SESSION I5 Succession Planning for Closely Held and Family-Owned Businesses ONLINE RESOURCES Session Handouts Can t be in two places at once? Download handouts for sessions you aren t able to attend. www.mncpa.org/materials Log in with your MNCPA username and password. Note: Your conference registration fee must be paid in full to access session handouts online. CPE Transcript (Certificate of Attendance) Need proof of attendance? Print your official transcript from the MNCPA website. www.mncpa.org/transcript Log in with your MNCPA username and password. Note: Tax Conference transcripts will be available Wednesday, Nov. 21. CPE Log (Members only) What CPE did you take? When? Where? Track your credits in your personal CPE Log. It s a free, easy-to-use tool for MNCPA members. www.mncpa.org/cpelog Log in with your MNCPA username and password. Materials Disclaimer: These materials are provided for the exclusive, personal use of the customer. Any other reproduction, retransmission, republication or other use is expressly prohibited without prior written consent from the Minnesota Society of Certified Public Accountants (MNCPA) and/or the content author. The MNCPA makes no warranty, guarantee or representation as to the accuracy or completeness of these materials. The contents of these materials are subject to change without notice. The content authors and/or instructors are not engaged in rendering legal, accounting or professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. W. Douglas Hile KleinBank Corporate Center 1550 Audubon Rd Ste 200 Chaska, MN 55318-0487 952-448-2484 d.hile@kleinbank.com W. Douglas Hile is president and CEO of KleinBank, Minnesota's largest family-owned state bank. He also currently serves as a director of the Federal Home Loan Bank of San Francisco and the Minnesota Bankers Association. Thomas W. Larkin 121 W Main St Ste 200 Waconia, MN 55387-1005 952-442-7700 twlarkin@mhslaw.com Thomas W. Larkin, is a partner at. He has 20 years of experience counseling family and closely held business owners on formation, capitalization, governance, shareholder agreements, succession planning, contract matters, and mergers and acquisitions. Bradley W. Solheim 121 W Main St Ste 200 Waconia, MN 55387-1005 952-442-7700 bwsolheim@mhslaw.com Bradley W. Solheim is a partner and lead attorney in the real estate practice group at. He has over 30 years of experience and specializes in small business representation, financial institutions and real property law. Ritch L. Sorenson, PhD University of St. Thomas Opus College of Business 1000 Lasalle Ave Minneapolis, MN 55403-2025 651-962-4270 rlsorenson@stthomas.edu Ritch L. Sorenson, PhD, a third-generation family business owner, is the Opus chair in family business and director of the Family Business Center at the University of St. Thomas. His accomplishments include developing a major for undergraduate students and helping establish an Ownership Academy.
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Succession Planning for Closely Held and Family-Owned Businesses Sponsored by Ritch L. Sorenson Twenty years of family business education 1
Why Family Business? Family business provides 80-98% of world businesses 49-75% of gross domestic product 80% of US workforce... 86% new jobs 60% of publicly held businesses However Only 32% make it to 2nd generation Only 12% make to the 3rd generation..... Why? 3 Family Business Succession 4 2
Three Family Business Stories Three Family Business Stories Sorenson Family Three Family Business Stories Three Family Business Stories McNeely Family 6 3
Three Family Business Stories Three Family Business Stories Klein Family 7 CPAs Primary Advisors to Family Business 8 4
CPAs Family Business Advisors CPAs -- Family Business Advisors Good Questions Promote Governance Increase knowledge Demonstrate concern Strengthen relationships Help focus on big picture Promote future thinking 9 The Big Picture The Big Picture Landscape of Family Business Yu, Lumpkin, Sorenson, Brigham. Family Business Review, 2012 Long Term Succession Business Business Strategy Governance Family Business Performance Social and Economic Impact Family Dynamics Family Business Roles Short Term 5
Questions focus on Five Areas Questions focus on Five Areas Strategy Succession Governance Longterm Shortterm Performance Family Dynamics and Roles Business Family Basic Family Business Questions Basic Family Business Questions 1. Is yours a family business? 2. Do you intend to pass ownership to your children? 3. What have you discussed with your family regarding #1 and #2? 6
For a Family Business For a Family Business In addition to business performance, ask questions to focus on big picture Governance Family Succession Strategy Ask About Governance Ask About Governance How will you prepare family members to be owners? What kinds of human relations policies will you have? How can your business mission include family vision and values? 14 7
Ask About Family Ask About Family Would you like children to own or work in the business? What can you do to help family members to be satisfied with the business? What can you do to promote commitment to the business? What are you doing now to make them want to work with you later? What can you do now to prepare them? Understand business and finance Adopt family business values 15 Ask About Succession Ask About Succession Early on, ask Do you tell business stories at dinner? Do your kids come see you business? Later, ask What are family member strengths? How might they contribute to your business? What jobs might your children do at work? Still later, ask Do you have a plan for developing leaders? What are your plans for succession? 16 8
Ask About Strategy Ask About Strategy How do you plan to grow the business to sustain more family members? What is your overall strategy for the business? Does your family know what to do in case of a sudden transition? 17 Ask About Business Performance Ask About Business Performance Do you regularly share financial performance with your family? Do family members know the meaning of reports? How well do family members understand the business model underlying performance? 9
Ask Questions that Reveal Big Picture Ask Questions that Reveal Big Picture Strategy Succession Governance Longterm Shortterm Performance Family Dynamics and Roles Business Family 10
Key Documents Shareholder Agreement, Member Control Agreement, Partnership Agreement (with buy-sell and management provisions) Wills or Trusts of the Principals Articles of Incorporation and Bylaws, Articles of Organization and Operating Agreement These should all be integrated or complementary, in a well-designed succession plan. Future Management Designate successors to key offices (CEO, CFO, COO, Managing Partner). One, or a few collectively, holding controlling shares, but with super majority approval required for certain actions, expenditures, loans, etc. With second and third generation owners: consider outside directors and officers; establish policies regarding nepotism; consider more complex ownership structures, including holding companies and multi-generational trusts. 11
Consider Future Risks and Rewards: Loans & Sureties-generally, lenders and sureties want anyone holding 10%-25% or more to sign all guaranties and indemnity agreements. It is important to consider whether non-controlling and inactive shareholders or members should be put in the position of having to either risk their own assets on a venture they do not control or are not involved in, or hamstring those whose assets are at risk. Buy-Sell Provisions: Buy-out provisions are key; those who will be active and in control need the ability to buy out those who won t be. Those who won t be in control or active may also want or need the ability to put their interest to the company or active parties. Involuntary Transfers; Sale Restrictions; Other Un-invited Guests. Terms and Timing: Open-ended option, or window; payment terms; security. 12
Buy-Out or Redemption Price: The threat of the runaway or low-ball appraiser; i.e., why just specifying a fair market value price can be dangerous. Consider that the future growth will be largely a result of the efforts of those active in the business. Consider who the buyers and sellers are; don t assume the objective is to maximize a buyout price or minimize a gift value. ESOP s and other forms of Employee Stock Ownership; Future Sale The importance of tag-along and similar provisions, in particular when considering the future ability to sell the company or the assets. Some alternatives to Qualified ESOP Plans. Other considerations for future stock or asset sale (marketability, etc.). 13
I. Family businesses have unique opportunities in planning A. Current tax liabilities B. Estate planning and valuation Discounts Control 14
I. Family businesses have unique opportunities in planning (cont.) C. Family members in the business and family members not in the business D. Creation of solid balance sheet/capital needs I. Family businesses have unique opportunities in planning (cont.) E. Reportable Income requirements/need Retirement Vehicles Real estate Family employees Health care Charity 15
I. Family businesses have unique opportunities in planning (cont.) F. Maximizing sale/valuation Use of SBA Seller financing Traditional bank financing II. Use of the next tier of advisors by the CPA and the lawyer A. Financial planners Concentration/diversification of assets Retirement planning 16
II. Use of the next tier of advisors by the CPA and the lawyer (cont.) B. Bankers a. Loan Covenants i. Subordinated debt ii. Debt to income ratios 2-1 to 10-1 iii. Cash flow covenants 1.2-1 to 1.5-1 iv. Today s world II. Use of the next tier of advisors by the CPA and the lawyer (cont.) B. Bankers (cont.) b. Guarantees i. Principals involved in the business ii. Ownership iii. Releases of Personal Guarantees 17
III. Summary A. Family businesses are different than regular businesses. a. Tools used by professionals are the same as regular businesses b. Preparation, communication, planning are all unique c. There are dramatically different sizes and longevity of the family business III. Summary (cont.) A. Family businesses are different than regular businesses. (cont.) d. Where is your client in the cycle? i. 100 year businesses - 100M businesses ii. Start ups e. Family business non-lineal 18
IV. Role of the CPA GET BEYOND THE NUMBERS A. Large businesses know the value of the CPA and use their services a. There are exceptions to the rule b. Do not assume clients know what they need IV. Role of the CPA GET BEYOND THE NUMBERS (cont.) B. Most small and medium size businesses, unless they are in an industry which uses lawyers regularly, need the CPA to take the lead a. Trust b. Regular contact through tax preparation c. Need to tell them what they don t know d. Understanding the client doesn t necessarily have all the tools 19
IV. Role of the CPA GET BEYOND THE NUMBERS (cont.) C. Make sure your client does not outgrow you D. Use of the next tier of advisors E. Not any one of us alone Succession Planning for Closely Held and Family-Owned Businesses Sponsored by 20
Thomas W. Larkin, Partner Waconia, Minnesota KEY CONSIDERATIONS FOR A SUCCESSION PLAN The Key Documents: Shareholder Agreement, Member Control Agreement, Partnership Agreement (with buy-sell and management provisions) Wills or Trusts of the Principals Articles of Incorporation and Bylaws, Articles of Organization and Operating Agreement. These should all be integrated or complementary, in a well-designed succession plan. Firming Up Plans and Setting Expectations. Planning For the Unexpected. Determining Who Has Input and How Much. Suggestion: Bring in the next generation with some ownership at the time the plan is put in place, so they are parties to the shareholder/control agreement from the outset. Future Management: Designate Successors to key offices (CEO, CFO, COO, Managing Partner) Who are the key employees or control key relationships/customer loyalties. You can allow for more flexibility with businesses/investments that require less day to day or hands-on management, such as leased-up rental real estate, particularly with outside property managers. One, or a few collectively, holding controlling shares, but with super majority approval required for certain actions, expenditures, loans, etc. With second and third generation owners: consider outside directors and officers; establish policies regarding nepotism; consider more complex ownership structures, including holding companies and multi-generational trusts. The Importance of Checks and Balances. The Importance of Having People Who Can Make Decisions Day to Day. The importance of retaining some veto authority if you are financing a buyout. Consider Future Risks and Rewards: From the perspective of both incoming and outgoing owners. Loans & Sureties-Generally, lenders and sureties want anyone holding 10%-25% or more in equity interests to sign all guaranties/indemnity agreements. 1
It is important to consider whether non-controlling (and/or inactive) shareholders or members should be put in the position of having to either risk their own assets on a venture they do not control or are not involved in, or hamstringing those who are. How are you tying risk, reward, and authority together. Buy-Sell Provisions: Buy-out provision can be key to a business surviving through the next generation; those who will be active or in control need the ability to buy out those who won't be. They are the ones who will be putting their own assets and credit at risk. Those who won't be in control or active may also want or need the ability to 'put' their interest to the company or active parties. They are the ones who may be finding themselves dragged into an adventure they didn t sign up for. Involuntary Transfers; Sale Restrictions; Other Un-invited Guests. Divorce, Death, Disability, Bankruptcies, Creditors, and the unapproved sale. Terms and Timing: Open-ended option, or window; payment terms; security. i. Who will be the buyer, i.e., the company or the other principals? ii. If the buyers are the other owners, there can be significant shifts in control if some participate while others don t. iii. Security: equity interests or business assets; remedies if there is a default (such as reversion of voting rights and rights to distributions, etc.). Consider demands of primary and other lenders, effect on flexibility for future financing. iv. Future cash flow needs, ability to fund the buy-out. v. Life and disability insurance as funding source. Typically spelled out in the Shareholder, Member Control, or Partnership Agreement. Consider: Conditions to purchase option or forced sale, such as release of guaranties and indemnity agreements; reduced redemption price if a key person won t agree to competitive restrictions; earn-outs if it is a key person that is leaving. Buy-Out or Redemption Price: The threat of the runaway or low-ball appraiser; i.e., why just specifying a 'fair market value' price can be dangerous. Consider: The use of formulas, such as an adjusted book value, with certain assets marked up or down to current value, and a factor for good will; Capping the factor for goodwill (such as some multiple of EBITDA), and be sure to factor out regular salaries and bonuses, i.e., a buyer shouldn t be buying their own job, at least to the extent their compensation is reflective of what they could get working for a third party; Sellers can t expect a factor for what they would have earned as salary or bonus had they continued, as that will now have to be paid to someone else (and the seller won t be providing those services anymore); and, Future growth will be largely a result of the efforts of those active in the business. ESOP s and other forms of Employee Stock Ownership; Future Sale: 2
The importance of tag-along and similar provisions, in particular when considering the future ability to sell the company or the assets. Most purchasers see the ESOP as a burden to be closed out by the seller. Some alternatives to Qualified ESOP Plans. Other considerations for future stock or asset sale (marketability, etc.). In addition to the tax implications, keep in mind that the assumption of fixed liabilities (i.e., term loans, purchase money loans, leases, etc.) is much more palatable to a buyer than assuming warranty and tort liabilities-which is generally the case when they buy stock or membership interests. Buyers are generally going to be asking for representations and warranties, and indemnities against liabilities during the seller s period of operation; consider tail insurance coverage. Closing: Work for harmony, but plan for dissension. Have a path, but build in flexibility for course corrections along the way. Consider whose approval will be necessary to make changes. Thomas W. Larkin, Partner 121 West Main Street, Suite 200 Waconia, Minnesota 55388 Phone: 952-442-7700 Direct Dial: 952-442-7768 e-mail: twlarkin@mhslaw.com 3
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58TH ANNUAL MNCPA TAX CONFERENCE November 15-16, 2012 Minneapolis Convention Center, Minneapolis, MN Please rate the following using the scale below: 5=Excellent, 4=Very Good, 3=Average, 2=Fair, 1=Poor I5. Succession Planning for Closely Held and Family-Owned Businesses Excellent Poor Relevancy of Topic 5 4 3 2 1 Stated Objectives Met 5 4 3 2 1 Overall Satisfaction 5 4 3 2 1 W. Douglas Hile Knowledge of Subject 5 4 3 2 1 Presentation Skills 5 4 3 2 1 Quality of Materials 5 4 3 2 1 Engagement of Participants 5 4 3 2 1 Thomas W. Larkin Knowledge of Subject 5 4 3 2 1 Presentation Skills 5 4 3 2 1 Quality of Materials 5 4 3 2 1 Engagement of Participants 5 4 3 2 1 Bradley W. Solheim Knowledge of Subject 5 4 3 2 1 Presentation Skills 5 4 3 2 1 Quality of Materials 5 4 3 2 1 Engagement of Participants 5 4 3 2 1 Ritch L. Sorenson, PhD Knowledge of Subject 5 4 3 2 1 Presentation Skills 5 4 3 2 1 Quality of Materials 5 4 3 2 1 Engagement of Participants 5 4 3 2 1 Do you have any additional feedback regarding the instructors and/or materials? If so, please share it with us. What would you like to learn at the 2013 conference? Who would you like to hear speak at the 2013 conference? Minnesota Society of Certified Public Accountants www.mncpa.org 952-831-2707