The Keys to A Successful Succession Plan (Part 2)

Succession planning is important to prepare for. Without any sort of plan, new business leaders would have to start from scratch. Here are key points to planning for a successful succession plan.

An Example Succession Plan

Three types of succession plans

Depending on the situation of your business and your own personal preference, there are three types of succession plans.

• Continuity
• Family Member
• Third Party

Continuity succession plan

Among continuity succession plans, there are buy/sell agreements and management buyout. Buy/sell agreements are legally binding agreements between shareholders and the company that the shareholders are required to purchase the stock of the business owner. These are often flexible. It is a method for evaluating stock value is included in the agreement. Any restrictions are recorded on the stock. There are different types of buy/sell agreements



Cross Purchase

An agreement among business owners to collectively purchase the interest of departing owner at a specified or ascertainable price. Cross purchase agreements require each shareholder to have sufficient funds to purchase the shares.



For example, Kevin designed a plan where his two sons purchased 16% each and three managers purchase the remaining 19%. This plan leaves his sons with a combined 51.6% of the stock therefore retaining family control of the business.



Stock redemption

An agreement that the business itself will purchase a departing owner’s interest at a specified or ascertainable price. Funding a stock redemption agreement is an important facet of succession plans. Without a plan, the agreement may cause financial crisis for the company. Agreements require total redemption of all shareholder’s stock. The IRS may argue stock purchase equates to dividend check and could require taxes on proceeds.



For example, Ken owns 90% of stock in his business. John owns 10%. When Kevin’s redemption agreement was “triggered”, his family sold his stock to the company at the predetermined price. Since Kevin’s stocks are now retained by the company as treasury stock, John becomes a sole owner of the company.



Wait and See

An agreement that permits the business owners to wait until the first death or other triggering even occurs to decide whether the business or the owners will purchase the business internet. This type of continuity has the greatest flexibility but also complicates funding.

ESOPS, GRATS, IDGT, and Gifting

Insiders or participating family members qualify for ESOPS, GRATS, Intentionally Defective Grantor Trusts, and Gifting. ESOP stands for Employee Stock Ownership Plans. This is similar to a 401k plan. The ESOP invests in the stock of the company and can borrow money to do so.

Some advantages to ESOP is:

• Fair Market value
• Reduce financial cost
• Employee job security
• Avoid capital gains
• Control

Family member succession plan

The money will be put into a trust. The shares that contribute to trusts can be excluded from estate and estate taxes. Some types of trusts include grantor retained annuity trusts (GRANT), Charitable Remainder Trust, Grantor Intentionally Defective Trust, and Life Insurance Trust.

Grantor Retained Annuity Trust (GRATS) or Grantor Retained UniTrusts (GRUTS)

GRATs and GRUTs are techniques for transferring property to family members in trust. By retaining a qualified annuity or unitrust interest, the value of the gift is greatly reduced. Generally, property is transferred to a trust that lasts for a specified period of time that the grantor is expected to outlive. At the end of the trust term, the property passes to the family member’s beneficiaries of the trust. The value of the gift for gift tax purposes is the fair value of the property reduced by the present value of the retained interest.

GRATS can be a very beneficial tool to use with rapidly appreciating closely-held stock because the growth rate of the stock should be greater than the rate used to calculate payments back to the grantor. This would leave a larger amount passing to the beneficiaries.

The disadvantage is if the donor dies before the end of the trust term, the fair market value of the assets reverts back to the estate.

Intentionally Defective Grantor Trusts

If a grantor would like the transfer to the trust to be complete for estate tax purposes so the property will not be included in his or her gross estate but incomplete for federal income tax purposes (so the grantor will be taxed on the trust income), they want what’s referred to as an “intentionally defective grantor trust.”



It is “defective” for income tax purposes, but effective for estate tax purposes.

Advantages of an Intentionally Defective Grantor Trust (IDGT)

• The income tax liability for the trust assets may be lower if taxed at the grantor’s, rather than the trust’s, tax rates. With the compressed income tax rate structure now in effect for estates and trusts, having the grantor taxed on the trust income may create income tax savings.
• By causing the grantor to be taxed on the trust income, the value of the trust assets is not diminished by the taxes, thus allowing a greater value to pass to the remainder beneficiaries. This effectively results in a tax-free gift of the income to the trust’s remainder beneficiaries.
• The trust assets and the appreciation of the trust assets after the date of transfer to the trust are removed from the grantor’s gross estate. Thus, appreciation on assets transferred to the trust can be shifted to younger generations with minimal transfer tax.

Third Party Succession plan

This type of succession plan is not a traditional succession plan. There is a four step process to it.

• Clean up
• Hire advisor
• Inform market of available business
• Price and terms are negotiated

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