valuation and succession planning manufacturers
TRANSCRIPT
Valuation and Succession Planning forValuation and Succession Planning for Manufacturers
Victor W. Vaccaro, Jr., CPA/ABV, [email protected]
1
2
Circular 230
Any tax advice contained herein was not intended orAny tax advice contained herein was not intended orwritten to be used, and cannot be used, for the purposeof avoiding penalties that may be imposed under theI t l R C d li bl t t l l tInternal Revenue Code or applicable state or local taxlaw provisions.
3
Disclaimer
This presentation is © 2012 Dannible & McKee, LLP. All rightsp , greserved. No part of this document may be reproduced, transmitted orotherwise distributed in any form or by any means, electronic ormechanical, including by photocopying, facsimile transmission,recording rekeying or using any information storage and retrievalrecording, rekeying or using any information storage and retrievalsystem, without written permission from Dannible & McKee, LLP. Anyreproduction, transmission or distribution of this presentation or anymaterial herein is prohibited and is in violation of U.S. law. Dannible &McKee, LLP expressly disclaims any liability in connection with the useof this presentation or its contents by any third party.
4
The Planning Process for Successful Ownership Transitionp
“Pl i i b i i th f t i t th t th t d“Planning is bringing the future into the present so that you can do something about it now.”
~ Alan Lakein
Introduction to Ownership Transition 5Introduction to Ownership TransitionFamily-Owned Businesses
PWC’s updated 2011 Family Business Survey of more than 1 600 family-PWC s updated 2011 Family Business Survey of more than 1,600 familybusiness owners and managers indicated that 62% of the businesses surveyedhave NOT prepared for the sickness or death of a shareholder and the majorityof business owners have NOT had their companies valued within the last year.For businesses expected to change hands within the next five (5) years moreFor businesses expected to change hands within the next five (5) years, morethan half are expected to be transitioned to the next generation.
11%Other / Didn't know
21%
15%
Sell to another company
Sell to management team
53%
21%
0% 10% 20% 30% 40% 50% 60%
Transition to next generation
Sell to another company
0% 10% 20% 30% 40% 50% 60%
6
The Need for Ownership Transition
A th t ti ti i di t hi t iti i i th t MUST bAs these statistics indicate, ownership transition is an issue that MUST beaddressed in every closely-held manufacturing company.
The lack of a clearly-defined ownership transition plan can quickly lead to confusionand disputes among key employees and family members; cause disruptions inand disputes among key employees and family members; cause disruptions inbusiness operations and result in the dissolution of value to existing and futureowners.
The existence or absence of a clearly-defined ownership transition plan is ay p psignificant risk consideration impacting the valuation of a manufacturing business.
An ownership transition plan will establish a framework for providing ownership to anew generation of owners.
The plan will also determine how stock will be repurchased from current ownersunder various events of transfer, including the retirement, death, disability orseparation from service (voluntary or involuntary) of a shareholder.
7
Stages in Ownership Transition
Th C i till d b it f dThe Company is still owned by its founders.
Future transition of ownership has been contemplated, plannedor structured.
Transition to next generation family members or a limitednumber of key employees has already occurred, and their maybe second or third tier ownersbe second or third tier owners.
Ownership changes occur on an annual or regular basiso Using valuation based on shareholders buy-sell agreement, or
o Value is based on independent calculation of Fair Market Value (FMV).
An ESOP is currently in place or is being contemplated.
8
Challenges in Ownership Transition Planning
Economic ChallengesCurrent economic downturn and future uncertainty impacts strategicplanning initiatives for closely-held businesses.Devalued or depleted retirement assets have delayed retirements andhave stalled transition planning.p gUnstable and uncertain tax rate structures fueled by political uncertainty.More stringent lending environment reduces available financial resourcesto implement ownership transition.
Demographic Challenges78 million “Baby Boomers” are being replaced by 20% less “GenerationXers.”
fYounger generations are generally more cautious, more life-balanced andhave fewer financial resources.Demand for talent has exceeded supply.
P l Ch ll L tti G !Personal Challenges – Letting Go!
9
Opportunities in Ownership Transition
Business expansion through mergers and acquisitionsp g g q
Attract outside talent from competitors
Retain existing talent through ownershipRetain existing talent through ownership
Interest rate environment for companies with borrowingcapacitycapacity
Extension of long-term capital gain tax rates throughDecember 31, 2012
10
Comprehensive Plan for Ownership Transition
All companies, no matter what stage they are in, should have ap , g y ,comprehensive, written plan for ownership transition.
Long-term strategic ownership transition plans are designed to providea framework for ownership transition within a closely-held companya framework for ownership transition within a closely-held company,which addresses both foreseen and unforeseen events.
The plan should address all financial aspects of the plan for ownershipt iti i l di th th d f l ti f t ktransition, including the method for valuation of stock.
A company may also chose to address the transition of Managementin this plan or address that separately. However, the plan shouldspecifically address issues of voting control during transition.
An important part of the plan will be to project the future transfers ofownership for years into the future.ownership for years into the future.
11
Comprehensive Plan for Ownership TransitionA cash flow analysis must be performed, as a crucial step, to ensure thaty p , p,the plan is affordable for the Company and equitable to both the sellersand purchasers.
The ownership transition plan should evaluate and determine the methodsto be utilized for the transfer of stock and value, including cross-purchases, redemptions, installment sales, deferred compensation andemployee stock ownership plans (ESOPs).
Sh h ld h ld l l t h th t l l f thShareholders should also evaluate whether an external sale of theCompany might best accomplish their financial and non-financial goals.
An effective plan must include a buy-sell agreement among theshareholdersshareholders.
The ownership transition plan should be updated as necessary.Companies that have already gone through ownership transition or haveongoing sales could also benefit from updating or preparing a plan!ongoing sales could also benefit from updating or preparing a plan!
Components of a Business 12Components of a BusinessSuccession Plan
- ValuationOwnership
Transfer
Valuation- Structure/Funding- Buy/Sell Agreement
Business Succession
PlanLeadership
DevelopmentManagement Succession
- On-the-Job Training- Delegate Responsibility- Mentoring/Coaching
- Admin. & Finance- Operations- Sales & Marketing PlanSa es & a e g
Governance- Corporate Structure- Management Structure- Control
Successful Ownership Transition Planning is a 13Successful Ownership Transition Planning is a “Team Sport”
Two (2) Main Types of Ownership Transition Plans14
Two (2) Main Types of Ownership Transition Plans
Internal – transition of existing ownership to family members and/orkey employees who have or will take an active role in the businesskey employees who have or will take an active role in the business
• Common internal ownership transition strategies include gifts,cross-purchases, redemptions, stock bonuses, deferredcompensation and employee stock ownership plans (ESOPs)compensation and employee stock ownership plans (ESOPs).
External – transition of existing ownership to individuals or entitiesoutside the business enterprise
• Common external ownership transition strategies include mergers,stock acquisitions, asset acquisitions and liquidations.
Closely-held business owners generally seek to accomplish aninternal business succession plan before looking to outside buyers asan exit strategy; however, due to synergies, business value may begreater with an external plan (merger/acquisition).
I t l O hi T iti Pl15
Internal Ownership Transition Plans
When closely-held business owners approach retirement, they are oftenfaced with a dilemma Common questions they may ask themselves are:faced with a dilemma. Common questions they may ask themselves are:
Who should be admitted as new owners?
What percentage of ownership should I sell?p g p
When should I retire?
Where will the funds come from to purchase my ownership interest?
Why should I sell my interest and relinquish control of the Company?
How should the sale be structured?
I t l O hi T iti Pl16
Internal Ownership Transition Plans
Pros ConsPros
• Retention of control• Continuity of
operations/culture
• Retention of control• Continuity of
operations/culture
Cons
• Lack of future owners• Candidates for ownership
may be more risk adverse
• Lack of future owners• Candidates for ownership
may be more risk adverseoperations/culture• Enables orderly and
gradual ownership transfer• Retain/reward key
operations/culture• Enables orderly and
gradual ownership transfer• Retain/reward key
may be more risk adverse• Funding through current
operations• Transfer for less than
may be more risk adverse• Funding through current
operations• Transfer for less than y
employees• Opportunities for expansion
with additional owners
yemployees
• Opportunities for expansion with additional owners
maximum value• Greater risk post-transition
if management and leadership not properly
maximum value• Greater risk post-transition
if management and leadership not properly leadership not properly transitionedleadership not properly transitioned
Internal Ownership Transition Planning Process 17Internal Ownership Transition Planning Process
• Establishes the current value of the business• Aids in projecting the value over term of planPhase 1 Valuation • Estimate of “dollars” to be transitioned
• Identify the goals of existing owners family members & key employees
Phase 1
Transition Plan Structure
• Identify the goals of existing owners, family members & key employees• Develop plan structure that “meshes” these goals• Addresses key elements of timing, funding, affordability & taxesPhase 2
Buy/Sell Agreement
• Incorporates key elements of valuation and transition plan structure• Provides legal substance to transition plan• Eliminates confusion in the event of death, disability, retirement or
separation from service of a current or future ownerPhase 3
E t l O hi T iti Pl18
External Ownership Transition Plans
Pros Cons
• Transfer for maximum price
• Provides for greater
• Transfer for maximum price
• Provides for greater
• Difficulty in finding right buyer
• Confidentiality
• Difficulty in finding right buyer
• Confidentiality• Provides for greater liquidity and less risk for existing owners post-retirementSh t ti f
• Provides for greater liquidity and less risk for existing owners post-retirementSh t ti f
• Confidentiality• Post-merger integration
can be difficult• Loss of control and
• Confidentiality• Post-merger integration
can be difficult• Loss of control and
• Shorter time frame• Adds new talent, skills,
markets, products or service offerings
• Shorter time frame• Adds new talent, skills,
markets, products or service offerings
identity• Cultural differences• Employee/customer
retention
identity• Cultural differences• Employee/customer
retention service offeringsservice offerings retention retention
Merger/Acquisition Planning Process 19Merger/Acquisition Planning Process
Phase 1• Pre-Acquisition Review of Existing Business
Phase 1
Phase 2• Search & Screen Potential Buyers / Targets
Phase 3 • Investigation / Valuation / Due Diligence
Phase 4• Negotiation & Closing
• Post Merger IntegrationPhase 5
• Post-Merger Integration
20
The Buy-Sell Agreement
A mandatory step in the plan for ownership transition is theadoption of a comprehensive agreement among theshareholders that is often referred to as a buy-sell agreement.
A buy-sell agreement is a contract providing for the sale of ashareholder’s ownership interest in the Company upon theoccurrence of a specified eventoccurrence of a specified event.
Commonly referred to as Events of Transfer, these includethe retirement, death, disability or separation from service(voluntary or involuntary) of a shareholder.
21
The Buy-Sell AgreementA buy-sell agreement should be a “self-executing” agreement that will
f faccomplish all of the following objectives:
To provide for the orderly transfer of ownership interest upon the death,retirement or disability of an owner;
To create a market at a fair price for the interest of owners who desire totransition their ownership in the Company for expansion or incontemplation of retirement;
To permit retention of control by the remaining owners maintaining anTo permit retention of control by the remaining owners, maintaining anidentity of interest between ownership and management and eliminatingconflicts that might occur between owners active in management andinactive owners;
To fix the value for sale and/or purchase and the related payment terms;and
To reasonably assure the continuance of the business and reduce the riskof dissolution and loss of value.
22
The Buy-Sell AgreementThere are generally three (3) types of buy-sell agreements:
Cross-purchase agreement - This is a buy-sell agreement solely amongowners where, for instance, upon the death of a shareholder, the remainingshareholder(s) must purchase the stock of the deceased shareholder.
Stock redemption agreement - This is an agreement in which theCompany, as well as the owners, are parties. In these agreements, theCompany agrees to buy (redeem) the shareholder’s interest on theoccurrence of a specified eventoccurrence of a specified event.
Hybrid or combination agreement - In this type of agreement, theCompany and the shareholders agree to buy the shareholder’s ownershipinterest. Such an agreement has a provision that consists of both (i) ainterest. Such an agreement has a provision that consists of both (i) across-purchase and (ii) a redemption agreement. Upon an event of transfer,other shareholders first have the right to purchase the shares. Any sharesremaining unsold after the “right of first refusal” are then redeemed by theCompanyCompany.
23
Elements of an Effective Buy-Sell AgreementThe mandatory repurchase by the Company of a selling owner’s interest
f f fin conjunction with the non-selling owner’s right of first refusal;
The valuation price to be used for transfer and/or sale, as encompassedin the Certificate of Value, and the events leading to a required transfer;
A specific valuation formula determined based on objective factors andconsidering the adjusted book value and goodwill value of the Company;
The funding of ownership transition with life insurance policies;
The treatment of life insurance proceeds upon the death of an owner andits impact on company value;
A provision for the gradual reduction of ownership when approachingti tretirement;
The payment terms and interest rate on any promissory notes; and
A covenant not-to-compete.
24
Valuation of Closely-Held Businesses
“Managers and investors alike must understand that accounting numbers are the beginning, not the end, of business valuation.”
~ Warren Buffett
25
Valuation of Closely-Held Businesses
A proper business valuation is both an art and a science.p p
The science of business valuation is represented by systematicapproaches, quantitative analysis, fact gathering and research about thesubject company the industry in which it operates and other internal andsubject company, the industry in which it operates and other internal andexternal factors impacting the Company’s business and ability togenerate future cash flow.
Th t f b i l ti i t d b th h h thThe art of business valuation is represented by those who have thedepth of experience and expertise in the science of valuation to achievethe best result by weighing the underlying components of value andtaking into account all relevant issues at hand.g
The Valuation Process 26The Valuation ProcessPurpose, Standard of Value, Premise of Value, Valuation Date, Nature of Subject Interest, Limiting
Conditions
Financial Analysis, Economic Analysis, Industry Analysis, Site Visit
Benefit Stream
Risk Analysis – Discount Rate / Capitalization Rate
Valuation Approaches – Asset, Income, Market
Asset Approach – Adjusted Net Assets
Income Approach – Discounted Earnings (Cash Flow) or Capitalization of Earnings (Cash Flow)Flow) or Capitalization of Earnings (Cash Flow)
Market Approach – Guideline Public Company Method, Comparable Sales,
Rules of ThumbSelection of Most Appropriate
Approach or Model
Valuation Discounts / Premiums
Sanity Checks
Value
27
Purpose of a Valuation
Business valuations are conducted for a variety of strategic, legal, taxy g , g ,and financial reporting purposes, including the following:
- Internal Ownership Transition - Mergers & AcquisitionsE t t Gift & I T Liti ti & O hi Di t- Estate, Gift & Income Tax - Litigation & Ownership Disputes
- Employee Stock Ownership Plans - Dissenters' Rights Cases- Financial Reporting - Shareholder Oppression Cases- Allocation of Purchase Price - Goodwill Impairment- Buy/Sell Agreements - Family Limited Partnerships- Reorganizations and Bankruptcies - Recapitalizations- Business Planning - Stock Option Plans
St d d f V l28
Standard of ValueThe proper Standard of Value for valuing a closely-held business is anassumption or set of assumptions regarding the specific characteristicsp p g g pof the buyer and seller (either hypothetical or actual) in a given set ofcircumstances surrounding a particular transaction (or an assumedtransaction).
There are five (5) principal Standards of Value for valuing a closely-heldbusiness:
Fair Market Value (FMV)
Investment Value
Intrinsic Value
Fair Value (state rights)
Fair Value (financial reporting)
F i M k t V l29
Fair Market Value
Revenue Ruling 59-60 defines Fair Market Value as:“the price at which the property would change hands between a willing buyer and a willingseller when the former is not under any compulsion to buy and the latter is not under anycompulsion to sell, both parties having reasonable knowledge of relevant facts. Courtdecisions frequently state in addition that the hypothetical buyer and seller are assumedto be able, as well as willing, to trade and to be well informed about the property andto be able, as well as willing, to trade and to be well informed about the property andconcerning the market for such property.”
Key elements of the Fair Market Value standard are that the parties tothe transaction are hypothetical, the transaction is at “arms-length” andthe buyer and seller are able and willing.
Fair Market Value standard is used most often in tax situations (estate,gift, income tax, purchase price allocations, etc.).
Fair Market Value standard is also used in internal ownershiptransitions, buy/sell agreements and marital dissolution situations.
I t t V l30
Investment Value
International Glossary of Business Valuation Terms defines InvestmentValue as “the value to a particular investor based on individualValue as the value to a particular investor based on individualinvestment requirements and expectations.”
Stated differently, Investment Value is the value to a particular investor,which reflects the particular and specific attributes of that investorwhich reflects the particular and specific attributes of that investor.
In contrast to Fair Market Value, the Investment Value standardidentifies a particular buyer or seller and the attributes that buyer or sellerbrings to the transactionbrings to the transaction.
Also commonly referred to as Synergistic Value because of synergiesbetween the buyer and seller (geographic location, specific product orservice offerings, know-how, customer base, competition, etc.).service offerings, know how, customer base, competition, etc.).
The Investment Value standard is typically used in merger/acquisitiontransactions.
P i f V l31
Premise of ValuePremise of Value is an assumption regarding the most likely set oftransactional circumstances that may be applicable to the subject
l tivaluation.The three (3) main Premises of Value are:
Going Concern Value - the value of a business enterprise that ist d t t i t th f t th i t ibl l t f iexpected to operate into the future; the intangible elements of going
concern value result from factors such as having a trained workforce,an operational plant and the necessary licenses, systems andprocedures in placep pOrderly Liquidation Value - the liquidation value at which the assetor assets are sold over a reasonable period of time to maximize theproceeds receivedForced Liquidation Value - the immediate liquidation to minimizethe timing in which the sale proceeds are received (i.e. auction price)
32
Levels of Value
Levels of Value refer to the value of a business enterprise consideringp gthe characteristics of marketability in the public or private marketplaceand the degree of control to be exercised by the buyer over the futureoperations of the enterprise.
A valuation will determine either a Control or a Minority value and willalso address whether the investment is Marketable or Non-Marketable.
In arriving at the proper Level of Value in valuing closely-heldIn arriving at the proper Level of Value in valuing closely-heldbusinesses, valuation discounts and premiums are often applied.
Alternatively, adjustments to the Discount Rate or Capitalization Rateunder the Income Approach are applied to reach the appropriate Levelunder the Income Approach are applied to reach the appropriate Levelof Value conclusion.
L l f V l33
Levels of Value
Synergistic Value (Investment Value or Acquisition Value)
Strategic Interest in Closely-Held
Business (Investment Value or Acquisition Value)
Control Value
Synergistic Premium 10% - 50%
Controlling Interest in Closely-Held Co t o a ue
(Value of Controlling Interest in Business Enterprise)
M k bl Mi i V l
Control Premium Minority Interest Discount25% - 50%
Publicly Traded
yBusiness (i.e. >50%)
Marketable Minority Value(Value of Minority Interest, Freely Tradable)
Marketability/Liquidity Discount10% - 40%
Publicly-Traded Common Stock
Nonmarketable Minority Value(Value of Minority Interest, Not Freely Tradable)
Minority Interest in Closely-Held
Business
34
Elements of Value – Revenue Ruling 59-60Revenue Ruling 59-60 introduced eight (8) factors that must beconsidered in determining the fair market value of a closely-heldconsidered in determining the fair market value of a closely heldbusiness.
The nature of the business and history of the enterprise since its inception;
The economic outlook in general and the condition and outlook of the specificThe economic outlook in general and the condition and outlook of the specificindustry in particular;
The book value of the stock and financial condition of the business;
The earning capacity of the business;The earning capacity of the business;
The dividend-paying capacity of the business;
Whether or not the enterprise has any goodwill or intangible value;
Sales of the stock and the size of the block of stock to be valued; and
The market price of stocks engaged in the same or similar line of businesshaving their stocks actively traded in a free or open market.
35
Valuation ApproachesValuations of closely-held businesses fall into one of three (3)general approaches:general approaches:
Asset Approach – value of the business is based solely on thevalue of the entity’s assets net of liabilities, including both tangible
d i t ibl tand intangible assets
Income Approach – most widely used method of valuing aclosely-held business where value is the sum of the presenty pvalues of the expected future economic benefits attributable tothe ownership interest
Market Approach – value of a closely-held business isMarket Approach value of a closely held business isdetermined by reference to the market values of comparablecompanies who are either publicly-traded or were recently sold inthe private marketplacep p
36
Valuation Approaches – Asset Approach
Book Value Method – The value of the business is determined byreference to its historic book value (assets liabilities) as reflected on itsreference to its historic book value (assets – liabilities) as reflected on itsfinancial statements.
Adjusted Book Value Method – The value of the business isdetermined by reference to the historic book value, adjusted to fairmarket value to reflect the settlement of its assets and liabilities in cashas of the date of valuation.
Presents the value of all tangible and intangible assets and liabilities
The Asset Approach is most appropriate for asset-intensive businessessuch as investment or holding companies banks family limitedsuch as investment or holding companies, banks, family limitedpartnerships and professional practices where there is little or nogoodwill (practice value).
37
Valuation Approaches – Asset Approach
Pros Consos
• Easy to calculate and understand• Establishes “baseline” value or liquidation
value of the business
• Easy to calculate and understand• Establishes “baseline” value or liquidation
value of the business
Co s
• Ignores future earning capacity of the business
• Financial statements prepared under GAAP may not be representative of market
• Ignores future earning capacity of the business
• Financial statements prepared under GAAP may not be representative of market GAAP may not be representative of market value due to historical cost principleGAAP may not be representative of market value due to historical cost principle
Although Revenue Ruling 59-60 requires that the Asset Approach beconsidered in business valuation, it is seldom relied upon in rendering afinal Conclusion of Value for operating companies in which value is moreappropriately determined by reference to earnings or cash flowappropriately determined by reference to earnings or cash flow.
38
Valuation Approaches – Income ApproachThe Income Approach is most reflective of the “forward looking”premise of business valuationpremise of business valuation.
Under the Income Approach, the value of a closely-held businessequals the present value of the expected future economic benefitsdiscounted at the appropriate rate to reflect the risk associated with thediscounted at the appropriate rate to reflect the risk associated with theentity.
The Income Approach can be represented by a fraction (or series offractions) where present value equals:fractions) where present value equals:
Expected Future Economic Benefit StreamDiscount Rate
The Discount Rate or Cost of Capital is determined under one ofseveral methods including the Build-Up Method (BUM), Capital AssetPricing Model (CAPM) and the Weighted Average Cost of Capital(WACC)(WACC).
Income Approach – Build-Up Method39
Income Approach – Build-Up MethodRisk-Free Rate
Market rate of return of an investment free from risk. Generally equal the 20-year Treasury Bond rate as of the date of valuation 4.35%
fMarket Driven Rates of Return – Company
Cannot ControlEquity Risk Premium
Market rate of return that investors must receive to entice them to invest in the public equity markets often derived by Morningstar's Stocks, Bonds, Bills and Inflation (SBBI) 6.10%
Size Premium
Market rate of return that investors must receive to entice them to invest in smaller businesses compared to those which comprise the Equity Risk Premium often derived by
Industry Driven Rate of Return – Company
Has Little Control
which comprise the Equity Risk Premium often derived by SBBI 6.50%
Industry Risk PremiumMarket rate of return that investors must receive to entice them to invest in a particular industry whose rates of return are determined by SBBI 1.45%
Final component of Build-Up Method which considers the
Subjective Risk Premium
Final component of Build Up Method which considers the particular quantitative and qualitative information of the subject company being valued including size, operations, management strength, diversification, etc. determined by the valuator 4.00%
Discount Rate 22.40%
Company Driven Rate of Return –
Company Has Complete Control
Less: Long-Term Sustainable Growth Rate -5.00%
Capitalization Rate 17.40%
40
Income Approach - Methods
Discounted Future Earnings (Cash Flow) Method – a method underthe income approach in which a series of future economic benefits isconverted to present value using an appropriate Discount Rate
Capitalization of Earnings (Cash Flow) Method – a method under theincome approach in which the economic benefits for a single period areconverted to present value through division by a Capitalization Rate
As illustrated in the foregoing, the key difference between a DiscountRate and a Capitalization Rate is the expected long-term growth rate ofthe business being valued.
Capitalization Rate = Discount Rate – Long-Term Growth Ratep g
Income Approach - Process41
Income Approach - Process
Normalization
• Restatement of historic financial statements that can be used to determine future economic benefit stream• Normalization adjustments include adjustments for ownership characteristics (control vs. minority), GAAP departures, extraordinary or nonrecurring items, non-operating items, taxes and synergies
• Restatement of historic financial statements that can be used to determine future economic benefit stream• Normalization adjustments include adjustments for ownership characteristics (control vs. minority), GAAP departures, extraordinary or nonrecurring items, non-operating items, taxes and synergies
Processnonrecurring items, non operating items, taxes and synergiesnonrecurring items, non operating items, taxes and synergies
Define Benefit
• Single period benefit streams (capitalization method) and multi-period benefit streams (discounted method) are usually defined as “net income” or “net cash flow”
• Whether earnings or cash flow is used, it is important to determine who will receive benefit stream – equity holders or invested capital
• Single period benefit streams (capitalization method) and multi-period benefit streams (discounted method) are usually defined as “net income” or “net cash flow”
• Whether earnings or cash flow is used, it is important to determine who will receive benefit stream – equity holders or invested capital Define Benefit Stream
et e ea gs o cas o s used, t s po ta t to dete e o ece e be e t st ea equ ty o de s o ested cap taholders (debt and equity holders)
et e ea gs o cas o s used, t s po ta t to dete e o ece e be e t st ea equ ty o de s o ested cap taholders (debt and equity holders)
• Build-Up Method• Capital Asset Pricing Model (CAPM)Weighted Average Cost of Capital (WACC)
• Build-Up Method• Capital Asset Pricing Model (CAPM)Weighted Average Cost of Capital (WACC)Develop
Discount Rate• Weighted Average Cost of Capital (WACC)• Weighted Average Cost of Capital (WACC)
• Utilizing either the capitalization method or the discounted method, apply the proper discount or capitalization rate to the economic • Utilizing either the capitalization method or the discounted method, apply the proper discount or capitalization rate to the economic Calculate
Present Value
g p , pp y p p pbenefit stream to determine present value under the Income Approach
g p , pp y p p pbenefit stream to determine present value under the Income Approach
42
Valuation Methods – Market Approach
Public Multiples of Value Method - Uses guideline publicly tradedfcompanies and applies median multiples of items such as earnings, cash
flow, EBITDA, revenue and book value.
Comparable Transaction Method - Various services provide details on theacquisition of private companies. From these databases, comparablecompanies can be selected and median multiples can be determined similarto those with public companies as indicated above.
Industry Rules of Thumb - A formula based valuation calculation usingmultiples of company data such as sales, net income or EBITDA usingmultiples commonly applied for actual transactions within specific industries.
43
Valuation Methods – Market Approach
CPros
• Easy to calculate and understand
• Easy to calculate and understand
Cons
• Comparable public companies often are not really comparable
• Comparable public companies often are not really comparable understand
• Considers external factors including market multiples at the valuation date
understand• Considers external factors
including market multiples at the valuation date
often are not really comparable to a privately held company that is considerably smaller and often less diversified
often are not really comparable to a privately held company that is considerably smaller and often less diversified
• Utilizes key value indicators that buyers in a particular industry might consider
• Utilizes key value indicators that buyers in a particular industry might consider
• Rules of thumb often provide a very basic calculation that does not consider all relevant factors
• Rules of thumb often provide a very basic calculation that does not consider all relevant factors
44
Succession Planning for the Closely-Held Business
“It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.”
~Charles Darwin
I t l O hi T iti Pl45
Internal Ownership Transition Plans
Gifts to Family Members
Cross-Purchase Transactions
Stock Redemptions
Stock Bonuses
Employee Stock Ownership Plans (ESOPs)Employee Stock Ownership Plans (ESOPs)
Deferred Compensation
Gifti St k t F il M b Gift/E t t T46
Gifting Stock to Family Members – Gift/Estate Taxes
Tax Relief, Unemployment Insurance Reauthorization and Job CreationAct of 2010 provided sweeping changes to Federal estate gift and generation-Act of 2010 provided sweeping changes to Federal estate, gift and generation-skipping transfer taxes for 2010 through 2012.
The new law set unified estate tax, gift tax and generation-skipping transfer taxexemption at $5 million per individual.
The new law also added “portability” of the Federal estate tax exemptionbetween married couples, which effectively allows married couples to transfer$10 million to their heirs free from Federal estate tax (effective for transfersocc rring in 2011 and 2012)occurring in 2011 and 2012).
Under current law, the Federal estate tax exemption is scheduled to revertback to the $1 million level effective January 1, 2013.
In addition to the gift/estate tax exemption, individual taxpayers may give cashor property of up to $13,000 to any one donee in a calendar year and if ahusband and wife elect “gift-splitting,” they may give cash or property of up to$26,000 to any one donee in a calendar year.
Gifting Stock to Family Members – Valuation47
Gifting Stock to Family Members – ValuationTreasury Regulation Section 20.2031-2 provides that the value of stocktransferred by gift is the Fair Market Value on the date of transfer and therecipient receives a carryover basis from the donor (no step-up to FMV).p y ( p p )
The Regulations provide that the degree of control is one of a number offactors on which the stock’s FMV is based giving rise to applicable MinorityInterest Discounts (20%-30%).
The Regulations also provide that the marketability/liquidity of the stock is alsoa significant factor to be considered giving rise to applicableMarketability/Liquidity Discounts (20%-35%).
If a minority interest is being gifted, the proper Level of Value is aNonmarketable Minority Value with each discount applied independently.
Taxpayers are required to provide solid and objective support for the validity ofany valuation discounts used and must attach an explanation giving the factualany valuation discounts used and must attach an explanation giving the factualbasis for the claimed discounts to Form 709, Schedule A.
There is no such thing as a “standard discount.”
Gifti St k t F il M b E l48
Gifting Stock to Family Members – ExampleAssume that in determining the Fair Market Value of a closely-held business,the valuation expert has determined a pre-discounted value of $7,500,000, aMi i I Di f 24% d Di f L k f M k biliMinority Interest Discount of 24% and a Discount for Lack of Marketabilityof 22%, the following represents the discounted Fair Market Value of thebusiness for Federal estate and gift tax purposes (i.e. the Fair Market Value ofa Nonmarketable Minority Interest).
Pre-Discounted Fair Market Value $7,500,000
Minority Interest Discount (24%) (1,800,000)
Always address the control aspects of stock ownership y ( ) ( , , )
Marketable Minority Fair Market Value 5,700,000
Discount for Lack of Marketability (22%) (1,254,000)
pbefore marketability; therefore, minority interest discounts are considered first Discount for Lack of Marketability (22%) (1,254,000)
Nonmarketable Minority Fair Market Value $4,446,000
and then discounts for lack of marketability
C P h T ti49
Cross-Purchase TransactionsA Cross-Purchase is a transfer of stock that occurs between two (2)individuals; the Company is not a party to the transaction and thep y p yremaining shareholders are unaffected by the transaction.
Beginning O hi C P h
Resulting O hiOwnership Cross-Purchase Ownership
Shares % Shares % Shares %
Bill Adams 500 50.00% (250) -25.00% 250 25.00%Ci d B t 500 50 00% 0 00% 500 50 00%Cindy Bates 500 50.00% - 0.00% 500 50.00%Jim Collins - 0.00% 250 25.00% 250 25.00%
Total 1,000 100.00% - 0.00% 1,000 100.00%
50
Cross-Purchase Transactions
Cross-Purchases of closely-held stock enable the purchasing shareholders toincrease their tax basis in their stock holdings thereby reducing their individualincrease their tax basis in their stock holdings thereby reducing their individuallong-term capital gain exposure when the stock is sold or otherwise transferredin the future.
Cross-Purchases serve to foster internal ownership transition as individualCross Purchases serve to foster internal ownership transition as individualfamily members and/or key employees are directly purchasing stock fromretiring owners.
Properly structured Cross-Purchase transactions can result in a tax-Properly structured Cross Purchase transactions can result in a taxdeductible alternative to ownership transition if a bonus/compensation fundedplan is implemented to address purchasing shareholder affordability.
Since Cross-Purchase transactions occur between individuals, selling, gshareholders may be at greater risk of potential default; however, this risk canbe minimized with a bonus/compensation funded cross-purchase arrangement.
St k R d ti51
Stock RedemptionsIn a Stock Redemption, a shareholder sells his/her stock back to theCompany. In contrast to a Cross-Purchase, the remainingp y gshareholders realize a proportionate increase in stock ownership sincethe issued and outstanding shares of the Company are reduced.
Beginning ResultingBeginning Ownership Redemption
Resulting Ownership
Shares % Shares % Shares %
Bill Adams 250 25 00% (250) 25 00% 0 00%Bill Adams 250 25.00% (250) -25.00% - 0.00%Cindy Bates 500 50.00% - 0.00% 500 66.67%Jim Collins 250 25.00% - 0.00% 250 33.33%
Total 1 000 100 00% (250) 25 00% 750 100 00% Total 1,000 100.00% (250) -25.00% 750 100.00%
St k R d ti52
Stock Redemptions
In contrast to Cross-Purchase transactions, the remaining shareholders in aStock Redemption do not obtain an increase or a “step-up” in basis in theirp p pshares even though their individual ownership percentages have increased.
Everything else being equal, the remaining shareholders are in the sameeconomic position before and after the Stock Redemption.
Stock Redemptions can be used in tandem with Cross-Purchasetransactions, Gifts or Stock Bonuses to permit retention of voting control byexisting owners or generations of owners.
By themselves Stock Redemptions generally do not foster ownershipBy themselves, Stock Redemptions generally do not foster ownershiptransition as new owners are not being added to the Company (must be usedin conjunction with Cross-Purchases, Gifts or Stock Bonuses).
Stock Redemptions are not tax-deductible, which creates a significant taxdisadvantage when compared with other ownership transition vehicles.
For family-owned businesses, extreme care must be exercised in utilizingStock Redemptions due to Internal Revenue Code Section 302 and theimpact of constructive ownership and family attribution rulesimpact of constructive ownership and family attribution rules.
St k B53
Stock Bonuses
Stock Bonuses are an effective tool for transitioningownership to successors who are employees of the Companyownership to successors who are employees of the Company.
A bonus is paid to an employee in the form of stock instead ofcash.
Assuming no unreasonable compensation issues, theCompany receives a tax deduction for the Fair Market Valueof the stock distributed and the recipient includes the FairpMarket Value of the stock in their gross income.
Stock Bonuses aid in the ownership transition process as theexisting shareholder’s shares are diluted as a result of theexisting shareholder s shares are diluted as a result of theadditional shares outstanding.
Stock Bonuses54
Stock BonusesBeginning Ownership Stock Bonus
Resulting Ownership
Sh % Sh % Sh %Shares % Shares % Shares %
Fred Jones 500 100.00% - 0.00% 500 83.33%George Smith - 0.00% 100 20.00% 100 16.67%
Total 500 100.00% 100 20.00% 600 100.00%
Stock Bonuses transfer ownership to successors without theconsequence of triggering gain on the part of existing owners. In theexample above, no gain or loss is recognized by the existing owner ofthe Company when his percentage of ownership is diluted as a resultof the Stock Bonusof the Stock Bonus.
The recipient employee receives an increase in stock basis equal tothe Fair Market Value of the Stock Bonus received.
St k B55
Stock Bonuses
Stock Bonuses enable the recipient to acquire stock in the Companyfor only the tax cost of the shares acquired (i e the income tax cost onfor only the tax cost of the shares acquired (i.e. the income tax cost onthe acquired stock’s Fair Market Value) as opposed to paying the fullFair Market Value in the case of a Cross-Purchase transaction,thereby, providing for significantly greater affordability for next
tigeneration owners.
In addition, the Company can “gross up” an employee’s compensationto cover the income taxes assessed to the employee on the StockB t l t l li i t th t f k t t t th i i tBonus to completely eliminate the out-of-pocket cost to the recipientemployee; however, the Company will still be responsible for its shareof the payroll taxes on the Stock Bonus.
H th t t l ti f l t b blHowever, the total compensation of an employee must be reasonablerelative to the service rendered in order for the amounts to be taxdeductible pursuant to Treasury Regulation Section 1.162-7.
St k B56
Stock Bonuses
Due to reasonable compensation limitations and other factors,it will usually take a number of years to transfer significantit will usually take a number of years to transfer significantblocks of stock to an employee under a Stock Bonus program.
As a result, Stock Bonuses are generally used as a secondaryhi l f t f i hi i bi ti ith Cvehicle for transferring ownership in combination with a Cross
Purchase transaction and, more commonly, a Redemption.
Valuation rules similar to those pertaining to Gifts of stockp g(including application of appropriate discounts for minorityinterest and lack of marketability) apply to valuing stock forStock Bonus transfers.
Installment Sales 57Installment Sales
Installment Sales are a common funding arrangement in connectionwith internal ownership transition plans (and may also apply towith internal ownership transition plans (and may also apply toexternal sales!).
In a Cross-Purchase transaction, few individuals have the necessaryfinancial resources for a full cash payment; similarly in a Stockfinancial resources for a full cash payment; similarly, in a StockRedemption, companies may not have the borrowing capacity intoday’s lending environment requiring the selling shareholder to hold anote payable over time.
Most Installment Sale arrangements are stipulated in a Buy-SellAgreement over a three (3) to seven (7) year period depending on themagnitude of the selling price, the size of the block of stock sold andth fi i l iti f th h ll th Cthe financial position of the purchasers, as well as the Company.
Pursuant to Internal Revenue Code Section 453(b), any arrangementthat provides for two (2) or more installment payments payable in two(2) t bl ill lif I t ll t S l(2) or more taxable years will qualify as an Installment Sale.
Installment Sales 58Installment SalesInterest rates used in structuring Installment Sale arrangements with sellingshareholders vary and are usually tied to an index such as prime, LIBOR or theApplicable Federal Rate (AFR) and are usually clearly stipulated in a Buy-SellApplicable Federal Rate (AFR) and are usually clearly stipulated in a Buy SellAgreement.
Interest received on an Installment Sale is ordinary income to the sellingshareholder.
Interest paid by a purchasing individual under an Installment Sale arrangement(Cross-Purchase transaction) is tax-deductible depending upon the form of entity.
For Cross-Purchase transactions in which an individual is purchasing stock ina C corporation, the interest qualifies as “investment interest” and is deductiblea C corporation, the interest qualifies as investment interest and is deductibleas an itemized deduction, limited to the individual’s “investment income” in aparticular tax year, with the excess carried forward indefinitely to future taxyears.
For Cross-Purchase transactions in which an individual is purchasing stock inFor Cross-Purchase transactions in which an individual is purchasing stock inan S corporation or LLC, the interest paid is deductible as “business interest,”which offsets the “pass-through” income above-the-line.
Interest paid by entities in a Stock Redemption results in an ordinary income taxd d ti t th titdeduction to the entity.
Installment Sales 59Installment SalesInternal Revenue Code Section 453 maintains that when an asset is sold subject toan Installment Sale, the resulting gain is only taxable as the principal payments arereceived under the terms of the note.
On the surface, this appears to be beneficial to the selling shareholder since thetiming of the gain recognition (and resulting tax liability) is commensurate with whenthe cash is received under the installment note.
H i th t i t i th F d l i t t t t ti l lHowever, given the uncertainty in the Federal income tax rate structure, particularlyafter December 31, 2012, this tax treatment could prove to be detrimental to aselling shareholder since the gain recognized subsequent to 2012 could be taxed ata marginally higher rate, assuming the preferential 15% tax rate on long-term capitalgains expires and reverts back to its pre-2001 rate of 20% (or potentially higher)gains expires and reverts back to its pre-2001 rate of 20% (or potentially higher).
As a result, selling shareholders should consider making an election, pursuant toInternal Revenue Code Section 453(d), to forego the installment method ofreporting gain on the sale and, instead, elect to have the gain on the sale of theirstock taxed entirely in the year of salestock taxed entirely in the year of sale.
Although the timing of the tax on the gain is accelerated with this election, theelection preserves the 15% preferential tax rate on the gain.
Installment Sales60
Installment Sales
In addition to the potential tax savings to be derived through the use of aSection 453(d) election, consideration needs to be given to the magnitude, if( ) , g g ,any, of the down payment on the installment note to provide the sellingshareholder with the necessary cash to pay the entire tax on the capital gain atthe time of sale.
Th t ti l d id f ki S ti 453(d) l ti i 2012 i th tThe potential downside of making a Section 453(d) election in 2012 is thatthe preferential tax rate on long-term capital gains may be extended into futureyears (or potentially even reduced), in which case the payment of the tax isaccelerated with no “locked-in” tax benefit.
This risk is minimized given the current interest rate environment in which theinterest rate on the taxes deferred would be less than 1%.
Selling shareholders could also potentially take a “wait and see” approach bysubsequently securing the installment note with corporate assets, which wouldmake the installment obligation immediately taxable to the recipientshareholder at the time it is secured.
Nonqualified Deferred Compensation61
Nonqualified Deferred Compensation
Another alternative in structuring a long-term strategic ownership transitionl i th f N lifi d D f d C ti t dd thplan is the use of Nonqualified Deferred Compensation to address the
needs of retiring shareholders in the areas of risk, timing of cash flow andincome taxes while, at the same time, addressing the needs of purchasingindividuals in the area of affordability.
A Deferred Compensation plan is not a qualified plan under Section 401 ofthe Internal Revenue Code and, as such, it can be discretionary anddiscriminatory as it does not have to cover all employees.
A Nonqualified Deferred Compensation plan is an agreement between theCompany and the retiring shareholder for a future cash payout – typically uponretirement.
The impact of deferred compensation on an ownership transition plan isThe impact of deferred compensation on an ownership transition plan isessentially a “carve out” of the Fair Market Value to a retiring shareholder inorder to make the resulting stock value more affordable to purchasingindividuals in a Cross-Purchase transaction.
Ownership Transition Funding 62p gNonqualified Deferred Compensation
Example: Assume the same facts in the example above, except that Kevind th t (2) h i i di id l ld lik t l t th i t fand the two (2) purchasing individuals would like to evaluate the impact of a
Nonqualified Deferred Compensation plan in determining the “Phase 1” costof the interest to be sold under their company’s ownership transition plan. Thiscan be summarized by the following:
Without Deferred
CompensationWith Deferred Compensation
Value of Company $3,192,000 $3,192,000Value of Company $3,192,000 $3,192,000Deferred Compensation - (1,000,000) Revised Value of Company 3,192,000 2,192,000 Interest to be Sold to New Owners 30% 30%
Total Cost of Interest to be Sold $957,600 $657,600
Ownership Transition Funding 63p gNonqualified Deferred Compensation
As illustrated previously, the implementation of a NonqualifiedDeferred Compensation plan lowers the total Fair Market Value ofthe Company, making the ownership transition plan more affordableby the purchasing individuals.
However, it is important to recognize that the selling shareholderwould still receive his full value for his stock, carved out into the two(2) pieces below.
The deferred compensation payments in accordance with aproperly structured Deferred Compensation agreement with theCompany, plus
The stock value of the Company when sold to the employeesduring the term of a properly structured ownership transition plan.
E l St k O hi Pl (ESOP )64
Employee Stock Ownership Plans (ESOPs)
An ESOP is a special type of qualified retirement plan established forthe benefit of the Company’s employeesthe benefit of the Company s employees.
Unlike a typical qualified retirement plan (e.g. a 401(k) profit-sharingplan), an ESOP invests primarily in the stock of the employer.
In a typical ESOP arrangement, a corporate employer establishes theESOP to which it makes annual stock or cash contributions.
Cash contributed is used to purchase the Company’s stock or to retiredebt incurred to acquire the corporation’s stock in the case of aleveraged ESOP.
Assuming all technical requirements are met, the Company’scontributions to the ESOP are tax-deductible, within limits.
ESOP O ti65
ESOP Operation
Stock acquired by the ESOP is allocated to participants’ accounts,typically on the basis of their compensationtypically on the basis of their compensation.
Due to its status as a qualified plan, the amount allocated to theparticipants’ accounts is not included in their gross income in the yearcontributedcontributed.
Rather, the stock accumulates tax-free until a participant retires, dies,becomes disabled or otherwise terminates employment, at which pointthe stock is subject to a “put option ” which requires the corporation tothe stock is subject to a put option, which requires the corporation toredeem the stock at the then current Fair Market Value.
Amounts from the ESOP are subject to normal qualified plandistribution rules providing for qualified rollovers or taxation to thedistribution rules providing for qualified rollovers or taxation to therecipient upon distribution if no exception applies.
ESOP Mi ti66
ESOP Misconceptions
The term Employee Stock Ownership Plan suggests that theCompany’s stock is owned by the employees – this is not the case asCompany s stock is owned by the employees this is not the case asthe stock is held in a trust for the employees’ benefit.
The establishment of an ESOP does not effectively transfer votingcontrol of the Company to the employees – most ESOPs arecontrol of the Company to the employees most ESOPs arestructured such that the ESOP trustee votes the shares as directed byan administrative committee appointed by the Company’s Board ofDirectors.
The establishment of an ESOP does not require the disclosure ofconfidential company information, including financial statements andexecutive compensation – the only disclosure that is required is the
f th lifi d lsame for other qualified plans.
ESOP B fit67
ESOP Benefits
Creation of permanent succession plan and preservation of companylegacylegacy
Provide for shareholder liquidity for the value of their ownershipinterest in the Company
Ability for permanent deferral of shareholder gain on the sale of stock
Tax-deductible alternative to ownership transition providing forsignificant corporate-level tax savings
Ability for a shareholder to significantly reduce their stock and equityownership while providing for retention of voting control of theCompany
Reward long-term employees and executive management with indirectownership and creation of “employee-owned” corporate culture
ESOP Benefits – Section 1042 Deferral68
ESOP Benefits – Section 1042 Deferral
One of the most significant benefits of the ESOP in ownershiptransition planning is the Section 1042 deferral election.p g
Under Section 1042 of the Internal Revenue Code, the sellingshareholder is not subject to tax on the gain attributable to the sale ofstock to an ESOP when certain requirements are met.
To qualify for the deferral, (i) the ESOP must own at least 30% of theCompany’s stock immediately after the sale, (ii) the sellingshareholder must have held the stock for at least three (3) yearsbefore the sale, (iii) the selling shareholder must purchase QualifiedReplacement Property within twelve (12) months from the date of sale,and (iv) the stock sold to the ESOP must be a qualified security.
A Section 1042 election is only available to shareholders of Ccorporations; although an S corporation can have an ESOP, itsshareholders are not eligible for a Section 1042 election.
E t l O hi T iti Pl69
External Ownership Transition Plans
When closely-held businesses do not have the necessaryi di t f i t l hi t iti l b iingredients for an internal ownership transition plan, businessowners must then look to external exit strategies, including thefollowing:
Mergers
Asset Acquisitions
Stock Acquisitions
Orderly Liquidations
Forced LiquidationsForced Liquidations
Positioning Company for Sale70
Positioning Company for SaleConsider goals in selling company
• Obtain maximum in cash for sale of companyObtain maximum in cash for sale of company
• Provide for continuity of business
• Allow for continued employment of owners or key employees
Determine what will be sold
• Entire company
• Divisions, locations or business segments
• Specific assets
Evaluate steps to prepare company for saleEvaluate steps to prepare company for sale
• Maximize potential value
• Allow for a smooth sale and transition processp
Financial Reporting is More Critical71
Financial Reporting is More CriticalMust get internal financial reporting process in good order
• Evaluate quality of internal financial statements and makeEvaluate quality of internal financial statements and makeimprovements as needed
• Budgets, forecasts and projected financials may play a key role
• Consider other financial analysis that will be useful in evaluatingpotential sale
Consider type of annual financial statements and reliability ofinformation
• Audit
• ReviewReview
• Compilation
Annual tax returns will also be reviewed by a potential acquirer
Searching for a Buyer72
Searching for a BuyerFinding a buyer for your company
Who are your potential buyers?Who are your potential buyers?
How can you reach them?
Consider utilizing a business broker
Determine the value of your company at the start of the process
Establishes expectation for amount to be received by selling shareholders
Allows for planning to structure the Company to increase the potential value
Must be reasonable considering the current market and buyers must be able to finance or have capital to consummate the transactionable to finance or have capital to consummate the transaction
Remember that valuation may be at investment value and synergies should be considered
L l f V l73
Levels of Value
Synergistic Value (Investment Value or Acquisition Value)
Strategic Interest in Closely-Held
Business (Investment Value or Acquisition Value)
Control Value
Synergistic Premium 10% - 50%
Controlling Interest in Closely-Held Co t o a ue
(Value of Controlling Interest in Business Enterprise)
M k bl Mi i V l
Control Premium Minority Interest Discount25% - 50%
Publicly Traded
yBusiness (i.e. >50%)
Marketable Minority Value(Value of Minority Interest, Freely Tradable)
Marketability/Liquidity Discount10% - 40%
Publicly-Traded Common Stock
Nonmarketable Minority Value(Value of Minority Interest, Not Freely Tradable)
Minority Interest in Closely-Held
Business
Due Diligence Process74
Due Diligence ProcessPotential buyer should thoroughly investigate target company
• Due diligence should be a comprehensive process from the initial contactg p pthrough consummation of a transaction
• A detailed checklist should be utilized
• Focus should be both on internal operations of the target company, as wellas external factors, including the market in which it operates and itsreputation and relationships
• Consider obtaining support from outside experts, including CPA firm, aspart of investigation of financial recordspart of investigation of financial records
Seller should also perform due diligence on potential buyer• Ability to consumate transaction
• Ability to pay future amounts due in installment sales
• Maintain employment and fulfill promises to employees
• Protect and enhance reputation of business
Structure of Transaction75
Structure of TransactionShould the transaction be structured as an Asset Sale or StockSale?
Seller prefers a stock sale
• One level of taxation at favorable long-term capital gains rate
• No retention of liabilities
Purchaser prefers an asset sale
• Limitation of assumed liabilities• Limitation of assumed liabilities
• Step up basis of purchased assets
Work together and think creatively to structure a deal that worksbest for both parties!
Under certain circumstances, the buyer and seller may jointlyelect, under IRC Section 338(h)(10), to treat the stock sale as asale of assets for tax purposes.
Conclusion76
ConclusionAll manufacturing companies need to consider ownership transition planning,especially in today’s dynamic economic and tax environment.A b i l i i h k idi i i b h lliA proper business valuation is the key to providing incentive to both sellingshareholders and purchasing individuals to engage in an internal transition plan(i.e. willing buyer and willing seller); the valuation of a closely-held company isboth an art and a science.It is imperative to understand the purpose of the valuation and the methodsused to arrive at the proper indication of value.There are several options for business owners to consider in ownershiptransition – most closely-held business owners have a goal to see theirtransition most closely-held business owners have a goal to see theirbusiness continue through future generations of ownership and must developthose next generations of leaders and decision-makers.The utilization of the various ownership transition alternatives presented isb d th l f th t l d ith th fi i l d hbased on the goals of the current owners coupled with the financial and humanresources at their disposal.It’s never too early to embark on structuring an ownership transition plan; but insome cases, it might be too late!
77
Contact Information
Victor W. Vaccaro, Jr., CPA/ABV, CFF, CDA, Partner
E il @dEmail – [email protected] – www.dmcpas.comAddress
Financial Plaza221 S. Warren St. Syracuse, New York 13202-2687y ,
Phone – 315-472-9127