Transitioning your business is a major life event that requires careful planning. There are financial, emotional, and asset protection issues that all must be considered in tandem. While the COVID-19 pandemic has created a time of great uncertainty, it also presents an ideal environment for reviewing your business’s transition plans.
Here, we address commonly asked questions to help you seize planning opportunities and successfully transition your business.
Some key factors that have made this an attractive time to review transition planning include:
All these factors are temporary and while currently favorable, they’re likely to shift in the coming years.
Successful, closely held businesses have several options for transition paths, including:
If you haven’t investigated these options thoroughly, learn more about how to transition while meeting your professional and personal goals.
As of the date of publication, the yield on the 10-year US Treasury was around 1.7%. The Federal Open Market Committee (FOMC) has openly stated they have no intention of increasing the Federal Reserve Funds Rate (fed funds rate) in the next year or two.
This interest rate environment provides an opportunity to structure a transition to the next generation so it’s successful for the buyer, seller, and company. Often these transactions are internally financed and utilize a circular cash flow model as shown below.
The success of this plan relies on several factors:
Current low interest rates can help the buyer and seller structure manageable note payments, or, alternatively, help the buyer secure outside financing at a low cost of borrowing.
The federal estate tax exemption for deaths occurring in 2021 is $11.7 million per person. This exemption is scheduled to drop back to approximately $6 million per person—depending on inflation in the interim—at the end of 2025 and possibly sooner if Congress pursues tax legislative changes before then.
This exemption amount can also be used to make gifts during a person’s lifetime, which can provide an opportunity to structure a business transition to include purchases and gifts to the next generation.
Structuring a transition in this way can provide flexibility for the next generation to take over ownership in a business and reduce the income tax burden of the transition.
A farming operation belonging to owner A is worth approximately $10 million, and she would like to transition this business over the next 10 years to her son, B. A sale of the business with note payments over 10 years and bearing interest at a rate of 4% would require annual payments of $101,245 per year. Alternatively, if A chooses to gift 20% of the business to B and sell the remaining 80% over 10 years, the payments drop to $80,996 per year.
Additionally, the transfer of 20% of the business via gift wouldn’t be subject to income taxes, as is typically the case with a sale. Owner A should review her overall planning to make sure these reduced payments still allow her to achieve her personal goals. If doable, this arrangement can provide flexibility for B as well as the business and make the ownership transition successful from a cash-flow standpoint.
To learn more about transitioning a family farm, read our article.
After reviewing the general transition considerations that impact all companies, undergoing a transition preparedness evaluation, and preparing for due diligence, there are several considerations and issues to account for as you prepare for a transition. While every situation is unique, common issues owners should consider include the following:
To learn more about business transition planning, buy-sell arrangements, life insurance, and how they can work in your estate and succession plan, contact your Moss Adams professional.