Last month, I presented the tax implications of the six strategies of ownership transfer at the BEI 2017 National Exit Planning Conference. Ownership transfer can be filled with complexities, but once you’ve considered your exit planning options and have decided to transfer ownership of your company to an insider, the next step is to identify the insider(s) to whom you wish to entrust your company and begin the planning process. In this article, I’ll cover the 6 transition strategies.
But first, for context, there are various levels of business valuation reporting, which I fondly refer to as the “Cadillac”, “Oldsmobile”, and “Chevrolet” valuation reporting levels. Here’s what each one gives you:
- “Cadillac” – Full-blown report on valuator’s letterhead, which meets IRS guidelines
- “Oldsmobile” – Less complex report with scope restrictions, on valuator’s letterhead
- “Chevrolet” – Worksheet version with baseline
Now, for the 6 transition strategies:
#1: Bequeath the Ownership
This is the only one of the six common transfer strategies that cannot be completed during your lifetime. It is the simplest choice and easiest to accomplish – you need only amend your Last Will and Testament. There are some things to consider, however. This transition requires the more complex, and therefore more expensive, “Cadillac” business valuation. In addition, your estate receives no monetary payment for the value of your company.
#2: Gift the Ownership
This transfer of ownership is typically accompanied by a deferred compensation agreement to the donor and/or the donor’s spouse. Drawbacks are the same as those associated with bequeathing ownership – it will likely require a “Cadillac” business valuation and there is no payment to your estate for the value of your company. In addition, there is no step-up in basis on the price of units for those who receive the gift of ownership.
#3: Sell the Ownership Units
If you choose this route, you are no longer in charge of the company. To facilitate this transfer however, it may be necessary for you to finance the sale. So, you will still be attached to the success of the company, but with no authority – and thereby assuming all the risks but reaping no rewards. In addition, there is a step-up in basis to the price of ownership units.
#4: Bonus the Ownership
Advantages associated with this method of transfer are that the company will grow in value, there is a cash payout, and you deal with only one level of taxation. When you bonus ownership to key employees, they should be required to earn ownership based on metrics you establish in advance. Be aware that if you go this route an annual valuation will be required, but just the more basic “Chevrolet” report.
#5: The “Popeye” Plan
This plan requires that you have ten years of consistent earnings. The value of the company is converted to cash on a regular basis and distributed, making the business cash-poor. Those who acquire the stock will have little basis in it. Benefits to you are that, over the life of this plan, you draw all the accumulated equity and there are no valuation costs.
#6: “Oldco/Newco” Plan
Creating an entirely new company is also an option. This strategy can be both complicated and costly in that you will be maintaining two companies. And you may be subjected to greater scrutiny by the IRS. There are no valuation costs, however.
As you can see, the process of transferring to an insider can range from relatively simple to quite complex. But there is a strategy that fits every situation. Planning is the key to writing your own future. For help in choosing the transfer strategy that is right for you, contact me or visit my website for an overview of exit planning.