Planning early will maximize return from a liquidity event

By John Hoffman

The later your plan is developed and executed, the fewer the tax-saving opportunities that are available to you.

During chaotic economic times as well as in calm markets, private equity firms, strategic buyers, financial buyers and publicly traded firms are often seeking to purchase privately held businesses. Timely planning can ensure that you and your family maximize the value of your business in a sale. Time is your ally in planning for your financial future, and never more so than when your family firm is being sold.

When you suddenly find your business in play, how can you be sure if you are ready to sell?

Chances are you won’t know. Most business owners are focused on day-to-day concerns like inventory, cash flow, hiring and sales; they don’t see the need for presale financial planning or are reluctant to think about selling their biggest asset. But if financial advisers are brought into the discussion early enough (as much as a year in advance), there’s time for them to look broadly at your situation.

Your advisory team should include not only financial professionals but also a trusted network of friends, business associates and attorneys. Together they can coordinate a process to prepare you for a liquidity event, whether it’s a private sale or an initial public offering. They can also point out—ahead of time—opportunities to achieve specific goals that can be realized in sale negotiations.

Asking tough questions

Most business owners are too busy to consider how they want to protect and transfer their wealth until a sale has been proposed. But it’s never too soon to ask yourself the crucial “disturbing” questions that may spur the soul-searching required for thoughtful financial decisions.

These questions should go beyond basic estate planning to help you maximize proceeds from the liquidity event and identify how to deploy your new wealth. For example, have you thought about what legacy you want to create, or what you would like to do after the sale? Do you know how the proceeds from the sale of the business would be split up among family members?

Potential sale outcomes

It’s vital to discuss the potential sale outcomes with family members who are involved in your business to help identify potential long-term objectives. For example:

• Full sale for maximum liquidity. This would involve your selling the entire business outright and leaving to pursue new endeavors.

• Partial liquidity with retention of some assets or ownership. This consideration may be most effective with a private equity fund buyer who will ensure a second liquidity event in seven to ten years.

• Restructure of company. Some large privately owned companies might decide to restructure as several subsidiaries under one holding company. With this framework, one subsidiary can go public, be sold or engage in a joint venture with another company.

• Employee Stock Ownership Plan strategies. You may want to use an Employee Stock Ownership Plan (ESOP) to provide liquidity and a deferred tax on the capital gain. You may also want to reward employees with stock participation or reduce the outstanding shares so that acquisition of non-ESOP shares is more affordable.

It’s important to determine if there are constraints on the transaction. These constraints could include a requirement to keep current management in place or to retain employees and maintain their benefit package. If you are interested only in an all-cash sale, that should be made clear to prospective bankers and counsel.

Once all these issues have been ad-dressed, it’s time to implement a solid financial plan, including important tax-efficient strategies, so you don’t end up leaving millions of dollars on the table.

For instance, there are several pre-liquidity strategies that can help you lower federal transfer taxes, which include the gift tax, the estate tax and the generation-skipping tax. They range from the basic steps, such as taking advantage of the annual gift tax exclusion (under which you can make annual gifts up to $12,000 tax-free to any number of people), to complex trusts that require the assistance of an attorney.

Getting the wheels in motion

There are some preparations you can make to potentially increase the valuation of your business before the deal is done. One smart move is to separate personal assets and expenses from those of the business. This can also help you obtain a favorable credit score, lower interest payments and free up liquid capital.

If your business owns real estate, consider transferring assets to your family, so they can be leased back to the business or sold to a third party to provide income protection and flexibility.

There are also emotional reasons for putting the planning wheels in motion early. The weighty decisions you are making require time and, often, input from family members. Your family must be engaged in the process for it to succeed, and those dynamics require a timeline longer than a day or two before closing a company sale or IPO.

Cashing out has its challenges

An important issue that requires forethought is how to make the transition from owning a business to managing money. Each requires a different skill. The transition from being a powerful CEO of a business to being a private investor is a change in identity and self-image that can take considerable adjustment. As business owners consider how to use their newfound wealth, they should ponder a deeper question: “What am I going to do for the rest of my life?”

Cashing out raises complex issues, including family wealth preservation strategies, philanthropic goals and how to invest the windfall, be it millions or tens of millions of dollars.

One area that can cause many difficulties in second- and third-generation businesses is the issue of employment. Multigenerational businesses have a mix of owners and non-owners. Income from a family business may be simply dividends for one family member, while for others it may be salary and dividends. Given these circumstances, you may need to put processes in place to make decisions about how the income from the sale is divided or rely upon mechanisms such as a family business charter that are put in place for family members to realize their capital.

Transition planning

Presale transition planning is an important component. You may want to consider tax-advantaged strategies such as creating charitable entities, implementing sophisticated gift strategies for generational wealth transfer (including Delaware trusts) and reviewing insurance coverage, among others.

On the other hand, if presale planning is done too close to the sale date, the conversation needs to focus more on what to do with the cash once the sale is completed, including investment strategies and post-sale planning issues. The later your plan is developed and executed, the fewer the tax-saving opportunities that are available to you.

For example, Northern Trust recently assisted in presale transition planning for a business owner who was approached by a private equity firm about a sale. We moved in excess of $10 million out of the owners’ estate to the next generation without a gift-tax cost. It was a $5 million savings.

There are other options available with advance planning. A family limited partnership or family limited liability company, carefully drafted and implemented to conform to Internal Revenue Service guidelines, may facilitate gifting of assets at a discounted value, thereby maximizing the value of personal tax exemptions.

Gifting strategies should be care-fully considered, and business owners should coordinate a dis-cussion with all their advisers to de-termine the benefits and risks of various alternatives.

The power of collaboration

No matter how large or how small your business is, selling it is a complex event that requires the coordination of multiple activities. You should take the time to coordinate all the experts who are providing advice—from your estate planning attorney, tax adviser and investment advisers to friends and associates.

In the case of a liquidity event, all of these functional areas are related to each other. Being able to consider the effects together is critically important in achieving maximum value for the sale of your business and realizing your family’s financial goals.

John Hoffman is managing director, wealth advisory services at Northern Trust, based in New York City (

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Summer 2008

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