A presentation I recently shared with a family owned business ready to explore sucession planning.

1. Succession Planning for the
Family Business:
Understanding the Process and
the Strategies May 26, 2009

2. Why Most “Great” Plans Fail:
1. They ignore family dynamics.
2. They ignore basic business issues.
3. They are tax-driven.
4. They don’t involve “the next generation”.
5. Everyone wants to avoid confrontation.

3. Five puzzle pieces that drive the keep or sell decision
Governance of Family Leadership
Wealth Succession
is how the family develops its human is about who will run the company
and intellectual capital in addition to its in the future. Should non-family be
non-
financial assets. Philanthropy can be brought in, or the company sold?
used as a “learning lab.”
lab.”
Ownership
Succession
is about who will own the company
in the future. Those who own the
company may not be the same as
those who run the company.
Business
Opportunities, Risks, Family
& Market Value Cohesion
means understanding enterprise value, how the family will function
need for future capital, industry issues during and after a transition of
and other factors that influence its future ownership and management

4. Planning solutions (and governance) tend to be
generation specific
Governance
)
Owner- Rotating Board Members with
Go
ce
Investors staggered terms and outside
an
ve
members
rn
ern
G3
an
ov
c e(
sg
Family Trustees, Company
les
Hybrid Model
s
Officers, and a few outside
(le
sh
Family Shareholders members
On
an
Some Not Active
ds
s
nd
G2
on
Ha
)
Owner-Managers
Advisory Board
Entrepreneur or Sibling Partners
All Active
G1

5. Owner-Manager Model
Issues Typical Solutions
Who decides who can and cannot Installment sale to next
work in the company? generation (or redemption
Will daughters have the same agreement) – during lifetime.
opportunities as sons? Non-qualified retirement plans for
What to do for “non-actives”? senior generation.
Business valuation issues. For S corporations, distribute AAA
to manage value.
Financial burdens on the business
Equalization for non-active family
– to support growth and fund
members.
senior generation’s retirement
Gift and then buy-back of non-
needs. voting shares
Who will be CEO among siblings? Other assets (non-operating real
estate)
Life insurance

6. Owner-Investor Model
Issues Typical Solutions
Where to draw “the line” between Voting Trusts (for S Corps), Family
family and business? Partnerships (for C Corps), and
Generation-Skipping Trusts with
How to educate uninvolved owners? investment committees empowered
Time involved in managing to vote family business stock
shareholder relationships Sale of stock to defective trusts; life
Fair compensation for family (and insurance purchased for estate
non-family) executives liquidity
Family councils and family
Family perceptions regarding risk
committees for policy decisions
and strategic growth
Compensation agreements for key
Cash flow needed for distributions people – phantom stock and SAR
vs. retained for growth plans
Benchmark company performance –
enterprise level business valuations
Experienced outsiders on board of
directors

7. Hybrid Model
Issues Typical Solutions
How to give non-actives some Recapitalizations and creation of
“voice” … but not too much? new non-voting shares
Compensation and perks for Voting rights (on major decisions)
actives may become a source of for non-voting shareholders
contention
Shareholder Agreements with
What if actives feel it’s “their”
puts and calls
business?
Can checks and balances be Provisions if the company is sold
placed on those running the to a third party
company? Voting shares gifted, or sold, to
How to avoid freeze-outs and family in key positions
shareholder conflict?
Will shareholder agreements
create forced sale scenarios?

8. Hurdle: Evolving from an Entrepreneurial
to a Professionally-Managed Business
Organizational Culture and Values
Profit Orientation and Accountabilities
Key Focus Leadership and Management
Development
Areas
Budgeting
Innovation
Information and Communication

9. Using a Leveraged ESOP
• To business owners the ESOP is … a buyer of stock and/or
a means to start succession planning.
• To employees the ESOP is … a company funded retirement
plan and an incentive to act like owners.
• To companies the ESOP is … a technique of corporate
finance, a tool to increase productivity and provide a
qualified retirement plan.

10. Leveraged ESOP
Bank
3
Loan
Corporation
2
Contributions
15% of covered payroll Escrowed shares
ESOP
1 Sells shares
Financial Institution
Cash
4
Tax-free rollover
Qualifying replacement
securities
(1) Bank lends money to ESOP with company guarantee. (2) ESOP buys stock from existing
shareholders. (3) Company makes annual tax-deductible contributions to ESOP which in turn
repays bank. (4) Stock is held in suspense account and released as loan is repaid.
(5) Employees collect stock or cash when they retire.

11. Why ESOPS are Popular –
Business Succession Strategy
• Management changes only if shareholder/manager
chooses to leave
• If done in stages – less leverage, less interest expense
than an MBO or LBO
• Board of Directors retains control of company
• Not an all-or-nothing alternative

12. Why ESOPS are Popular – Liquidity
• Owners can sell all or part of their shares
• Can spread sale of shares over years
• No change of control
• No third-party participation
• No uncertainty of outcome

13. Why ESOPS are Popular –
Defer Gains on Stock Sold
• Pay capital gains now (only on shares sold) and reinvest
anywhere or spend the money, OR
• C corporation owners – can elect §1042 rollover and
defer capital gains tax (restrictions apply)
• S corporation owners – can defer capital gains by
receiving seller note instead of cash – pay tax as
principal is paid back

14. §1042 Tax-Deferred Rollover
• C corporations only
• Privately-held companies only
• ESOP must acquire 30% or more of the stock
(cumulative)
• Seller must reinvest the proceeds within 12 months
• Reinvested funds must be Qualified Replacement
Property or “QRP”
• Tax-deferred continues as long as seller holds QRP
• Shareholder must have owned shares for at least 3 years

15. Benefits of S Corp ESOPs
• ESOP’s share of S corporation earnings is exempt from
unrelated business income tax (UBIT)
• Taxation is delayed until distributions are made to ESOP
participants
• Thus, a 100% ESOP-owned S corp would NEVER pay
income taxes

16. Limitations of S Corp ESOPs
• No tax-deferred treatment on owner’s sale of stock to
the ESOP
• Interest and forfeitures are included in 25% of the
company contribution limit
• Must meet “broadly based” test (§409p) – in general,
need more than 10 employees

17. Voting Rights of ESOP Trust
• On ordinary issues – ESOP Trustee(s)
• On special issues – ESOP Participants
Vote as a group
On merger, consolidation, recapitalization, liquidation or sale of
substantially all corporate assets
No voting rights on sale of stock for cash
Employees only vote allocated shares

18. ESOPs Require Ongoing Planning
• ESOP exploratory committee to be formed
Hire legal counsel and appraiser
Fairness Opinion - separate from appraisal
• Borrowing rate determined (if ESOP is leveraged)
• Trustees
Administrative Committee
• Voting of shares (as trust fiduciary)
Voting reserved to committee
• Repurchase liabilities projected
• Contribution limits determined
Example: $7,000,000 covered payroll x 15% = $1,050,000 of
eligible contribution deduction
$1,050,000 will amortize a $4,600,000 ESOP loan
Assume loan term of 5 years at 7%

19. In summary, the right ownership structure should
align family and business interests
• Agreement on goals and objectives for the business
Growth rates
Tolerable risk levels
Expected returns
Non-financial benchmarks
• Timely and accurate information
• Leadership consciously cultivated/CEO succession
• Competent, empowered management team
Performance-based compensation
• Formalize family ownership
Linkage between company and family, roles and responsibilities,
role of the Board
Managing tension: leadership, politics, expectations
Liquidity for shareholders and capital for growth

20. Succession Planning for the Family
Business:
Understanding the Process and the
Strategies
We are Brown, Edwards & Company, L.L.P., a regional
accounting and consulting firm, serving our clients’
needs since 1967. Our mission is to provide business
management and tax saving solutions as a necessary
extension to traditional accounting and tax compliance
services.
Notification as required by the Standards of Tax Practice: Tax information
contained in this document is a discussion of relevant issues and is not rendered
as a covered or reliance opinion. Therefore it is not intended or written to be
used (and cannot be used) for the purpose of avoiding penalties that may be
imposed by any tax authority.