Business succession planning 2012 Mark Coriell

INTRODUCTION Closely held businesses; farming operations 4 organizing questions: When should the succession begin? What is being transitioned? What documents are needed? How much will this succession cost? Primarily talking about family businesses and transitioning that business to the next generation, particularly in cases where there are multiple children but only one successor.

When should the succession begin? Lifetime vs. Post-Mortem POST-MORTEM ONLY Sale/gift from estate or trust Will the successor operator be adequately prepared? Will the business be unexpectedly devalued? Unexpected loss of key person Banking problems How will the current operator fund his/her retirement?

When should the succession begin? LIFETIME; LIFETIME/POST-MORTEM HYBRID Practical Advantages For sales, retirement income (cash) to first generation First generation oversight; assistance *Be careful in income tax-advantaged redemptions First generation imprimatur over transition for other, non- business, members of second generation

When should the succession begin? LIFETIME; LIFETIME/POST-MORTEM HYBRID But first generation doesn’t want to give up ownership yet Employment Agreements Find out if second generation can handle responsibility without giving away control Financial incentives Stock/membership acquisition incentives For gestation period prior to ownership, easier to terminate employment than buy-back stock or deal with unhappy minority shareholder Non-competition/trade secret protection

When should the succession begin? LIFETIME; LIFETIME/POST-MORTEM HYBRID It’s time for ownership Unless the business is real estate heavy, the next generation probably can’t borrow to purchase the business outright Installment sale or part sale/part gift Valuation First generation takes back promissory note and security (retirement income!) Flexibility Interest

When should the succession begin? LIFETIME; LIFETIME/POST-MORTEM HYBRID It’s time for ownership Early introduction to financing institution Particularly if business relies on line of credit or other financing arrangement to operate, the first generation has probably been a long-term customer of the bank Introduce second generation to bank toward the beginning of the process Perhaps get second generation on loans (even smaller ones) at the beginning of the process to get his/her name in front of lending committee Continue banking relationship at the transition point without necessity of first generation But watch personal guarantees

What is for sale? ASSETS V. STOCK ASSET SALES Almost always the case in non-family transactions Buyer doesn’t want built-in risk related to the business – just assets However, beware non-payment of state-mandated premiums Substantial expense to first generation: depreciation recapture IRC 179

What is for sale? ASSETS V. STOCK STOCK SALES Very common in interfamily succession Protects company-level contractual relationships Shareholder to Shareholder v. Redemption Where are the dollars the cheapest?

What are the documents? Business Side Operating Agreement/Buy-Sell Agreement Joinder Agreement Company resolutions Promissory Notes Security Documents (Security Agreement, Financing Statements, Mortgage, Stock Pledge Agreement, etc.)

What are the documents? Estate planning side Trusts Reduces possibility of having probate court involved in operating business Longevity (if necessary) Federal estate tax reduction Ohio estate tax repeal effective 1/1/13 Overcome spousal election issues (if applicable)

What are the documents? Real estate side (particularly in farm setting) Long-term lease Rental income for first generation retirement Secure favorable terms for second generation operator Binding upon other non-operators in second generation to give successor operator additional time raise capital or complete installment sale (perhaps can’t afford both operations and real estate at once) Take lease/rent negotiations out of the hands of second generation non-operators Reduces conflict in second generation

What is the cost? Estate and gift tax becoming less relevant Federal estate tax exemption $5M+ Federal gift tax exemption; annual exclusion But watch for Medicaid implications Ohio estate tax repeal Income tax Shareholder to Shareholder v. Redemption Promissory notes to estate/trust Partnerships (LLC’s taxed as partnerships) to estate/trust C-Corps to estate/trust

What is the cost? What about S-Corps to estate/trust? Potential problems 2 year trust problem for typical revocable trusts (estate administration + 2 years) – lose S election 6166 election may allow more time

What is the cost? What about S-Corps to estate/trust? Potential solutions Qualified Subchapter S Trust All income distributed or required to be distributed to only one income beneficiary Separate trusts for all children in the 2nd generation Voting Trust Each beneficiary deemed a shareholder “all distributions with respect to the stock” paid to beneficial owners Terminates by terms or by state law on date certain Ohio = 10 years

Questions? Mark Coriell Laycock & Coriell 54 East Main Street Norwalk, Ohio 44857 Phone: 419-668-4896 Fax: 419-663-7835 Email: coriellm@flmlaw.com