Corporate transition strategies: estate planning

By Denny Axman, CLU, ChFC, AEP, CFP®


Co-written by Sam G. Torolopoulos, CPA/ABV, ASA

Corporate transition planning is quickly becoming one of the critical topics of our time. Baby boomer business owners are reaching retirement age at an ever-increasing rate. Their children are not nearly as desirous of taking over the family business as the baby boomers were when they took over for their parents, the World War II generation.

When you combine this dynamic with emerging and/or changing credit, estate tax and global economic markets, transitioning the ownership of a privately-held business is an uncertain proposition at best and at worst, a scary one.

In order for a business transition to be successful, it must:
  • Meet the owner’s personal goals
  • Allow the business owner to have a clear understanding of his or her management role going forward
  • Provide a reasonable replacement income from reinvestment of the selling proceeds
At the beginning of any retirement or estate tax planning discussion with a business owner, the issue of value will inevitably come up. A client often feels they have no choice but to “take a salary for life” and leave the business to children equally at death and, as a result, risk incurring unintended estate taxes and ownership transfer fees. This is why a value discussion is crucial prior to establishing a business transition plan.

Define motives to determine value

What many business owners intuitively know but spend little time contemplating is the many values their company possesses.
  • Orderly liquidation value — sell the assets, pay the liabilities and close the doors
  • Investment value — the value a non-working owner will pay to own a company that is part of a portfolio of companies
  • Fair market value — based on valuation rules put forth by the IRS for charitable, gift and estate tax transfers
  • Market value — the value a private equity firm or competitor might pay for the company
  • Synergistic value — the value a publicly traded company might pay to take advantage of market synergies or vertical integration
What business owners need to understand is they choose the value world in which their business will trade, based primarily on their motives. The business transfer spectrum, as depicted in the following chart, is taken from the book, "Private Capital Markets," and it shows the many options a business owner has when transferring equity interests from one generation to the next. At the top of the chart, we see the business owner’s motives. This represents the first and most important decision he or she has to make.


Attempting to make a recommendation of a transfer method without determining the business owner’s motives will often result in a breakdown of the overall planning process and, ultimately, trust in those who made the recommendation. It is also important the business owner knows the value conclusion reached will generate cash flow sufficient to meet his or her personal financial goals and objectives. Failure to discuss the financial issues with the client will likely cause the planning process to stall.

On the other hand, a business owner’s motives might make selling to management or to an employee stock ownership plan a very attractive option. Yet the business owner will likely take no action unless he or she knows how much the ESOP is legally able and willing to pay, what he or she will receive in cash at closing and over time, and how he or she will remain in control of the business at least until the company’s financial obligation to him or her has been satisfied.

All about the cash flow

Other than a business owner’s motives, what drives value? As previously mentioned, the transfer channel drives value within a reasonable range as it relates to the rules used in calculating the value of the stock. But ultimately, regardless of the transfer method chosen, cash flow is the largest value driver. It is therefore critical the value conclusion reached is reasonable to both the buyer and seller from a financial point of view.

At the end of the day, every business pays for itself via the cash flow of the company. The seller’s value expectation must be managed during the entire process through proper explanation and illustration.
Likewise, the buyer needs to know the net cash flow of the company will be sufficient to service the purchase price debt over a reasonable period of time without bankrupting the company. Generally speaking, no business owner will transfer the ownership of his or her largest asset without fully understanding what he or she is going to receive and what his or her role is going to be in the company going forward. As well, no managing family or other employee will be willing to work for below-market wages for an extended period of time just to satisfy the note payments for the purchase price of the stock in the company.

In the end, regardless of the transfer method ultimately chosen, the transition of a privately-held business is complex, requires a collaborative effort and is a process, not an event. It calls for all involved in the process to understand the business owner’s goals and determine the best outcome based on options available and policies in place in order to ultimately develop a sound retirement and transition plan. Failure to address the business transition issues in detail will ultimately stall and/or derail the entire personal planning process, causing the business owner to revert to his or her perceived default position: “take a salary for life.”

Going beyond the business

Once the business-transition planning strategy has been decided, the next step is to review the business owner’s personal estate plan. In 2010, President Obama and Republican leaders agreed to extend the so-called Bush income tax rates for two years, which included a temporary extension of the estate tax with a $5 million exemption and 35 percent rate. Shortly thereafter, the president signed into law the Tax Relief Act. This act has implications for almost all taxpayers because it not only extends the federal income tax cuts, but also changes the federal estate, gift and generation transfer tax rates and applicable exclusion amounts for 2010 through 2012.

The purpose of reviewing this new tax law is to see the tremendous collaborative planning opportunities available for advisors, along with the client’s planning team, to assist them in transitioning their businesses, as well as their personal investments. The two go hand in hand. Because many times the business represents the largest single illiquid asset in the client’s estate, as a result, the personal estate plan will need to be updated accordingly.

The planning opportunities of gifting are certainly enhanced, and according to most industry sources, the claw-back provision is really not a great risk for the client. In the event the client needs the value of the business to sustain his or her retirement income, selling the business interest and having the cash distributions of the business pay the note payments to the owner will provide retirement income as needed.

Properly owned life insurance is the product of choice in most of these planning scenarios. By working closely with the multi-disciplines of clients’ wealth-planning teams, we can provide peace of mind for business owners so their years of creating and building their businesses will provide for them and their loved ones the income to enjoy retirement years, as well as legacy planning for their families.

1 Robert T. Slee, Private Capital Markets, Valuation, Capitalization, and Transfer of Private Business Interests, (Hoboken, NJ, John Wiley and Sons, Inc., 2004) 10