"Baby Boomer Wealth Transfer
Additional Information"



Please click here to read Part 1 of the article "Baby Boomer Wealth Transfer" as seen in Business Magazine


The Effect of Balance Sheet Value
To this point, we have focused primarily on discussing the importance of improving the income stream and reducing company risk in order to enhance value, but a key factor that cannot be ignored is the balance sheet. The health of your balance sheet can add to or subtract from the income stream value of your company. This impact on value is determined by comparing the company's balance sheet to industry benchmark data.

To elaborate, let's consider a company that is carrying cash representing 15% of total assets in an industry where the common structure is to have cash at 8% of total assets. Additionally, the company has no long-term debt, whereas other companies in the industry typically have a debt-to-equity ratio of 1:0.

Assuming all other balance sheet items are consistent with industry benchmark data, there are two adjustments that should potentially be made that will have a significant impact on value. Having cash on hand greater than what the industry typically holds can provide an increase to company value.

Similarly, an adjustment should be considered for the company's excess debt capacity. In our scenario, the balance sheet would be adjusted for additional debt the company could incur and still remain within levels that are normal for other companies of this industry to carry.

This additional value can be realized by the seller in one of two ways. It can be a part of the negotiation with the buyer in determining the ultimate selling price. However some of this value may be dissipated in the negotiation process. The seller can also realize this value in advance of sale of the business. This would be accomplished by establishing a higher level of financial institution debt, borrowing on this debt and withdrawing these proceeds and the excess cash as well. There would be less exposure to a reduction in value resulting from the back and forth negotiation process if these balance sheet changes were made in advance of company sale assuming these items are consistent with the industry benchmark data.
It is important to keep in mind that when balance sheet adjustments are made affecting a company's overall value, the income stream may need adjusted as well. For instance, consider the adjustment for excess debt capacity discussed earlier. In this case, the valuator would also need to consider the effect of interest payments that would be made as a result of this increased debt. The resulting interest cost would actually serve to reduce the income stream that is being capitalized in the determination of value (this decrease in value due to additional interest cost could be significantly lower than the additional value resulting from the ability to increase debt).

As you can see, even though most people think of income and cash flow being the primary determinants of value, being mindful of the health of your balance sheet, and taking thoughtful steps in evaluating and improving its health can go a long way in adding value to a company as well.

Transactions with Family Members
Often times in the case of closely-held businesses, the owner(s) approaching the point of retirement desire to have their next generation family member(s) either continue to operate the family business as its new owner(s) or be the recipients of the sale proceeds from selling the company, as well as other assets. When not properly planned, such transactions can result in significant tax consequences and can even effect the assets of the business.

When the desire is to transfer either the ownership interest in the business or the proceeds from the sale of a business to the next generation, several tools are available to minimize the impact of gift and estate taxes. One approach in the transfer of a business interest involves recapitalizing the stock in a company (for our example, we will assume the entity is an S Corporation) so that there are voting and nonvoting shares of common stock. The owner usually retains a control interest in the voting shares of stock and transfers all or most of the nonvoting shares to the identified successors. This allows for the transferor to maintain control of the company but allows the successors to obtain ownership interests with a portion of the future growth of the company to inure to the next generation and be excluded from the owner's estate. This transaction or gift transfer usually requires the filing of an IRS Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return. Because these shares do not contain voting rights, their value is significantly less as higher discounts can be applied due to the lack of control and marketability of these nonvoting or non-controlling shares. This is essential in minimizing any potential impact in terms of gift or estate taxes.
If the business has already been sold and all that remains to transfer to family members are investment assets, a useful form of organization may be that of the family limited partnership (FLP). An FLP is a legal entity in which the partners are usually family members. First and foremost, if the intent is to effectively gift an interest in the assets to the next generation, the use of an FLP greatly simplifies the process.

The FLP also affords several other benefits, not limited to the following:

  • The ability to maintain control over assets - allowing current generation family members to give beneficiaries an interest in the assets without losing control of the assets.
  • Protection against creditors - a creditor of a limited partner in an FLP is usually unable to reach the assets of the FLP. These interests are subject to the terms and restrictions of the partnership agreement, and are often unattractive to creditors and difficult for them to access.
  • Family control - With properly prepared documents, the FLP will be able to keep control of the assets within a family, offering protection against events such as divorce and claims arising from the marital estate.

As you can see, the FLP can be an excellent tool in the area of family succession planning. The FLP requires proper planning to be effective. Assuming the FLP is properly formed and operated, it should be successful in achieving its objectives. Similarly to the gifting of stock in a company as discussed earlier, the United States Gift (and Generation-Skipping Transfer) Tax Return usually is required to be filed. By the transferor keeping control over the assets, the value of the partnership interest that is gifted provides for the use of lack of control / marketability discounts that result in a lower value being transferred. Again, this calculation of value (and any resulting tax on the gift) requires the use of a professional experienced in business valuation. As this article implies, selling or gifting your business requires careful planning and consideration. The succession process or sale of a business done right is not something that will happen overnight. By taking measures to get your company in the proper financial condition, significant value can be obtained from a potential buyer. This process can often take months, perhaps even years. If you anticipate a sale or gift of your business in the coming years, the time to start planning is now.

If you have found this article to be of benefit to you, you may also be interested in reading another article written by Robert M. Power, "R&E Tax Credit: Recent Rulings in Favor of Taxpayer," by clicking here.

Additional information on the R&E Tax Credit can also be found in the R&E section of our website by clicking here.