Recapitalizations: A Two Staged Family Opportunity
Over the past few years, tax relief, the stock market bubble and bust, and the aging of both the World War II and (yes, it has come to this) the Baby Boomer generations have given new impetus to estate planning.
The central dilemma for those with significant taxable estates is usually how to maintain control while minimizing taxes. Secondary issues concern equitable distribution among heirs, business management succession, and meeting individuals' financial needs (for income, appreciation and safety).
A popular estate planning technique for family businesses is to recapitalize with multiple classes of stock. This is similar in concept to forming a family limited partnership. The company issues new non-voting shares pro rata to existing (voting) shareholders, who may then gift the non-voting shares, thus removing value from their estates while maintaining control. The issuance of new non-voting stock does not change the value of the business; in fact, there are no tax or valuation consequences except possibly for an adjustment in the tax basis of the voting shares.
From a business appraisal perspective, market studies have consistently shown that the value differential between minority voting common stock and non-voting stock is in the 5% range. That is, if there is a control owner, it does not make much of a difference whether a non-control owner owns voting or non-voting stock; the overall discount for lack of control will be about the same. Other considerations, such as who will receive voting and non-voting stock, and when the senior generation will decide to transfer voting control, are vastly more consequential.
By reducing any financial impact from estate taxes and concurrently distributing a significant portion of the value in the company, the controlling owner can then focus on when and how to transfer operating and ownership control.
There is no easy way to make this critical decision.
Many owner's hesitate and wait too long. In addition to the estate risks associated with such a delay, hesitation may inadvertently communicate a lack of confidence in the prospective controlling/operating owner(s). If necessary engage a outside advisor who is familiar with succession planning to help with the process. However, once the selection is made, the plan finalized, and implemented, the business should be positioned to continue serving all the stakeholders in the next generation.