05/01/2007
Two years ago I inherited a large sum of money, and recently started my own business. I am married, in my late 30s and have two young children. My business just received its second round of financing, and a friend suggested that I begin a preliquidation plan already. I am not planning to sell anytime soon, so is it too early to start thinking about liquidating?
It is never too early to start thinking about planning for succession of the business, whether as a result of a liquidation event or through a transfer to the next generation. Advisors often counsel their clients to consider the succession planning issue when the business is formed, but owners rarely take advantage of the opportunity at that time.
The earlier an owner considers succession planning, the more likely the business will succeed after the current owner is no longer running it. Planning for the transition has numerous benefits. It allows current owners to get involved in the process and to realize the economic value of their efforts. It also can reduce or eliminate unwanted tax consequences, provide warnings (and possible solutions) to the issues that will arise in the transition, and help ease the emotional and psychological barriers to transition.
By planning for a liquidation event or other transition of the business at this early stage, you will have more alternatives to consider to maximize the value of the business for your family. Once the business has grown significantly in value, many of the tax savings opportunities will be lost. Because taxes (both income and estate) take a large portion of the proceeds from the sale of a business when it is passed on to future generations, the earlier you start to plan, the more likely you can minimize those taxes.
Raymond S. Kreienkamp, Blackwell Sanders Peper Martin, St. Louis
Essentially, your friend is suggesting that you consider exit strategies, which ultimately affect your return and your investors’ return. While you are not planning on selling, clarity about long-term goals will help you make current decisions that will guide your business toward these goals.
You should also consider your personal estate planning. Because you just inherited money, your wealth may significantly exceed your spouse’s assets, and that could influence your planning. If you have significant assets outside of the business, you may want to look at how safe those assets are from risks posed by the business. Alternatively, if you have all of your assets tied up in the business, you might want to consider whether you have enough term life insurance to provide for your family in the event something happens to you. A well-drafted estate plan will help make sure that your goals are accomplished.
Finally, if your business has the possibility of significantly appreciating over the next few years, you should consider whether making a transfer to an irrevocable trust or a partnership with a transfer of partnership interests to your children (or other heirs) makes sense. There are many potential strategies for this type of transfer that a good estate planning and tax attorney or accountant can suggest.
Steven M. Goldberg, Friedemann Goldberg, Santa Rosa, Calif.Assuming that a qualified appraiser can readily obtain fair market valuations for your stock, there are two techniques you should consider that estate planners widely use: a grantor retained annuity trust (GRAT) and an intentionally defective grantor trust (IDGT).
Each trust has its particular strength. The GRAT works best when you anticipate that there will be a great deal of short-term appreciation of the value of your interest in your company—such as through a future public offering. Through the use of the GRAT, you will be able to shift that appreciation to a continuing trust for the benefit of your spouse and descendants, which will escape estate and gift taxation at your generational level.
The IDGT works best when there is a high cash flow from a business relative to the value of its stock, which is often the case in closely held partnerships and S corporations. The result in shifting equity to the next generation without estate taxes can be truly spectacular over a long enough time horizon, but it is not the quick-hit type of technique that a GRAT can be.
A successful GRAT or IDGT can also offer some benefits to you in terms of protection from future creditors. One thing neither technique will save, however, is income taxes. You will remain subject to income taxation on the income earned by each type of trust.
Mitchell Lapidus, Propp Lubell & Lapidus, New York
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