After a business succession plan is chosen, implementation may occur over many years. Meanwhile, an estate plan frequently remains securely tucked away. But that is a mistake. To ensure that an estate plan meets needs for successful transition of a business, periodic review must take place.

Evaluate whether the estate plan is still coordinated with the business transition plan.

• Has someone familiar with the business been named as the fiduciary? If the trust owns an interest in the business, make sure that the trustee understands the business and can implement the exit plan.

• Has the estate plan waived the fiduciary’s obligation to diversify assets? If not, the trustee may be required to diversify and sell a portion of the business. Consider including language that specifically directs the trustee to retain the business interests as an investment of the trust.

• Has appropriate planning taken place for beneficiaries not involved in the business? The plan may include creating voting interests for involved beneficiaries and nonvoting interests for beneficiaries not active in the business. Or, consider directing the trustee to allocate business interests and assets to the family members or managers participating in the business, and non-business assets to family members not participating. Are the business and non-business assets liquid enough to meet succession goals? Equal is not always fair.

• Are business interests held in an entity that is susceptible to partition or forced liquidation? This is of particular concern to businesses operated as sole proprietorships and general partnerships because beneficiaries could force a sale of the business.

• Does the plan allow the fiduciary to be involved in the business despite a conflict of interest? Consider using language that explicitly allows the trustee to serve as a co-owner, officer, director or employee of the business.

• Does the plan still reflect personal goals and desires? Is the business transition proceeding as planned – and if so, does the estate plan still complement the business plan to shift ownership or make generational change? If the transition has changed course, the estate plan will need to be revised accordingly.

Which other pieces of the estate plan should be reviewed?

• People. Are all the individuals named as fiduciaries (personal representative, trustee, etc.) and beneficiaries in the plan still alive? Have relationships changed such that they are no longer desired fiduciaries or beneficiaries? Have marriages, divorces, births or deaths changed wishes? Have key individuals in the business changed since the plan was drafted? Has the business moved to a different state since the plan was drafted?

• Entities. Has the business changed form or name? Has personal interest in the entity changed? Has a role in the entity changed? If charities are named in the plan, are they still in existence?

• Assets. Have personal assets changed significantly? In 2014, estate tax is imposed on estates in excess of $1 million in Oregon, in excess of $2 million in Washington, and federal estate tax is imposed on estates in excess of $5.34 million. There is no estate tax in Idaho. If assets have crossed any of these thresholds since the estate plan was drafted, it should be re-evaluated.

Does the structure of the estate plan still make sense under the current estate and income tax laws?

Federal estate tax laws have undergone a number of dramatic changes in the past five years. In particular, plans drafted before passage of the American Taxpayer Relief Act of 2012 (when the estate tax exemption was set at $5 million for 2011 and indexed for inflation, permanently unified with the gift tax exemption, and made portable) should be reviewed to ensure they accomplish goals in the most simple and tax-efficient manner.

The federal estate tax exemption increase has made the complicated planning that was previously done unnecessary for some clients. Estate planning documents that used trust funding formulas based on federal exemption amounts now have drastically different (and potentially undesirable) effects.

Additionally, because of the higher federal estate tax exemption and portability of the exemption between spouses, maximizing income tax benefits has become more important than estate tax planning in many cases. Depending on when the estate plan was drafted, review it to ensure that income tax planning opportunities are being maximized.

Do documents allow a representative to obtain one’s medical information?

Ensure that power of attorney contains a Health Insurance Portability and Accountability Act (HIPAA) release. It will allow the agent to obtain one’s health information that would otherwise be protected from disclosure. While HIPAA is not a new law, many estate planning documents do not contain HIPAA-compliant provisions allowing the release of information. These releases are critical in cases of incapacity.

Do documents contain provisions about digital assets?

It is important not to forget the transition of digital assets and digital devices. This includes, among other things, laptops, cellular phones, emails, digital music, digital photographs, software licenses, domain names, blogs, listservs, and online accounts. The same practices that make it difficult for hackers to steal personal information (choosing strong passwords and regularly changing them) make it very difficult for someone to act on another’s behalf with respect to those assets and devices in the event of death or incapacity. If estate planning documents do not include provisions dealing with these assets and devices, consult an attorney familiar with planning for these assets to update documents.

No matter how carefully an estate plan is crafted, it cannot possibly account for every change in one’s life or the law. It is only a snapshot in time of what was desired when it was documented. To ensure that an estate plan will accomplish goals and properly implement a transition plan, it must be reviewed periodically.

Jennifer Woodhouse is an attorney with Schwabe, Williamson & Wyatt, and a member of its business transitions group. She focuses her practice on tax controversy and estate planning. Contact her at 503-796-2858 or jwoodhouse@schwabe.com.

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Family businesses account for approximately 80 percent of U.S. companies and 80 to 90 percent of businesses across the globe. Some of the world’s biggest companies are family-owned, including Samsung, Tata Group, Wal-Mart and Cargill, and about one-third of all companies in the Fortune 500 are family-controlled.

Yet family business models often are overlooked because only 30 percent make it past just one generation, only 12 percent remain viable into the third generation and only 3 percent operate into the fourth generation and beyond. Nevertheless, there are valuable lessons to be learned from successful family businesses and the characteristics they all share.

Adopt a long-term vision and investment strategy

Many non-family businesses manage investment for near-term growth, or measure short-term performance; however, family businesses tend to take a longer-term perspective, focusing on benefits for the next generation rather than immediate gains by taking on risks. Family businesses will accept a lower return in good times to ensure survival in bad times; they will invest in an upturn or a downturn because of their long-term outlook.

This vision may be documented in a Family Constitution or Value Statement, or it may be manifested in the election process for those who serve on the board. Documenting this longer-term thinking and a broader perspective often sets the stage for stewardship and lasting culture. Recently, much talk has taken place about non-family businesses being encouraged to manage for the long term, yet many fail to put processes in place to measure progress in this regard.

Inspire more trust and commitment from employees and communities

Many decisions in family-owned businesses are measured by looking at family, employees and the community, including customers and suppliers.

While non-family companies use stock grants and options and other short-term incentives to reward behavior, many family-owned businesses create a culture of commitment and retain talent by investing in people and rewarding performance over the long term. Other businesses support and invest in their communities either through loyalty programs, gift giving, job creation and other mechanisms, while family-owned businesses tend to be more committed and reliable to the “family” causes.

The family may act through a foundation or independently through individual trusts, scholarships and other charitable vehicles.

Cope with exploration, conflict or change

Exploration, conflict and change are inevitable when the ownership, the family and the business have different interests. The owners have a financial stake, but the family holds the emotional core, including family communication, trust and rivalries. The business may be the only asset or one in a number of businesses within a family enterprise.

Providing a process for exploring different approaches and/or for anticipating and predicting how the family, the owners and the business will confront these issues as they react and respond to change is critical. Family-based issues often are more critical than business-based ones. Choice of entity, shareholder agreements, liquidity programs, family councils, family constitutions and other mechanisms help deal with multi-generational dynamics and inevitable disputes. Non-family businesses often have the same issues but don’t plan for this type of conflict resolution.

Nurture and take care of the family

Successful family businesses actively build connection and shared purposes over generations. Careful estate planning will preserve family assets and assure family control. Communication vehicles, such as family meetings, single-family offices (whether physical or electronic) and other training provide for future continuity. Non-family businesses have similar constituents and stakeholders, and these tools could be beneficial.

Plan ahead for leadership transition

Orderly transition requires planning whether succession is to own, manage or sell. Transition can build or break the family firm. Successors have to be selected, trained, groomed and given the opportunity to lead – and more importantly, they should want the job.

But in a family-owned business there is also the exiting CEO and the task of defining that person’s role going forward. For a smooth, conflict-free transition, the former head of the company needs to have a clearly defined role after stepping down. Oftentimes, an outside board of advisers or independent directors can assist this essential function. Non-family businesses must also plan and cultivate human capital for the next generation or next owner.

Transition is going to happen, whether planned or not. Given that family-owned businesses play a key role in our economy, there are numerous lessons to be learned from their successes and their failures. Family-controlled businesses can serve as an example of how planning and using a variety of corporate tools and processes can lead to long-term success and stewardship.

Carmen Calzacorta is a shareholder with Schwabe, Williamson & Wyatt in its business transactions; mergers and acquisitions; corporate finance, securities and capital markets; and business transitions practice groups. Contact her at 503-796-2994 or ccalzacorta@schwabe.com.

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When it comes to planning for a business transition, many business owners fail to implement value enhancement strategies that are often needed to achieve a desirable exit from the business, whether that is a third party sale or a transfer to a new generation of family or management.

According to the 2013 State of Owners Readiness Survey co-sponsored by the Exit Planning Institute, 86 percent of business owners have not taken on a strategic review or targeted value enhancement project. Yet transition planning is one of the most important issues facing any business – and one of the most commonly avoided.

Why? One reason is that many business owners do not associate transition planning with “working on” the business to increase its value. Preparing the business for succession and successfully completing a transfer is often more difficult than building the business itself.

A transition plan (also known as an exit or succession plan) is an integrated plan that asks and answers all of the personal, business, legal, financial, tax, and estate questions that are involved in exiting from a privately owned business. In practical terms, exit planning is a way of running a business that maximizes its value and provides a means to achieving the owners’ personal and financial goals. A key element that connects an exit plan with a company’s larger business plan is value enhancement.

Value enhancement results from actions that “de-risk” the business from legal, financial, and other variables. De-risking can add value to core business functions and can increase the salability of the business. This has benefits regardless of the owners’ time frame for exiting the business.

Before you know how much value enhancement is needed, it is important to determine the value of your company. There is often a large gap between what business owners think their business is worth and what it is actually worth. According to a study conducted by the Alliance of Mergers & Acquisitions Advisors, 95 percent of mergers and acquisitions professionals believe that business owners’ unrealistic expectations of company value is the biggest obstacle to sale or transfer. To help owners move swiftly and cohesively in considering strategic opportunities, it is important that all owners reach consensus about whether the enterprise value is acceptable.

If the value of a business is below what the owners feel they need to support a comfortable lifestyle after an exit, or if the value is insufficient to drive desired strategic growth, owners are usually best served by taking time to enhance the value of the business before transitioning.

What are de-risking strategies and which ones drive the most business value?

As advisors to privately held businesses, we focus on numerous value factors related to personal motivation, business operations, industry and market conditions, legal and regulatory conditions, and financial/economic conditions. Here are some examples of de-risking strategies:

Adopt a written “contingency plan” to document how core business functions will be performed if key personnel with institutional knowledge about those functions are absent.

Ensure that written agreements memorializing the terms of the company’s key relationships are in place, and that the agreements will not trigger a termination right if ownership of the company changes.

Ensure that key employees are incentivized to help the company grow and ultimately achieve a desired transition.

Appoint an advisory board of “outsiders” to advise the company regarding major decisions.

Audit the company’s tax filings and registrations to ensure that the company is paying taxes in all required jurisdictions.

Obtain an environmental assessment of the company’s facilities to identify and address possible environmental concerns.

Confirm that the company has sufficient insurance in place to cover potential liabilities, including product liability claims if applicable.

Identify and register or otherwise protect the company’s intangible assets such as patents, trademarks, copyrights, and trade secrets.

There are, of course, many more value factors and de-risking strategies. Owners should focus on strategies that present the most opportunity for improvement and the potential to yield the greatest benefit. For example, if a significant portion of the company’s value is related to its intellectual property assets, but the company has not secured intellectual property protections, focusing on this strategy is likely to create a high return. Your exit planning advisor can help you identify and rank the value factors applicable to your business.

To most effectively implement value enhancement strategies, focus on five actionable steps that can be completed in a ninety-day time period. Track the status of each action item. Assign responsibility for completing the tasks within the organization. Lay out a road map of all action steps needed to complete each task.

Once actions have been implemented, move on to the next items. Throughout the process, it is critical to take stock of how de-risking is affecting the value and salability of the company. Map the company’s progress by making at least a cursory valuation or “recast” of the financials each year.

The more a company de-risks during its life cycle, the more attractive it will be to a buyer if and when the owners decide to sell. If the owners want to keep the business in the family, de-risking can help preserve the business legacy, ensuring the next generation takes over a business that has a solid structure in place to support growth and to ensure stewardship over the business.

Matt Bisturis is an attorney with Schwabe, Williamson & Wyatt in its corporate, mergers and acquisition, real estate, and business transitions groups. Contact him at 360-905-1113 or
mbisturis@schwabe.com.

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According to a 2010 study by Boston College’s Center for Retirement Research, baby boomer business owners will be involved in what is predicted to be the largest collective transfer of wealth in U.S. history. Unfortunately, this transfer is occurring during a period in which capital gains rates have increased from 15 percent to 23.8 percent.

Oregon business owners bear the burden of having the third highest combined capital gains rate in the country at 31 percent. When a business is sold, the owner will generally pay capital gains tax on the difference between the price the owner is paid, or “basis” in the asset, and the sale price.

The question for many business owners is how to transfer ownership without the large tax liability. One option would be to hold onto the business until death. This would allow the owner’s heirs to receive the assets with a step-up in basis.

For example, if a business owner capitalized the business with $10,000, which over time increased in value to $1 million, upon the owner’s death, the owner’s heirs will receive the shares with a stepped-up basis of $1 million. When the owner’s heirs eventually sell the shares, they will be responsible for paying capital gains only on the difference between the $1 million value and the price the business is sold for. This results in close to $280,000 remaining with family members that would have otherwise been paid in taxes.

The main disadvantages of this option are that it requires the business owner to generally be involved with the business much longer than he or she would like, and it leaves the owner’s family with the responsibility to sell the business with little to no direction.

Several other ownership transition choices include selling the company, merging with another company, selling internally via a management group or an employee stock ownership plan (ESOP) or a combination of the two, transferring the business to family, liquidating or going public. One of these options allows a business owner to sell a company in the present, and still allow his or her heirs to receive the assets with a step-up in basis. This may be facilitated with the sale of the business to an ESOP.

An ESOP is a qualified retirement plan that was created by Congress in 1974. It has a myriad of tax incentives for the seller of a business and the sponsoring company, and it also provides a great benefit to employees by providing them ownership equity. An ESOP can be sponsored by any C corporation or S corporation.

Under section 1042 of the Internal Revenue Code, a qualified seller of a C corporation who sells at least 30 percent of his or her business to an ESOP may make a “1042 election,” which allows the seller to reinvest the proceeds in qualified replacement property (QRP) within 12 months of the transaction. Capital gains on the sale will be deferred until the QRP is sold, resulting in no immediate taxation to the seller.

If the seller desires liquidity, any portion of the QRP may be sold, with capital gains tax applying only to the sold QRP. Any remaining QRP still held by the seller at death is transferred to the seller’s heirs with a step-up in basis, avoiding capital gains tax entirely.

The ESOP also provides tremendous tax advantages to the company. Any contributions to the ESOP for purposes of paying down the ESOP loan are deductible, resulting in the purchase of the company from the seller on a pre-tax basis.

It should be noted that S corporation ESOPs have additional tax advantages. An S corporation is a pass-through entity similar to a partnership or LLC. As such, any profits are allocated to the company owners, and they pay personal income tax on the gains. Since ESOPs are tax-exempt retirement plans, any percentage of profits allocated to the ESOP is tax-free, and provides the ESOP with additional cash flow to pay off amounts owed to the seller or to grow the business.

The ESOP approach also allows the business to stay intact. A sale to a competitor has the inherent risk that employees may be laid off, corporate culture will be diminished, and the character and strength of the business developed for years by the owner will be extinguished. An ESOP allows current management to continue to operate the business, and as the company grows, all of the employees may share in the future success through growth in their retirement accounts. Studies have shown that on average, ESOP participants receive 50 percent to 100 percent more in contributions than traditional 401(k) plan participants.

In addition to the tax benefits of an ESOP, a study by the National Center for Employee Ownership has shown that when employees are given a percentage of ownership through an ESOP, sales growth of a company increases by 2.4 percent on average.

An ESOP is a valuable business succession planning tool with significant tax benefits. As such, ESOPs should be considered by any closely held company considering succession planning and transition from an owner to future management.

Even so, an ESOP isn’t the best solution for every organization because it is inherently complex, and as with any transition option, the owner, the employees and the company need to understand how it works and what to expect at every stage of the process from assessing feasibility to exploring and executing transaction alternatives. An ESOP can be the right tool for the owner and the company, but only after review of the options and determination whether it is a viable fit for strategic goals and personal legacy.

James Moser is a law clerk with Schwabe, Williamson & Wyatt in its ERISA, employment and business ?transitions groups. He is licensed to practice law only in California and Utah. He has a pending application ?for reciprocal admission in Oregon. Contact him at 503-796-2893 or jmoser@schwabe.com.

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One of a business’s most valuable assets is its people. The single most important factor giving rise to a company’s higher value, other than increasing cash flow, is the existence of a stable, motivated management team that will remain in place after the owner exits.

Yet in many transitions, owners don’t address the future of their employees in time to maximize value. In many cases, because of a failure to plan and anticipate, key employees become fearful of looming changes, and the company experiences reduced productivity and cash flow, a loss of good talent, or possibly sabotage – and all directly reduce a business’ sale price.

Putting the right employment incentives and agreements in place will help ease employees’ worried minds, protect the company’s assets, and increase the value of the business.

The scenario: Frightened key employees quit and compete

Consider a baby-boomer business owner who wants to transition into retirement, and enters into discussions with a buyer. The buyer begins its due diligence, reviewing the company’s financials, customer contracts and relationships, etc. The prospective buyer’s goal is to purchase a good business and make it even more profitable.

Key employees Alex, Brenda and Claudio become frightened for the future of their jobs. They inevitably distrust the buyer and don’t see what’s in this sale for them. Alex, Brenda and Claudio have the direct customer relationships, and Claudio holds the necessary state licenses to engage in business in the industry. The three key employees leave the company and start a competing business, leading to an immediate revenue loss of $50,000 per month. Amid the turmoil, the potential buyer walks away.

The unprepared owner is left not only with a botched sale, but also too few key employees to continue running the business, reduced market value, a lack of adequate licensing, and a new competitor that will make regaining market value difficult.

Plan ahead with precautionary and incentive agreements

While most employees fear change, they also realize change is inevitable. The smart owner can maximize the value of the business by ensuring that key employees are prohibited from competing and are incentivized in the short run to see the company through a profitable sale and years of smooth operation under the new owner.

• Nonsolicitation/noncompete/nondisclosure agreements

Many companies experience a direct increase in value if key employees and those with crucial client relationships are bound by an agreement that restricts what employees can do with the company’s proprietary information and relationships. Owners will want to bind key employees to noncompete agreements. Sales employees and others with key client relationships should be bound, at least, by nonsolicitation agreements to prevent them from moving to a competitor and calling on the company’s customers. And all employees should be bound by nondisclosure agreements that require employees to keep the company’s secrets confidential.

Restrictive agreements are highly regulated by state laws. An attorney is needed to evaluate the enforceability and assignability of existing agreements and a company’s options if no agreements are in place.

• Bonus retention and/or severance agreements

Unlike with long-term incentive programs, key employees may be comforted if they are promised financial gain in exchange for effectively transitioning operations to a buyer. These agreements typically motivate a key employee to: 1, maintain or increase the company’s income stream in the years leading up to a sale; 2, ensure a smooth due diligence process; and 3, provide successful management and operations after a change in control.

There are many ways to draft short-term incentive plans to meet these goals, like a bonus plan, retention or stay plan, or other golden handcuff plans. By way of example, a company could create an escrow account. When the sale closes, a percentage of the sale price is deposited into the account, with a small percentage vesting immediately and then greater percentages vesting each year for three years.

The first vested payment from the account, made at closing, would be large enough that the key employees would feel fully rewarded for their hard work preparing the company for sale, but not so large that they choose to follow the owner out the door. The annual payments thereafter are paid provided the employee remains with the buyer. Any money left in the account at the end of three years reverts to the owner.

With an agreement like this, the key employees are encouraged to build maximum value in the company in the years leading up to a sale so that a larger amount of money is placed into the account. If they are not hired by the buyer, they still receive their first vested payment, which is large enough to make them feel compensated for their hard work. If they are retained by the buyer, they are motivated to continue working hard to maintain and increase cash flow because if they remain employed by the buyer, they receive additional cash from the account.

There are many other examples of short-term bonus plans that can achieve an owner’s goal to maximize, capture and keep the value of his or her business in a sale. Regardless of how the incentive plan is structured, it is essential to begin planning early.

Such agreements add value to the company in the buyer’s eyes because it ensures consistency in operations during a transition. The last thing a buyer wants is for the employees to jump ship just before or after the transaction closes. And perhaps one of the greatest advantages to an owner is the assurance that if a deal falls through, the key employees will still be around to operate the company until the next transition opportunity arises.

Amanda Gamblin is a shareholder in the Portland office of Schwabe, Williamson & Wyatt and a ?member of ?its business transitions group. She focuses on employment law. Contact her at ??503-796-2903 or ?agamblin@schwabe.com.?

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