Approximately 15% of the United States population is over 65 years old. The segment of this population that owns privately held companies and family owned businesses is thinking and talking about succession plans for their businesses. The first trains of thought and/or conversations are often related to whether there is a successor for the helm of the business in the owner’s family. The emotional & mental benefits of transitioning ownership to a family member can be significant and frequently impact the value or terms desired in a transaction. It is also recommended that the appropriate family member’s business acumen, knowledge, and relevant experience be evaluated to mitigate the potential for successor failure.
If a succession of ownership from one family member to another is desired, a strong case can be made for completing the transfer of ownership as a business sale rather than a gift. The first reason that this is often advisable is that a sale establishes a value for the asset and that asset value can be used for transparent estate planning purposes to insure that heirs feel they were treated appropriately in the division of assets. The second reason is that a business value with a payment mechanism creates a business environment where both parties assess the potential transaction from the perspective of their own “best interest” asking questions like is the value fair, can the business successfully transition executive management, and is this the path I want to take into the future. If the parties agree that they want to complete a transaction the terms of sale can be established. Given the familial relationship between the parties the terms are often favorable.
One favorable term that can presently be offered in a transaction of this nature is a favorable interest rate in a seller financed transaction. The minimum interest rate that can be charged is not an arbitrary number and cannot be zero. The minimum interest rate that can be charged is set by the IRS on a monthly basis when it publishes base interest rates known as the Applicable Federal Rates. The minimum rates published for August 2015 for long term debt range from 2.78% to 2.82% based on the period of compounding. Rates are published for monthly, quarterly, semiannually, and annually compounded interest. It is anticipated that these rates will continue to increase over time, so time is of the essence if a provision of a favorable interest rate is desired. The interest rate was as low as 2.19% for similar financed debt earlier in 2015.
Another favorable present market condition to facilitate a sale is the availability of favorable institutional finance terms in the marketplace. Although, the interest rate in this situation will be significantly higher than what is possible for a seller financed transaction the advantages of not establishing a lender/borrower relationship between family members and creating a liquidity event for the selling owner often justify seeking a commercial or SBA loan to facilitate the transaction.
Relevant tax rates can also motivate parties to transfer ownership as a sale rather than a gift. It is our recommendation that appropriate accounting & legal professionals be consulted when structuring a sale or transfer of ownership to minimize the tax implications of the transfer in the present and future for relevant parties. It is common for wealthy families to obtain valuable tax discounts by making transfers into family partnerships and LLC’s. The IRS is thinking about implementing new regulations, potentially as early as September, that would raise the value of taxable assets that taxpayers transfer into these entities.
Business sales are completed on a regular basis between family members, to key employees, and outside parties. All three types of transactions can result in the selling party achieving their transactional goals and should be explored to maximize the tangible & intangible benefits received from the sale.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, and mergers & acquisitions community on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation in terms of successfully negotiating transactions that are “win-win” in an environment of full disclosure between the parties.