If you’re planning to acquire another company, it’s essential to take time to assess the impact of the deal on your succession and estate plans.

If you are like most owners of privately held and family businesses, the value of your company represents about 80% to 90% of your overall net worth. Properly planning for the growth of the business -- including acquisitions -- is critical not only for the long-term success of the company but also to optimize your personal wealth. Your company’s strategic plan should be carefully integrated with your business transition and wealth transfer planning.

Yet many business owners haven’t bothered to do any planning. In a 2004 study we prepared for a national industry group, fewer than 20% of the private business owners who responded had a written strategic plan, and more than 60% had no formal succession plan at all. Many business owners are too caught up in day-to-day operations to drill down and explore all their needs.

Family businesses today face two major challenges. First, many industries are consolidating. Margins have been compressed, overhead costs have increased and the competitive marketplace is volatile.

Second, there are new tax laws that affect succession and wealth transfer planning. The Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs Growth Tax Relief Reconciliation Act of 2003 have ushered in many changes and will probably spur more tax law legislation in the future.

While changes in the economy and tax laws have raised a number of difficult planning questions, they also provide significant opportunities for the well-prepared family business owner.

 Assess your objectives

If you’re considering an acquisition, begin by analyzing its impact on your business and succession goals. Sometimes in preparing a plan, your advisers and the planning team may focus only on “the numbers” and the tax and legal aspects of the acquisition. Technical issues are critical, but personal, family and other non-financial considerations are also important to assess. Ask yourself, “What’s really important at this stage of my life?” Balance your life goals with your wealth goals. Take time to address your hopes, fears and needs.

The strategic plan must be supported by a clear set of objectives that reflect your business mission and your family mission. For example, do you intend to eventually keep or sell the business? Your perspectives on that question may give you an idea on how to approach an estate planning or business succession strategy for the prospective acquisition.   

Why commit to building an acquisition strategy? An era of low interest rates, reasonable valuation multiples, low capital gains tax rate, industry consolidations and ample capital resources is a great time to acquire a business. As trillions of dollars are inherited over the next 30 years, many heirs will be looking to sell their families’ firms, creating logical synergies for family business owners seeking an acquisition.

Because acquisitions are generally low-risk and easy to finance, they offer a shortcut to growth for middle-market companies. The acquired company can provide access to new markets and offer synergies (1 + 1 = 3) that will enable your company to be potentially more profitable, more valuable and better able to compete in the future.

 Strategic planning perspective

Where are you vulnerable? Before you embark on an acquisition plan, you must understand the potential challenges you will encounter in the process. Obstacles include compensation issues and costs of the acquisition as well as potential culture clashes with new employees.

Compensation and culture: It’s essential to stabilize your key executive team. Review your executive compensation and incentive plans, including employment agreements. What are you doing to retain, attract and reward key managers? Your executive compensation plan may be very different from the plan of the target company. Differences in expectations of the new executives and your current management group may result in added costs and disruption to the business. Some may decide to leave at a critical time. Also, Section 409A of the Internal Revenue Code mandates new rules for all forms of non-qualified plans. These regulations can affect employment and salary continuation agreements. 

 Costs and capital resources: Where will you obtain the capital to fund the acquisition and the ongoing needs of the business? Depending on the deal, legal, accounting and even lender’s fees can create unexpected costs. For example, in addition to auditing fees and legal costs, if a deal requires complex funding arrangements, lenders may pass along legal costs. You must have an adequate “war chest” and properly assess the costs you may incur in the acquisition process.

Management team: Are your managers capable of taking on added responsibilities? Are your children active in the business? If you intend to transfer the business to them, can they handle the responsibilities? If they are not ready, will you need to consider incentive compensation programs to attract, retain or reward executive talent? Will the new management team be committed to staying? The incentive to stay can be vitally important, especially if the next generation is not quite ready to take over the reins of the company.

  Team of advisers: Your advisory team should include a board of directors, family members, key managers and selected consultants. Choose a strategic advisor/facilitator to guide the planning process and coordinate the team activities. More important, you need support to maintain your focus on the day-to-day operations of the business.

 Target identification: What has happened elsewhere in the industry? It’s very important to assess companies’ motivations for selling as well as the types and sizes of other transactions that have occurred. What kind of intelligence resources do you have available to give you critical information about the target?

 Deal structure: Structure can often prove to be the difference between closing a deal and going home empty-handed. Well-prepared buyers get a head start by studying the implications of the various structuring alternatives, for both the company and the target, early in the process. Structure, though a key component of any M&A transaction, should not drive the parties to effect a transaction. Transactions should be based on compelling commercial and economic factors.

The deal should be structured not only to result in a successful acquisition transaction but also to reduce the taxable estate, freeze future appreciation and provide for capital and liquidity needs.

 Valuation: We often tell clients that an acquisition involves three different valuations: the IRS valuation; what the seller thinks the deal is worth; and the true value, based on a set of assessment metrics. The most important factors to examine are the strategic benefit for your company and the target company’s earnings and cash flow. Don’t overlook the value of the management team and the potential synergies the target can offer your company.

In terms of transition planning, the valuation considerations are different. It may be beneficial to have your company valued before an anticipated acquisition for gifting purposes. These issues must be carefully evaluated in terms of your wealth planning.

 Taxation assessment: The buyer’s advantage is often the seller’s disadvantage. An acquisition is an after-tax expense. The timing and payment terms must be carefully worked out to meet anticipated cash flow needs and other capital expenses.

 Corporate structure: Consider how the corporate structure will fit with your exit strategy and your succession- and estate-planning objectives. For example, an acquired C corporation can be merged into an S corporation or a limited liability company (entities that offer significant tax benefits to family businesses). If you decide to sell your company in the future, you will benefit from a lower capital gains tax owing to the higher basis in the stock. There are important business succession implications, as well.

  Due diligence: Some have said due diligence is the most important part of the process. We recently were consulted by one business owner who acquired about ten retail operations from a public company. In his due diligence, he overlooked the fact that the target company’s pay scale was much higher than his company’s. This caused a major problem when he tried to adjust the new executive team’s pay after the transaction.

Employment contracts and salary continuation agreements are other items often overlooked in a pre-transaction plan. When properly structured, they can help enhance the net to the seller and can be more tax-efficient for the buyer. The contracts can go a long way toward stabilizing your key executive talent.  Legal and accounting fees and lender’s agreements also must be carefully reviewed to assess costs and potential liabilities for the buyer.

 Succession and transition considerations: Succession planning is a critical part of the acquisition process because it offers opportunities to avoid potentially huge valuation increases in future corporate and estate transfer taxes and costs. Here are some succession questions that have major estate and corporate transfer implications: Who will own the company, how will it be owned, and when will the successors take over? For example, active and inactive ownership status should be explored. If the intent is to keep the business in the family, it might be a good idea to make a pre-transaction offer to purchase the shares of an inactive shareholder. Aside from the cost of paying dividends to inactive owners, buying the shares now will avoid potentially costly buyouts in the future.

Business leaders who plan to transfer ownership to the next generation may want to consider purchasing the new company via an entity that is partially owned by the successors. If this is part of the strategy, the ownership structure should be built with transfer restrictions in an agreement to keep the assets in the family. In this case, the bank lending covenants may need to be reviewed or negotiated to permit such a transfer in the acquisition process.

Shareholder planning: After an acquisition, the shareholder and buy-sell agreements must be reviewed to determine if adjustments in the structure or price/valuation formula are required or if changes are needed to address any new shareholder issues. For example, an increase in the value of the shares can result in increased estate tax liability for a shareholder, or a need for more capital to fund a shareholder buyout.

The cost of an acquisition can rise when a shareholder dies or wants to be bought out during or after the deal. Redemption of shares is an after-tax expense to the owner. Often this will be funded with some form of life insurance to provide funds at death. Even so, a buyout can cause an unexpected financial burden for the company.  

  Estate planning: Very often we find clients are unsure of what can be accomplished in the estate planning process. Many estate plans are outdated or incomplete. Most traditional estate plans involve wills, trusts and life insurance owned in a trust and include some level of gifting.

In planning for an acquisition, it’s important to review your estate planning in terms of what is possible. Merely having a set of legal documents does not constitute a proper business succession or transfer plan. Changing tax laws and the probable increasing value of your business and estate make a review critical during the acquisition planning phase. The process should also address lifetime planning strategies to control the future potential increase in estate tax.

If the transaction is likely to accelerate growth and increase the value of shares, consider making a partial transfer to the next generation prior to the acquisition. There are strategies available that provide for the transfer of equity over time and shift the future appreciation of the business to the next generation, while avoiding potential estate tax on the asset transferred. Under these strategies, the senior-generation owner can retain income for a term of years and potential gift tax problems can be avoided.

For example, gifting up to $1 million of stock during your lifetime will shift the future appreciation of the asset to heirs free of estate and gift tax. In this case, gifting the $1 million prior to the acquisition is more effective than waiting to shelter estate taxes at death. This takes advantage of the $1 million lifetime gift tax exemption under current estate and gift tax law. A gift of stock worth $1 million that appreciates at 8% over ten years will be worth about $2 million and result in a larger tax bill if you keep it in your estate. 

A business transition is a multidisciplinary process. Whether it is a strategic acquisition, the sale of a company or the transfer of ownership from one generation to the next, no one person or discipline has all the answers necessary to solve the complex problems associated with the strategic transition needs of a privately owned business. Rather then piecemeal planning, we believe in comprehensively addressing the transitional issues that affect a privately held family business.

Owners of closely held companies have complex business and personal planning needs. A comprehensive strategic planning process addresses tax considerations, personal concerns, financial strategies, legal issues and a host of other matters that will take time to assess and plan for.

During the acquisition process, you must consider the opportunities and unforeseen liabilities that may affect your business planning. It’s important to engage a skilled facilitator who can provide project leadership and coordinate the planning. It’s also essential to take the time to evaluate where you want to end up and integrate your life planning with your wealth planning. When too much is left to chance, the results can be costly and catastrophic. It is simply not sufficient to examine one issue without evaluating its impact on the other planning considerations.      FB

 James J. Kirlin Jr. is senior director, business transition and wealth management and Stephen R. Raymond is managing director, investment banking at the Benchmark Group Inc. in Cherry Hill, N.J. (www.thebenchmarkgroup.net).

CALLOUTS: 

Differences in expectations of the acquired company’s executives and your current managers  may result in added costs and disruption.

 The deal should be structured to reduce the taxable estate, freeze future appreciation and provide for capital and liquidity needs.

 If the transaction is likely to accelerate growth and increase the value of shares, consider making a partial transfer to the next generation prior to the acquisition.