CategoryFamily Business and Succession Archives — Page 2 of 3 — C. Lynn Northrup, CPA, CPIM
Now that we have a new President many people will think that his recovery program will have us back on track in a few months. I’m not so optimistic. My advice is to prepare for a longer term period of slow economic activity, maybe as long as two to three years. This isn’t what you want to hear, but it could well be reality. Assuming such a dismal projection, it is important for us to develop a survival strategy – perhaps strategies.Your strategy needs to include a thorough understanding your competition and markets. You will need to be aggressive and radically different to gain the necessary market penetration. Don’t think your sales volume will be like prior years. It’s probably going to be lower and with reduced profit margins. The world is different now. Keep reworking your strategy almost on a daily basis to make sure you’re on track. Agility is the key to survival.
Developing a budget is essential. The budget needs to include revenue projections together with generation of cash flow. This means managing how you invoice, manage accounts receivable, manage inventories, and manage accounts payable. Maintaining an effective and effective cash conversion cycle is the most critical measurement indicator that you can monitor. When projecting your expenses you need to reduce them to various levels to match the level of revenue projected. Your expenditure budget needs to include survival level outlays representing the minimum level of expenses possible. When you understand how low you can go then you can adjust to revenue levels appropriately.
A component of the budgeting exercise should draw you into analysis of your business processes to understand where there are opportunities to improve these processes. In the new business environment improvement of business process flow will be the key to attaining a competitive advantage. One of the best opportunities to improve business processes will be in reducing paper work and improving accounting efficiencies. We have forgotten the back office which represents huge opportunities.
Many CPAs are too focused on taxes and financial statements and fail to provide the business advice that clients need. This will change as businesses will seek out the advice they need to survive the recession. If businesses fail to receive what they need from their CPA then they should seek a professional who has the expertise to guide them through the tough times ahead and will be responsive to their needs and requirements.
My advice is to be flexible, disciplined, patient, and focused. This is a time to think different because life will be different. The old rules aren’t going to work so you need to find new guidelines and ways to do business. Lower your expectations and hope for the best while preparing for the worst. While things look pretty dismal, this is a good time to look for opportunities to improve your competitive position and profitability.
Clients that wish to make contributions to charities can take advantage of low interest rates and depressed asset values to create and fund a charitable lead trust. This technique works much the same as a GRAT, but provides a stream of payments to a charity rather than back to the grantor during the initial term of the trust. A charitable lead annuity trust (CLAT) is an irrevocable trust that gives a designated charity (this can be a family foundation or a public charity) the “lead” interest consisting of a stream of payments for a term of years or for an individual’s life and thereafter passes the remainder interest to (can continue as a trust for the benefit of) remainder beneficiaries – usually the donor’s children.There are special rules on the use of CLAT’s for GST tax purposes which make this tool less attractive for estate planning on passing wealth to grandchildren. Because of this drawback it is best that donors designate their children (or trusts for their benefit) as the remainder beneficiaries of any CLAT.
The charitable beneficiary receives an annuity from the trust for the term of the CLAT, after which the remainder flows to the grantor’s children. Similar to a GRAT, the value of the gift to the remainder beneficiaries is established by referencing the 7520 rate. Any return in excess of this assumed interest factor results in a tax-free gift to the remainder beneficiaries.
Another variation and an alternative to a CLAT is establishing a GRAT and then making annual gifts to charity of the amounts received back from the GRAT in the form of an annuity payment. This allows the grantor to retain complete control over amounts given to charity as well as selecting the charitable recipients in each year. It also provides the grantor with an annual income tax deduction for the amount of the contributions.
The techniques we have been discussing is appropriate for people with estates large enough to incur an estate tax imposed at death. The current exemption from federal estate tax is $3.5 million. While this was scheduled to phase out in 2010, it is likely that the Obama administration will continue the exemption at this level. I don’t know how long interest rates will remain at these levels but it represents a great chance to pass on wealth to children at a significantly reduced cost of federal estate tax.
These are unique tools for high wealth individuals to preserve the value of their estates. I hope you enjoyed these series and can benefit from them.
Low interest rates and assets values represent a perfect opportunity to freeze estate values and minimize inheritance taxes. The freeze technique utilizes a grantor trust which takes advantage of even lower interest rates than afforded by the 7520 and avoids revaluation of trust assets on an annual basis. This technique is more attractive than the GRAT application for use with assets that are difficult to value.A grantor creates and funds an irrevocable trust for the benefit of descendants. The initial funding of the trust is usually done with cash in an amount equal to 10 percent of the value of the property that will be included in the sale. This trust is a “grantor trust” making the grantor the owner of the entire trust for income tax purposes, even though the trust is a completed gift for gift and estate tax purposes.
Once the trust is funded, the trustees purchase the assets from the grantor in exchange for a promissory note. Since the trust is not a consideration for income tax purposes, the sale does not result in recognition of a capital gain. The trustees continue to pay down the note using the cash flow generated by the purchased assets, or by borrowing funds from a third-party lender, or by making payments in kind. The note can be structured as an interest-only note with a balloon payment of principal at the end of the term of the note.
The property sold to the trust is removed from the grantor’s estate immediately; with no risk of inclusion should they die during the term of the promissory note. If the grantor dies before the note is paid, any portion of the unpaid balance will be included in the grantor’s estate.
The interest rate used for the promissory note is lower than the 7520, meaning that less value is returned to the grantor via the sale technique than would be the case when using a GRAT. The promissory note is structured as a balloon note in contrast to GRAT annuity payments which must be paid with no more than a 20 percent annual increase. Accordingly, the sale technique has the advantage of allowing the subject property more time to appreciate outside of the grantor’s estate. One of the key advantages of this technique is that it is more appropriate for passing wealth to grandchildren than the GRAT technique.
One of the disadvantages of the sale technique is that it must be funded initially by a gift with sufficient assets to provide security for the promissory note. This strategy also requires some use of the lifetime gift tax exemption and cannot produce a $0 gift like the GRAT strategy. The value of the assets subject to the sale can change upon audit. The GRAT technique is based upon a specific tax statute whereas the sale to a grantor trust is a creative use of several different tax laws. However, if the technique is successful, there is an opportunity to pass on wealth to grandchildren with very minimal use of the life time gift tax exemption and GST tax.
We have one more neat estate freeze technique which we will share with you in the next blog post.
Because values and security prices have dropped to all time lows combined with record low interest rates means it’s a good time to lock in the value of your estate for estate tax purposes. It could preserve future cash flow by reducing inheritance taxes on the transfer of estate assets to your beneficiaries.There are a number of strategies you can use to take advantage of depressed market values to remove future appreciation on assets in your taxable estate and pass that appreciation to beneficiaries with no gift tax. One of the best tools to accomplish this is utilization of Grantor Retained Annuity Trusts (GRAT). This strategy is accomplished by the donor placing property that is likely to appreciate over its current value into a trust combined with the grantor’s right to receive a fixed annuity with remaining trust assets passing to the grantor’s children or other beneficiaries. This can be an outright transfer or includable into a continuing trust.
The neat component of this strategy is that the grantor’s retained annuity is designed so that its present value determined by IRS rules is equal to the current value of the contributed assets. The effect of this action is that the present value of the remainder gift to beneficiaries is zero ($0).
The IRS assumes that assets contributed to a GRAT will appreciate at a fixed interest rate which is called the “7520 rate.” For GRATS funded in January 2009 the 7520 rate will be 2.4%. Accordingly, to the extent that appreciation of GRAT asset exceeds 2.4%, it will pass to the remainder beneficiaries with no transfer tax consequences. Therefore, the GRAT program effectively freezes the value of assets for estate tax purposes at current low prices and values.
There could be some drawbacks in that some portion of the annuity payments will have to be made in kind, thus requiring revaluation of the trust assets on an annual basis. Another drawback is that this strategy isn’t well suited for passing wealth to grandchildren and other more remote descendents.
There are other strategies we can utilize which will be discussed in future blog posts. The GRAT strategy is a no lose situation. All you need if for one GRAT trust to work and you’re ahead because if other GRAT trusts don’t work you still haven’t lost anything.
We’ll share other estate and gifting strategies in subsequent blog posts.
My wife and I decided to move to Montrose, Colorado as our final step toward retirement. After realizing that I was flunking retirement, it was important to develop a working life style that would fit and also provide a vehicle to deliver years of experience to individuals, business owners and CPAs. Thus, the new web site became a reality. The web site was built at the same time we were building our new residence.One of my objectives was to provide other CPAs with the benefit of my consulting experience and training. Accordingly, the web site was developed to offer a variety of resources that would enable CPAs to deliver a wider range of business advisory services and support to their clients.
Most Montrose CPAs haven’t realized that I live in their community and that they have access to a wide variety of CPA resources. Since I believe in a team effort, these professionals can directly access my capability without any fear of losing clients. I only wish to provide support and help others in the community. Besides, I need a little time for golf and fly fishing.
Owner managed businesses in Montrose and throughout the western slope of Colorado also have new resources available to them without having to leave the area. My expertise can help these businesses achieve greater bottom-line profitability. Another area where I can help family-owned businesses is with succession planning.
Since my wife and I developed a life plan approach to retirement planning, I decided to offer our methodology to others contemplating and planning for retirement. In addition to pure estate and tax planning, my approach is to provide guidance in a wide range of areas from budgeting, life style decisions, where to live, and how to achieve your retirement goals and objectives.
In this current economic environment, which will last for some time, individuals and businesses will need a different level of service and guidance to help them navigate these difficult times. CPAs are uniquely suited to provide this guidance. CPAs can no longer just prepare tax returns and financial statements. They will need to learn other skills such as strategy and operational management. It is interesting to view the proposed format of the Uniform CPA Exam to see the emphasis that will be placed on these areas. This is all about helping businesses become leaner and do more with less.
I am looking forward to providing my contribution to the re-education process. My wife and I also look forward to working together with our neighbors and contributing to the Montrose, Colorado community.
Well 2009 is here. Now we have a chance to put the trauma of 2008 behind us and move forward to new beginnings. I already have. My goals are set and I’m moving on to where my dreams are going to take me. 2008 was a pretty good year for us. First and foremost was creating the new look to my web site and this blog. That said, there’s even more to do now 2009 is under way.
My advice is always to be patient, focused, and disciplined because in the long run this type of thinking and action is what gets the job done. This motto combined with a habit of always set goals and objectives is crucial. Then you need to monitor your results and adjust as quickly as possible if things aren’t going the way you anticipated. It’s a process – and not a short one.
Some of the things we are pursuing for this New Year include actions in multiple areas. I want this blog and web site to be an authoritative resource for CPAs, family businesses, and retirees as they navigate the difficult journey ahead. My plans include new training programs, up to date information on the potential adoption of IFRS, solid support for building business value, and guidance for family-owned businesses seeking to develop succession and transition plans to a new future. Plus all the other material we have always provided.
A new mission will include retirees and those looking toward retirement. This will include a new book and lots of guidance on how to make the transition. I am flunking retirement, but have put ourselves into a place where I can play, work, and live like I always dreamed we would. I learned a lot in making our journey, so it’s time to share this knowledge and information with others. I hope you will enjoy and benefit from this initiative.
Well, Happy New Year and stay tuned as we move forward and enjoy! We’re looking forward to the challenge that lies ahead.
How you do survive the worst economic downturn since the great depression? This is a big question. Many people never experienced the depression or even the big recession of 1981 and 1982. I was a controller of a large corporation back in 81-82. This got me thinking about how could I provide guidance to those who haven’t experienced such turbulence.
Based on my experiences I created a toolkit to package all the tips and techniques of how to get through the tough times. One of the key elements of the survival toolkit is developing a plan and a budget for recession survival. The toolkit contains a cash flow and budgeting template. The process of developing a plan should include an assessment of whether the business needs a tune up, a turnaround, or is in a state of crisis. When you can’t cover payroll, you’re in a crisis. This is why cash is king. If you don’t have adequate liquidity or access to cash, the chances for survival get pretty slim.
During a recession it is time to get aggressive with your sales and marketing. It isn’t always just pricing. Make sure you reach as many potential customers as possible. It’s a numbers game, and having more leads in the pipeline is crucial. Understanding your profit margins is another essential step so you can make price adjustments and at the right level to secure a greater share of the market.
The Recession Survival Toolkit outlines tips and techniques for reducing costs on every facet of the business. Just reviewing all of the potential opportunities to reduce costs is a healthy process. Usually the first step in cutting back is reduction of headcount. There are numerous ways to control payroll costs without reducing headcount. Consider adjusting hours worked or vacations with out pay as a way of keeping your valuable employees.
Another opportunity is to use lean workflow techniques and paperless systems to streamline the office and accounting functions. Not only is it cheaper, but it speeds up data retrieval, improves accuracy and saves time. It also minimizes the cost of paper and storage space.
Getting financing and having a relationship with your banker is a key element of making it through tough times. When your bank is your partner, your survival chances get a lot better. The toolkit reveals the techniques used by banks to make loan decisions. When you understand what the bank wants, you are in a better position to get the necessary financing.
Having developed a recession survival toolkit for businesses, I am now motivated to provide more guidance for individuals and retirees. I think CPAs have a responsibility to help citizens achieve a higher level of financial fitness. The AICPA and the Virginia Society of CPAs have launched a website that offers a great deal of information and advice on financial management.
Remember, it took a while for us to get in this mess, and it is going to take focus, patience, and discipline for us to get healthy again.
One of the key components of succession planning is deciding where the business should be going and who is going to provide the necessary leadership. This process is a double edged sword. It involves planning for both owners as well as the business. Things can get pretty emotional in family-owned businesses. Accordingly, it is very important to make sure the planning process gets done properly.The emotional process is what stalls many initiatives. It is critical to have a skilled outsider to help to balance the emotions, personalities, and politics of the family-owned business. An objective facilitator with no stake in the outcome dramatically increases your chances of success.
Organizational planning combines development of ownership plans with strategic planning for the business. Achieving balance between these two plans is the key ingredient. This function is where facilitators can earn their money. They balance management interests with ownership goals and the board. Many family-owned businesses don’t have a formal board of directors’ function. We think that boards provide a balance point between owners and management. The board provides a key role in providing continuity between business strategy and long-term vision that helps to preserve owner’s value.
When owners and the business look to the future, the shareholders have to ask the following questions:
• Where do we want to be in 5 to 10 years?
• Can the business survive without the founder?
• What are the goals of non-family team members, entrepreneur owners, and family of the entrepreneur?
• What are the strengths, weaknesses, opportunities, and threats associated with this business?
It is amazing how many family-owned businesses haven’t developed a succession and transition planning process. A well-designed and systematic succession planning process focusing on the family, management, and the organization of the business pays big dividends. This represents a huge opportunity for family-owned businesses to step up and do what they need to do. Planning for the future pays off.
There are tons of issues and challenges associated with succession planning. Most family businesses want the family to be involved with the business. This gets tricky when there is more than one child and even worse when spouses and cousins are thrown into the mix. Another component of the process relates to non-family managers involved in the business. They have a stake in the business and usually represent a critical link to the future success of the business.
There are many stories about fights and disputes that arise when family members get side ways over the selection of who is in charge. Without an effective planning and communication process, you open the door for lawsuits and fighting between family members. It doesn’t need to be that difficult when the succession and transition process is handled properly from the beginning. We use an approach that sets the stage for proper evaluation of both involved family members and non-family member managers. Our methodology makes a clear distinction between owners, boards, and management. This is done at the beginning and family owner plans are developed and shared with management in an effort to achieve agreement on how to move forward in a balanced fashion. Owners have a role separate from management and it should not be mixed with management responsibilities. These are separate roles and responsibilities. Open communication amoung family members is critical as they reach consensus on ownership goals and on the direction of the business.
One of the major obstacles to succession is the failure of entrepreneur owners to give up control of the company. This often is an attitude of denial and deceit relative to their own mortality. Once founders realize that it is healthy for them to move out of the center of the circle, we start to see progress. The lack of an effective ownership transition plan could be fatal if something unforeseen happens to the founder.
Our process involves family and non-family members in a positive fashion. By fostering effective communication, the business can focus on the right things and achieve a smooth transition. The failure to engage in this critical planning and communication process can prove fatal to the business. Maintaining a balance between all family owners and non-family management is the best way to secure a successful future and build the value of the business.
Usually most of the planning done by family-owned businesses is in the area of retirement and estate planning. Owners here are attempting to accomplish the following objectives:
- Avoid or minimize estate taxes
- Attempt to minimize built-in gain taxes on company stock
- Establish the value of their business
- Diversify investments
- Establish that there will be enough cash flow for their retirement years
- Provide for funding of estate taxes at death
- Assess and analyze the cash flow and financial statement impact on the business.
Unfortunately, this is where the succession planning process stops. There are many other components to the planning process that need to be considered. Our family-owned business planning process is designed to deal with the family and their goals in addition to addressing how the business will continue to be managed.
This later point is critical because the market in which to sell businesses has shrunk because of the economy and the credit crunch. Going forward in ways that preserve and build business value is an essential step in preserving adequate cash flow to cover the owner’s retirement. Finding the balance point for owners and management is a key element of succession and transition planning.
We’ll talk more about family needs and management planning in our future posts.