What to do before signing that letter of intent

By Kevin Kerstiens and Amanda Loupin-Bartlett
The Daily Record Newswire
The decision to sell or exit a business can be daunting at best. Often the focus is on finding the perfect buyer who can provide the maximum return on the owner's hard work in building the business.

But before a buyer is selected, owners should carefully consider their long-term financial goals and priorities. Is retirement income a necessity? Is there a desire to provide for loved ones? Has charitable giving always been an aspiration?

These decisions need to be made before committing to a buyer because there are many beneficial tax-planning vehicles that are available only if implemented prior to a binding letter of intent being signed. While not exhaustive, the options below present some solutions to meet the differing needs of business owners in the early stages of transition.

Grantor retained annuity trust

An owner who anticipates growth in the value of the company's stock in the years leading up to a sale and also wishes to provide for future generations might want to consider a grantor retained annuity trust. A GRAT is a wealth transfer technique that may be used to transfer sale proceeds to designated beneficiaries, such as ?children or grandchildren, with little or no gift tax consequences.

In a business sale context, an owner would gift stock in the business to the GRAT typically a couple of years before the sale. The owner retains the right to receive fixed annuity payments from the trust, and if these annuity payments are structured such that they are essentially equal to the value of the stock when it is gifted (taking into account available discounts, such as minority interest or lack of marketability), the value of the gift (and the related tax consequences) will be reduced. When the business sells, the increase in the value of the stock since the time of the gift will be passed on to the beneficiaries, tax free, at the end of the trust term. The owner, however, is responsible for taxes on the proceeds from the sale.

Charitable Remainder Trust

For the business owner who requires a steady retirement income but also has charitable giving goals, a charitable remainder trust may be a viable option. A CRT allows for the proceeds from the sale of a business to be split between two beneficiaries: a charity and individuals.

Here, the owner would contribute stock in the business into the trust prior to the sale of the business. This contribution generates a charitable tax deduction for the owner, and the taxable gain from the sale will be deferred and may be recognized at a later date. When the sale occurs, a fixed percentage of the proceeds will go to the beneficiary (typically the owner) each year for a specified term (usually the life of the beneficiary). At the end of this term, the remainder is distributed to a specified charity.

In contrast to a GRAT, where the contribution should be made when the value of the stock is low, it is advantageous to wait as long as possible before contributing shares to a CRT. This is because a higher valuation at the time of contribution will generate a larger charitable tax deduction.

However, it is important not to wait too long to make this contribution. If the contribution is made after the signing of a binding agreement to sell the business, the IRS will likely treat the owner as if he or she had sold the stock and then donated the proceeds to charity. The owner will still receive the charitable tax deduction, but he or she will also be taxed on the increase in the value of the stock from the time that he or she became an owner (which can be quite significant for many longtime owners).

Other points to consider

These techniques are applicable only when the sale is structured as a stock sale rather than an asset sale. Because buyers often prefer to purchase assets for liability and tax reasons, this may be a sticking point in the sale negotiations.

Additionally, many deals don't end up closing, which can lead to unintended results for an owner who had been counting on the sale proceeds to reap the benefits of the tax planning vehicles. This is why it is critical to carefully coordinate the tax planning with the sale process.

The planning tools described above are just some of the pre-sale tax planning methods available to a business owner. There are a myriad of other techniques and trust vehicles that may be better suited to the owner and the company, depending on the owner's specific circumstances and goals. The important thing is to start planning early and, most of all, to have that plan in place before committing to a buyer.

-----

Kevin Kerstiens is an attorney with Schwabe, Williamson & Wyatt. He focuses his practice on estate planning and taxation. Contact him at 503-796-2909 or kkerstiens@schwabe.com. Amanda Loupin-Bartlett is an attorney with Schwabe, Williamson & Wyatt. She focuses on business and corporate law. Contact her at 503-796-7466 or aloupin-bartlett@schwabe.com.

Published: Tue, Apr 14, 2015