Illustration by Janet Atkinson
In the traditional sense, estate planning means preparing for the orderly and efficient transfer of assets at death. However, estate planning has also come to involve planning for the accumulation and distribution of an estate during one’s lifetime.
For business owners of multiple businesses and locations, their most valuable assets are usually the ownership of franchise(s) and the underlying real estate. Regardless of your business structure, for any successful business continuation or disposition plan to work, one must consider the factors of value and control. What happens to control and value upon the death, disability, or retirement of the owner(s)? How these issues are addressed will dramatically affect not only your life but that of your family and partners.
In our experience, we find that the three biggest problem areas are:
- Antiquated language in Wills that force New Jersey taxes to be paid at the first death.
- Incomplete and dysfunctional Business Agreements that do not protect either party and have not had a valuation update in years.
- Lack of a comprehensive and structured management program for the next generation of children working in the business.
Wills
Most people are aware that the American Tax Relief Act of 2012 raised the Federal Exemption to over $5,340,000 (2014 adjusted for inflation) per individual. What most people do not realize is that the New Jersey Estate Tax Exemption remains at $675,000 per person. Most wills and other legal documents drafted before 2011 do not provide the flexibility at the first death to defer the New Jersey taxes, and with a top rate of 16%, the result can be unnecessarily expensive. The correct language in your Wills can delay and reduce the amount of taxes payable.
Additionally, the issue of estate equalization for those family members not in the business is generally not coordinated with the succession process. Many people inadvertently discriminate against the children not involved in the business. A big question for many business owners is: How do I treat all my children and grandchildren equally?
Business Succession Agreement
A Buy-Sell Agreement is an arrangement for the sale of a business interest upon a triggering event, such as the owner’s death, disability, or retirement. A well-drafted and properly funded buy-sell arrangement can protect the interests of the business owners and help facilitate the continuation of the business.
Some questions business owners should ask themselves before executing an agreement are:
- Will succession management be available and willing to operate your business?
- Would a satisfactory return on invested business capital be available to your family?
- Is there a desire for family members to continue an involvement in the business?
- Is there a ready buyer or partner available?
If the answers to the above questions result in the determination that an agreement with a partner is appropriate, then the main components to be addressed are the Seven D’s: death, disability, departure, divorce, deadlock, disagreement and default.
The business valuation process offers many formulas from a low one of Book Value to the most realistic and highest of Capitalization of Earnings.
- Does your agreement have a Fair Market Value clause?
- When was it last reviewed?
- Is the value agreed to in writing? If not, what amount would the backup formula calculate the value to be (assuming that there is a formula in your agreement)?
The next question is: What type of agreement should you have? Most owners we meet have a Stock Redemption type of agreement in which the corporation is the main conduit for purchase and sale. If the agreement is funded with life insurance, these proceeds are, 1) accessible by your banker at the death of one shareholder, 2) can cause excess income taxes upon payment and 3) create excessive capital gain taxes if the survivor eventually sells the franchise. With proper planning, there is a way to avoid all three of these economic calamities.
Next, if the determination has been made that your children will succeed you and continue to run the business, then the issue of training comes to the forefront. They become the protector and guardian of your most valued asset and, unfortunately, not always at the best possible moment.
For the next generation of owners, is a college degree and/or years in one area of the business sufficient training to successfully navigate the perils of ownership of a complex business? If family is the future of your business, why not implement a plan now for several years of thorough training in all areas of your business including but not limited to the following:
- New Sales
- Operations
- Customer relations
- Technical expertise
- Internet marketing
- Service
- Inventory control
Years down the road, when the next generation has difficult decisions to make about any number of business issues, comprehensive training should help them in the decision-making process, by understanding all the ramifications of the issue(s) before them.
You have spent a lifetime of maximum effort to achieve your current economic state, along with the attendant anxiety that accompanies growing, sustaining and running a complex business. Protecting and preserving your valuable business is essential. Why not devote some time and effort into your Estate and Business Succession Planning? Safeguarding your hard work will be rewarding, gratifying and reassuring and will make sure the next generation reaps the fruit of your labor.