Accounting Chapter 11 With It The Family History The Passed

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62 Section 2 Chapter and Lecture Notes

Chapter 11 Estate Planning

Learning Objectives

1. To understand the effect of estate taxes on ownership transfer across generations of

family-business owners.

2. To discuss the implications of ownership structures on the speed and agility

advantage that many entrepreneurial and family businesses have traditionally

Chapter 11 Essence

Business owners often delay estate planning because they do not want to discuss their

death and its implications for the family and the business, they do not want to give up

control of the business, or they are trying to avoid potential family conflicts.

An estate plan must address the appropriate allocation of income sources to the

retiring founder, his or her spouse, family members active in management, and nonactive

family members. It must also address corporate control issues. The speed and agility that

help entrepreneurial and family businesses gain competitive advantages in the

marketplace must not be hampered by an inability to make decisions promptly: whether

caused by cumbersome trust arrangements, consensus-dependent co-presidencies, or the

desire to treat all heirs equally.

Recapitalizing common stock into two classes (voting and nonvoting) allows the

senior generation to divide the estate equally among heirs in terms of value, but

differently in terms of corporate governance. In preferred stock recapitalization, the value

of ownership by the senior generation is frozen, and the heirs realize all succeeding

growth in the value of the enterprise.

Section 2 Chapter and Lecture Notes 63

Valuation approaches include book value; multiple of equity, earnings, or sales;

comparative transactions by companies in the same industry; the net present value of cash

future flows or expected dividends; and the appraisal of tangible and intangible assets.

A variety of trusts are particularly beneficial to family businesses in their efforts for

wealth transfer and business continuity; grantor-retained annuity trusts and intentional

Discussion Questions

1. What is estate planning, and why is it so important to family-business

continuity?

Estate planning is the discipline

in an orderly fashion and over a period of time significant enough that estate taxes are

minimized and business leadership and control are assured.

Estate plans also need to consider the possible need for restructuring of corporate

forms and assets in order to maximize wealth retention for heirs and for charitable

giving by the philanthropically inclined. Some of these corporate forms and estate

planning techniques are reviewed in this chapter.

The complexity of the tax laws colludes with business owners pressed for time and

64 Section 2 Chapter and Lecture Notes

2. What are some of the pitfalls in estate and ownership transfer planning?

Procrastination and denial of the facts The emotional barriers to estate planning

and ownership transfer are formidable. But business owners have the ultimate

responsibility to lead their families and their businesses into the future by actively

Failure to use estate planning as an opportunity to teach and pass a legacy and

not just financial assets Greed steps into the vacuum created by goodwill and

love not being articulated, discussed, and acted upon before the death of a

business leader and loved one. Family meetings should be held to discuss family

Lack of communication and consultation with heirs People tend to better

support that which they help create. In the absence of education, communication,

and consultation, the people affected by the estate planning decisions will not

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Insufficient preparation of successors and/or failure to prune the family tree

Wishful thinking on the capabilities of successors or hoping for consensus while

giving the angry minority the power to veto what next-generation leaders consider

Failure to submit the estate and transfer plan to frequent professional advisor and

board review Professional advice on estate planning and ownership transfer is

not the place to be thrifty. Gift and estate tax advice from top-notch professionals

3. Why is business valuation essential to estate planning? What valuation

approaches are available?

Business valuation by an independent third party is becoming essential in planning

the estate in such a way that the IRS does not unnecessarily contest the value of the

transferred assets. Estate tax compliance is a priority for the U.S. Treasury, and most

66 Section 2 Chapter and Lecture Notes

Here are several valuation approaches currently in use:

Accounting Approach

Book value

Market Approaches

Multiple of equity

Application of Discounts

Lack of marketability (35 45% if minority interest, 20% majority)

Majority/Minority, Control premiums (30%)

Size and lack of management depth relative to public (15%)

Past transactions

4. What are buy sell agreements and what benefits do they provide family business

shareholders?

Buy sell agreements are contractual arrangements between shareholders typically

used by family-business owners to formulate an orderly exchange of stock in the

corporation for cash. They typically include the expectation that the stock will be

Section 2 Chapter and Lecture Notes 67

Relevant Case and Exercise Resources

The Fasteners for Retail: A Question of Succession (Part A) case addresses the

subject of estate planning directly and discusses many difficult conversations that the

Conway family had about it over the years in the context of their family council