure during
the transfer process. Common triggering events include the retirement,
disability or death of the business owner. Tough questions must be asked
and answered. Otherwise, a business that took you decades to build can
be destroyed overnight. For example, who will run the business after
you? Will it be your spouse, one of your children or a non-family member
key employee? If not your spouse, will your spouse be financially
dependent on the business or financially independent of the business?
What arrangements have you made for the inheritance of your
business-inactive children? Have you in-law proofed your estate?
Thinking ahead to the second-generation transfer of your business, what
provisions have you made to encourage thrift and industry among your
grandchildren?
Tax
Truths
The Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA) went into effect on January 1, 2002.
This new law provides welcome relief from federal estate taxes by
increasing the estate tax exemption and reducing the top estate tax rate
until full repeal of the federal estate tax in 2010. Unfortunately,
Title V of EGTRRA declares its own death effective January 1, 2011. At
that time the federal estate tax returns to its pre-EGTRRA form...unless
Congress and the President agree to make it permanent.
Not only is the future of this estate tax
uncertain under current federal tax law, but many states are even
imposing their own estate taxes, independent of any federal estate
taxes. Accordingly, careful monitoring of the economic, political and
legal climate is required. Why? Without proper planning, your family may
have to sell your family business just to meet the IRS cash call. [For
more about EGTRRA, view a chart
detailing the new federal estate tax exemptions and rates effective January
1, 2002.]
Money
Matters
Will there be enough money to fuel the survival
of your family business? Unless you coordinate your financial plan with
your estate plan, there may not be enough cash to fund your ultimate
objectives. For instance, an appropriately funded plan could provide
financial security for your spouse, ensure that your preferred successor
takes over the business, equalize the eventual inheritance among your
children and protect their inheritance from future problems (e.g.
divorces, lawsuits and bankruptcies). Typically, life insurance is used
to fund such money matters, when owned in the proper amount, type and
manner.
Conclusion
This has been a brief introduction to a complex
topic. Always seek qualified legal counsel when planning for the
survival of your family business.
Buy-Sell
Financing: Insuring the Outcome
True or false: Most family business owners want their businesses to be
liquidated when they retire, become disabled or die? If you answered false,
then you are correct. However, the sad
truth is that most family businesses fail to survive the loss of their
owner due to retirement, disability or death. In this article, we will
survey the fundamental key to the survival of a family business — a
Buy-Sell Agreement (BSA).
Introduction
A BSA is a lifetime contract providing for the
transfer of a business interest upon the occurrence of one or more
triggering events as defined in the contract itself. For example, common
triggering events include the retirement, disability or death of the
business owner. An interest in any form of business entity can be
transferred under a BSA, to include a corporation, a partnership or a
limited liability company. Also, a BSA is effective whether the business
has one owner or multiple owners. As a contract, a BSA is binding on
third parties such as the estate representatives and heirs of the
business owner. This feature can be invaluable when the business owner
wants to ensure a smooth transition of complete control and ownership to
the party that will keep the business going. Subject to certain Family
Attribution Rules under Internal Revenue Code § 318, a BSA can help
establish a value for the business that is binding on the IRS for
federal estate tax purposes as provided under Internal Revenue Code §
2703.
Three
Flavors
A BSA is commonly structured in one of three
general formats: An Entity BSA, a Cross-Purchase BSA and a Wait-And-See
BSA. Under an Entity BSA, the business entity itself agrees to purchase
the interest of a business owner. Conversely, under a Cross-Purchase BSA,
the business owners agree to purchase one another's interests. The
Wait-And-See BSA gives the entity a first option to purchase the
interest before the remaining business owner(s).
In addition to these three general formats, a
One-Way BSA may be used when there is one business owner and the
purchaser is a third party. The selection of the appropriate BSA format
is critical for a variety of tax and non-tax reasons beyond the scope of
this discussion. However, no BSA is complete without a proper funding
plan. Like a beautiful automobile without fuel in the tank, a BSA
without cash to fund the purchase is going nowhere.
Funding
Options
Some common options to fund the purchase
obligation under a BSA include the use of personal funds, creating a
sinking fund in the business itself, borrowing funds, installment
payments and insurance. Of these options, only the insured option can
guarantee complete financing of the purchase from the beginning.
Accordingly, a proper BSA will include both disability buy-out insurance
and life insurance. Since the health of the business owner determines
their insurability, any delay in acquiring appropriate coverage could be
fatal to the success of the BSA and with it the survival of the business
itself.
Copyright © 2005 Integrity Marketing Solutions. All rights
reserved. Some artwork provided under license agreement. This
publication does not constitute legal, accounting or other professional
advice. Although it is intended to be accurate, neither the publisher
nor any other party assumes liability for loss or damage due to reliance
on this material.
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