Don't Give Your Business Away, Sell It - Forbes

Author: Steve Parrish

I often address business groups, and many of the attendees own family-operated businesses. I challenge these individuals with this question: “Do you want your kids to be heirs or successor owners?”

Here’s the difference. A successor owner is one who takes the legacy of the business you built and moves it to the next level. An heir is a loafer who sits around waiting for you to die.

To encourage children to act like successors, you need to get them thinking like business owners sooner. And the best way to do that is to make them owners now – but for a price.

There simply has never been a better time to facilitate the transfer of some of the family business to the kids.

The primary economic driver for these positive conditions is incredibly low interest rates. This makes the transaction workable from a cash flow standpoint. Second, the tax environment is also favorable in that owners can still legitimately discount privately owned business interests for valuation purposes.

But both of these conditions can change. Interest rates are likely to increase, and tax law writers may ultimately succeed in limiting what discounts can be used in valuation of a family-owned business.

How a transfer works

Assume you own a family business, and your daughter wants to succeed you in ownership of the business. Rather than gifting her stock or, worse yet, having her wait for you to die to inherit the stock, sell her part of your business now.

Here’s the process:

1. Value your business. You may know your business, but that doesn’t mean you know what an outside party – or the IRS – will attach for a value.
2. . C or S Corporations can issue non-voting stock. A partnership can be changed to a limited partnership. An LLC can have members as well as managers. You don’t have to hand over the keys to your business in order to have your daughter become an owner.
3. Sell a portion of your business to your daughter. She would buy an equity stake for a contractually agreed, IRS-defensible value. She can either sign a long-term installment note or an interest-only note with a balloon payment far into the future. Your daughter now owns a part of your business, has established a tax basis in her stake, and can start thinking like an owner.

Why now?

Your daughter is not wealthy. How can she possibly afford to buy into the business?
It’s all about the terms of the loan. The IRS is required to use tables known as the Applicable Federal Rate (AFR) to determine the minimum interest rate to charge so as to avoid the loan being treated as a gift.

The March 2015 annual, long-term AFR is an incredibly low 2.19 percent. Ten years ago it was 4.52 percent. Fifteen years ago it was 6.75 percent. Think of these current low AFR rates as a tax and cash flow gift to business owners.

You can set up a long-term agreement with your daughter to sell an interest in your business and be able to lock in a rate of only 2.19 percent. This rate will not increase during the period of the loan, even though interest rates are likely to increase in the future.

Consider how this could work. If you sell your daughter a stake in your business worth $1 million, the annual interest charge on that stake would be $21,900.

How can she afford the interest payment? The earnings she receives from her equity stake in the business can provide her with the working capital needed to pay you the interest on the loan and perhaps some of the principal. And this doesn’t necessarily mean a loss of cash flow for you. What you give up in earnings from the sold stock will be recovered in whole or in part by the loan payments your daughter makes to you.

For estate planning purposes, you’ll probably want your daughter to pay off the loan no later than the date when you die (hopefully a long way down the road). A common planning technique is to have her use some of the earnings from her equity share to purchase life insurance on your life. That way she’ll pay off the loan at your death. She’ll own her stake in the business free and clear, and your estate will have liquidity for other estate planning needs.

The benefit

The bottom line is that your daughter will now start thinking aboutyour bottom line. She’ll think like an owner because she will be an owner.

For example, if your company makes additional profit because of her contribution to the business’s success, she will share in the financial rewards through her stock ownership. Conversely, she’ll feel the cash flow pinch when times are bad.

This will set her up for eventually taking over the legacy you’ve created and becoming a successor owner.

This favorable alignment of the stars will not last forever. Both interest rate and tax changes are looming. If you want your children to be your successor owners, now is the time to act.

Article at:  http://www.forbes.com/sites/steveparrish/2015/03/02/dont-give-your-business-away-sell-it/3/

For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com or my personal website at www.BuySellFLbiz.com.