August 2016 eNewsletter

When to Buy Lunch for an Expert?

Larry Grypp, President of the Goering Center

Would you pay $3.46 million to have lunch with Warren Buffett at New York’s Smith & Wollensky legendary steakhouse? Well, as part of a charity auction, one unidentified woman did exactly that. Maybe there’s value in picking his sage brain over surf and turf. Maybe it’s just for the bragging rights, or a fondness for that charity.

By contrast, one Goering Center member was approached by an executive of a family business who was concerned about some potential and fundamental conflicts with a sibling in the business. When they approached the other sibling about bringing in an outside coach to help sort it out, the one sibling said, “No way, this is a family matter!”

High performance leaders know when to bring in expert advice or counsel, but is there something about family business that makes it harder?  Do family businesses face a greater risk in not seeking outside advice at the right time and in the right way?

Families, by their nature, are private institutions. For some, the cultural roots run deep that you don’t take family issues outside the door. At the Goering Center, we have always suggested that you make business decisions in the best interest of the business and use forums like family meetings and councils to deal with the family dynamics.

The natural culture around family privacy or “discretion” can create a subtle reluctance to engage outsiders in the family business itself. Outside experts can turn over some rocks, and bring clarity to issues that are sometimes easily kept in the shadows when a family member is worried about offending or challenging someone with whom they will be passing the mashed potatoes and gravy at the next Thanksgiving dinner.

When family members make up most of senior management, when a business has been in family hands for several generations, it’s critical to bring in outside experts from time to time to keep things sharp and in touch with a rapidly changing market. It’s just good business. And good businesses support good families.

If you meet over lunch, just make sure you pick up the tab. It won’t cost $3.46 million in our region.

Employee Stock Ownership Plans May Offer Family Owned Businesses Transition Opportunities

David Whaley, Esq., Dinsmore & Shohl

Employee Stock Ownership Plans are business transition vehicles that, in certain instances, can address many of the ownership transition issues existing in family owned companies. When designed correctly an Employee Stock Ownership Plan (also referred to as an “ESOP”) can create liquidity to resolve potentially contentious family business issues related to estate planning or generational transfers. While there are other transition vehicles that can offer potential solutions to address these family owned business challenges, none can do such with the desirable tax advantages available to the owners who sell to an ESOP and to the companies that have an ESOP as a shareholder while still permitting (and often requiring) the continued operation of the company by the same management team. The end result allows for a sale of the company to its employees in a tax advantaged means while offering the selling family and existing management the opportunity to continue to operate the company for the benefit of the employees.

At its base, an ESOP is a defined contribution retirement plan (an account based retirement plan like a profit sharing or 401(k) plan) which invests primarily in a company's stock. The stock is held in a trust and held for the benefit of the employees who participate in the ESOP. To facilitate the ESOP in acquiring the company’s stock, the ESOP trust is allowed to obtain a loan to purchase the company’s stock from the family owners. Then the loan is repaid as the company makes deductible retirement plan contributions to the ESOP on an annual basis.

During employment, employees are not taxed on their share of the ESOP assets, nor on their share of appreciation of the ESOP stock. Upon an employee's departure from the company, the stock in the employee's account is purchased by the company from the employee at fair market value and those proceeds can be rolled into either an IRA or another qualified plan – allowing the employee to utilize the proceeds for retirement savings.

An ESOP offers the potential for significant tax advantages to a selling shareholder as well as to the operating company following the sale to the ESOP. For the selling shareholder, subject to certain requirements, federal law permits the seller to incur no taxable gain on the sale of the company’s stock to the ESOP. Then, the replacement property purchased with the proceeds of the sale to the ESOP will receive a carry-over basis, thereby deferring tax until its later sale. Furthermore, if the replacement property is held until death, there is the potential to eliminate the tax entirely through a step-up in basis.

In addition, the taxable income of the company can often be eliminated or greatly reduced through a deduction of retirement plan contributions at the maximum amount permitted. Realize, these contributions are immediately utilized to re-pay the loan utilized to obtain the stock of the company. The tax advantages are even greater when the company elects to be taxed as an S-corporation. In that instance, the profits of the company which are attributable to the company’s stock held by the ESOP are retained by the company tax-free. This is because the typical pass through of the tax liability to the shareholders of an S-corporation doesn’t result in the payment of any tax liability for the shares owned by the ESOP trust since the ESOP trust is a tax-free entity which is not typically subject to tax liability.

Finally, unlike other business transition strategies, an ESOP will often provide for the continued operation of the company in the same means in which it was operated prior to the sale. For example, a sale to a strategic purchaser will often result in a loss of jobs. In addition, a sale to private equity fund will often result in significant corporate reorganization. In contrast, a sale to an ESOP typically results in a desire to have the company continue on the same trajectory in which it was operating prior to the sales transaction. Thus, the company often continues to be operated on the same basis as it was prior to the sales transaction with largely the same board of directors and management.

Thus, a sale to an ESOP can provide significant benefits both to the shareholders of a family owned business and to the company and is a strategy that should be investigated by any family owned company that is investigating the potential of a business transition.

What’s Next for Your Business?

Jennifer Riesenberg, CPA, Senior Manager, BKD, LLP

Many surveys show that family owned businesses view succession and continuity planning as one of their most important issues.  According to a 2015 succession planning survey performed by BKD, LLP, the majority of family owned businesses will experience a change in ownership and/or a change in leadership within the next 10 years.  With the baby boom generation that is at or near retirement, there is an above average wave of ownership and leadership changes expected in the majority of privately held companies in the near term.  Even still, the same 2015 study showed that more than two thirds of most family owned businesses have not developed a formal and written succession plan.

How well business owners manage and prepare for a succession event may be the decisive factor in the overall financial success of their business and its stakeholders.  Wisely managing this event will help business owners capitalize on the fruits of their labor.  Failing to plan for this event could throw their future into a tailspin. 

Developing a holistic succession and continuity plan that protects a business owner’s family can provide peace of mind and reassurance to themselves and all stakeholders.  Given the obvious need and benefits of developing a succession plan, why do so many fail to do so?  First, day-to-day operational demands seem more urgent than “long-term” succession planning.  Second, more often than not, leadership has not been through a succession event, and the lack of knowledge and experience related to developing a plan can easily lead to procrastination.

It’s also important to remember that not all succession plans are equal, and while a well-developed succession plan can perpetuate success, a poorly designed succession plan can lead to failure.  Some common reasons why succession plans fail include:

  • A failure to consider the perspective of all stakeholders, including shareholders, leadership and family
  • Developing a plan by starting with a review of liquidity options, instead of developing goals and objectives first
  • A singular focus on tax driven planning versus goal driven planning
  • Failure to resolve conflict within business or among stakeholders
  • Failure to pick and/or train a qualified and capable leader(s) to succeed current leadership

An effective succession plan should include a thoughtful approach that accounts for the interplay between business, ownership and family.  If done correctly, a succession plan will align with a business owner’s goals while addressing contingencies, gaps and opportunities.  As previously mentioned, many business owners fail to address succession due to lack of time and experience.  Therefore, we suggest beginning the process by identifying a lead advisor who can manage planning and implementation.  This will help a business owner efficiently use their time to develop a thoughtful and comprehensive plan.  This advisor should have experience in succession planning and a solid understanding of the interplay between the business, ownership and family.  This advisor also should have a developed process and toolkit for navigating these relationships.  Also, the right advisor will readily seek assistance from other qualified advisors at various points in this process. The lead advisor won’t be an expert in all fields (if they claim to be, we would exercise extreme caution) but will be able to identify potential needs and access the right professionals.

The brevity of this article limits in-depth review of the issues and topics related to the development of an effective succession plan.  However, here is one final thought—an effective succession planning is a never-ending process that requires re-evaluation as circumstances change.  Succession planning likely will always be a concern (as it should be), but having a plan in place will hopefully give a business owner the peace of mind to get a good night’s rest.

The Goering Center’s succession planning program, the Next Generation Institute, is enrolling now.  If you would like more information, please contact Steve McLemore at 513-556-7409.

This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.