What Gollum from Lord of the Rings can teach us about Family Business Succession

What Gollum from Lord of the Rings can teach us about Family Business Succession

Article by Chris Rhyme, J.D.

After years of work with family businesses, I have come to the striking realization that owner-operators (particularly founders) of closely held family businesses often have one deep commonality with the character Gollum from J.R.R. Tolkiens’ Lord of the Rings:

Owners treat control of the organization with the same possessiveness and focus with which Gollum treats his ring.

 The power of business ownership grows almost imperceptibly slowly, but after compounding for decades it has a pervasive impact in the business owner’s life and psyche.  At times you can almost hear the owner thinking about control and the accompanying identity tied up in the business as her “Precious.” This is never more apparent than when you begin to take control of the business from the owner and give it to a future leader.  Yet to successfully transfer the business to the next generation of leaders, the owner must willingly open their palm and hand all the power/control to a chosen successor.

 

I observe that departing owners struggle to let go of three primary facets of power. Prior to an exit, succession, or transition, an owner should think about these three things:

  1. Financial Control = For many entrepreneurs and leaders who have grown a successful enterprise, they become accustomed to a nice lifestyle and a large pocketbook with no one looking over their shoulder to monitor spending or income. When it comes time to transition, the owner has to open the kimono and share financial details with the successor-owners. This can feel exposing to the departing owner in addition to the challenge of relinquishing control of the checkbook and the accompanying perks and benefits that go with the power of the purse.
  2. Ownership Control – Again, the entrepreneur has generally grown to be the center of her organization, and her insight, leadership and attention is desired by all. The right to call the shots and dictate how things get done is often cemented into the organization with decades of history, making changes difficult both to accept and to implement.
  3. Identity – Lastly, the owner who opens her hand to relinquish control of the ‘precious’ company must confront the challenging question of who she is if not the owner of XYZ Corp. How will she introduce herself in professional or social situations? Who does she become in the community? What is the deeper thread of personal purpose if not to run the company? This is particularly challenging for founder-owners.

Here are three quick thoughts on how to slay these ownership monsters:

  • Financial Independence – Start running clean books so that you know what you spend each year and therefore how you might recreate that after ownership ceases. Work with a financial planner to create visibility around re-creating the income you want/need after your exit.
  • Ownership Control – Intentionally delegate and hand off tasks to capable successors, gradually decreasing how pivotal you are in the business. This should include both operational and strategic tasks.
  • Identity – Conduct low-commitment exploration into other things you might be passionate about. This can begin to create purpose in the next chapters of your life.

The non-permanence of power means that you have to be ready for the eventual moment of giving up your Precious. Whether you face the difficult process of willingly opening your palm to the next generation (Frodo), or wait for time and circumstance to take it from you (Gollum), your actions will determine both the future viability of the business you built and your own happiness post-transition.

Family Businesses Gather in Sioux Falls for 26th Annual Forum

Family Businesses Gather in Sioux Falls for 26th Annual Forum

A few pictures from Chris Rhyme’s recent trip to Sioux Falls, SD, speaking with Jay Brenneman of SageQuest Consulting. Prairie Family Business Association has been gathering business owners together for 26 years with their annual conference, a celebration of the unique complexity of family businesses as well as a community gathering for owners to share ideas and processes. Over 200 family businesses were represented in the largest year ever for PFBA. The subject of Jay and Chris’ talk was “Integrating Your Head and Heart” through family business leadership and ownership transitions.

See the other work coming out of University of South Dakota’s outreach center at http://www.fambus.org

Wealth Preservation Planning

Wealth Preservation Planning

WealthPreservationPlanning.cropped

Death And Taxes vs. Preserving Wealth – The Final Exit Planning Contest

Full disclosure: Wealth preservation planning can’t help any of us cheat death, but it can help business owners to avoid taxes and achieve financial security. Read on.

The ideal Exit Plan (one that provides the business exit you desire) includes a strategy to help you preserve your hard-earned wealth from unnecessary taxation when it is transferred to your family. But to preserve wealth, business owners must take steps before they actually have it. In other words, to realize all of the potential benefits of various wealth preservation techniques, owners must make plans before they convert the value of their businesses to cash.

The foundation for wealth preservation planning is found in the answers to two of the questions you answered in Step One of this Exit Planning process:

How much wealth do you want when you exit your company? And, for parents, the follow-up question: How much wealth do you want your children to have?
How long before you leave your company?
Using your answers as guideposts, you (and your advisors) can then choose the planning technique that will best preserve your wealth, provide for your family and minimize your tax bill. Let’s look at how one fictional owner used wealth preservation techniques to do exactly that.

George recognized that he’d waited too long to begin gifting part of his company to his kids. A week before, George’s CPA had told him that, based on the company’s pre-tax cash flow of $2 million per year, his company could be worth as much as $12 million to a third party.

After recovering from that shock, George realized first that he didn’t need nearly that much cash to retire in style and second, that if he didn’t transfer at least half the value of his business before a sale, his family could be looking at millions in gift or estate taxes!

To remedy this situation George and his Exit Planning advisors:

Hired a Certified Business Appraiser to assign a conservative, but supportable value to the company.

Result: Based on current tax case law and valuation principles, the appraiser valued the transfer of a 49% minority (less than controlling) interest at $4 million. In her opinion, the appropriate minority discount was 35 percent of the full fair market value (assumed to be $12 million) of the stock.

Result: Using the 35 percent discount, George could give away half of the company to his children (a gift valued at approximately $4 million) and would pay no gift tax based on 2011 law which provides for a $5 million lifetime gift tax exemption.

While George was happy with the idea of not paying tax, he didn’t relish using most of his lifetime gift and estate tax exemption, and wanted a better answer. So he took another step to avoid needlessly wasting this most valuable exemption.

Created a GRAT—a Grantor Retained Annuity Trust. (See “GRAT Note” at the end of this article for more detailed information.)

Result: Using a GRAT—perhaps the biggest lever in the Wealth Preservation Game—George would avoid using a significant part of his $5 million lifetime gift tax exclusion, and would still give almost 50 percent of the company to his children.

Through wealth preservation planning performed well in advance of George’s exit George was able to:

Transfer one-half of a business with a fair market value of $9-$12 million to his children in four years (a timeframe George chose) using little or none of his lifetime exemption.

Receive all of the cash flow from the company during that four-year period, because the annuity payment to George was designed to equal the amount of cash flow expected from the stock transferred into the GRAT. And George needed this income to achieve his financial security exit objective.
Transfer (after four years, or at the termination of the trust) the trust asset (one-half of the company) to trusts for his children, completely free of any gift tax.
George had established these trusts when he created the GRAT to carry out his wishes regarding when, and if, his children would receive money from those trusts.

Techniques such as GRATs and the careful use of minority discounts (as well as many other estate tax avoidance techniques), only work as intended if they are put in place well before you exit your business. These techniques also work well when two objectives, in this case George’s financial security and his desire to provide for his family, must be achieved in tandem.

If you wish, we can provide you with additional information about transferring wealth to children and/or protecting as much wealth as legally permissible from unnecessary taxation.

GRAT Note:

We provide here additional details about how and why a GRAT can help to achieve an owner’s twin objectives: the need for financial security and to provide for one’s family.

A GRAT is an irrevocable trust into which the business owner (and the Trustee of the GRAT) transfers some of his stock. The GRAT must make a fixed payment (annuity) to the owner each year for a pre-determined number of years. At the end of that period, any stock remaining is transferred to the owner’s children.

Stock transferred into a GRAT is treated as a gift. The amount of that gift is the value of the asset transferred minus the present value of the annuity that the owner will continue to receive. (George’s advisors made sure that the present value of the annuity paid out over four years almost equaled the value of the stock transferred into the GRAT. In doing so, George made only a nominal and non-taxable gift.)

The key to a GRAT’s success is to transfer to it an asset that appreciates in value and/or produces income in excess of 120 percent of the federal mid-term interest rate, which fluctuates monthly.

The information contained in this article is general in nature and is not legal, tax or financial advice. This information is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial advisor. Exit Planning is a discipline that typically requires the collaboration of multiple professional advisors.

Any examples provided are hypothetical and for illustrative purposes only. Examples include fictitious names and do not represent any particular person or entity.

Copyright © 2016 Business Enterprise Institute, Inc., All rights reserved.

Photo courtesy of FreeDigitalPhotos.net.

Did You Know?

Did You Know?

DidYouKnowcropped

  • Metro Denver ranks 11th among the nation’s 50 largest metro areas for aviation employment*
  • Colorado has the second-largest aerospace economy in the nation**

*http://www.metrodenver.org/industries/aviation/
**http://www.spacecolorado.org/why-colorado/industry-overview/

BTG helps great aviation and aerospace companies transition success through implementation of key employee plans and exit plans.