Transferring a Family Business An Important Part of Estate Planning

Hook Law Center (formerly Oast & Hook)

Virginia Beach, VA (Law Firm Newswire) August 8, 2016 – Among the most significant factors to consider when establishing a business succession plan is the timing of the change of ownership. Whether the owner is planning to sell or make the business a gift, or combine the sale with a gift, the changeover should not occur prior to the identification and development of the next generation of leaders.

Several estate planning methods for business succession plans work most effectively in an environment of low interest rates. Usually, when there are lower interest rates, the seller has more chances to finance the sale of equity or permit smaller payments if a grantor retained annuity trust (GRAT) is used.
Andrew H. Hook, a prominent Virginia estate planning attorney with Hook Law Center with offices in Virginia Beach and northern Suffolk, states “When contemplating the sale or gift of a family business, it is advisable for the owner to choose the new owners wisely and to seek legal counsel regarding the establishment of a succession plan.”

Before a transfer takes place, there may be a distribution to the ownership group that receives financing in the form of a loan. A “leveraged dividend” or “leveraged distribution” will permit the owners to derive value from the business, and the balance sheet leverage will reduce the equity that is being handed over. In a lower interest rate climate, the buyer can borrow a larger amount.

In addition, a succession plan may entail the borrowing of funds by the transferee from a third party, an example of which is a bank, so that the transferor is fully paid at the closing of the transaction that facilitates the transfer of equity. In this scenario, both parties can benefit from lower interest rates. The seller can get a higher purchase price and the buyer is better able to take out a loan if the terms of repayment include a lower interest rate.

Another factor to take into account is that business transfers are frequently seller financed. Generally, the seller chooses the installment method of reporting the gain on the sale so that the taxable gain and tax owed correspond with the installment financing payments received by the seller. In the event of an installment sale, the death of the holder of the note can result in challenges to the estate of the note holder. If the note holder’s Will states that there is to be debt forgiveness, then the resulting estate’s debt cancellation income could cause a significant income tax burden for the estate.

Usually, the change in ownership of a family business is marked by the transfer of equity interest that is eligible for a discount in valuation for the absence of marketability and the absence of control. For instance, the current owner of a corporation or LLC would shift non-voting ownership interests, which would qualify as the discount for the absence of control. The ability to transfer these interests would be limited by a “buy-sell” agreement, which would qualify as the discount for absence of marketability.

Carrying out a succession plan can take years. There are several tax, financial and family matters that must be considered. Moreover, due to the presence of external influences over which the seller has no control, including interest rates and tax laws, a succession plan could be thwarted prior to its implementation.