BY JOE KRISTAN, CPA, Partner, Eide Bailly
What do the Queen of England, the Pope, and every family business CEO have in common?
They aren’t going to be around forever.
While the Queen and the Pope can rely on ancient traditions for their succession, closely-held businesses need to make their own plans. How well it’s done can determine whether the business endures like the House of Windsor or vanishes like the line of Zog of Albania.
It’s never too early to start planning for business transition. Upcoming changes in Iowa’s tax law give business owners contemplating succession extra reason to look to the future.
When an Iowa owner of a business sells out, capital gains on the sale may be tax-exempt on the Iowa 1040. Qualifications for the tax exclusion include:
- The owner has held the business for ten years.
- The owner has “materially participated” in the business for ten years.
- The gain must result from the sale of “substantially all” of the assets of the business.
- Sales of stock or partnership and LLC interests don’t qualify.
However, the days of this exclusion are numbered. Iowa’s 2017 tax reforms will end this break for everyone, other than farmers, after 2022 if revenue targets are met—part of a larger tax reform package signed in 2018 by Governor Reynolds.
While every business is different, they all must confront some of the same questions: Will control be kept within the family? Will there be a sale to employees or management? Is there a strategic outside buyer who will pay a premium for the business and its customer base?
Keeping it in the family. If ownership will stay in the family, should the family still run the business? Or should the family be content with a “board of directors” role and hire professionals? Should there be outside board members? If the family will run the business, which members will run it? If there is more than one child in the business, this can be a delicate problem.
If you are keeping it in the family, will you be selling it, gifting it, or bequeathing it? Selling it to one child, or to a group, can be a way to spread the value of the business to children who lack interest or aptitude to carry on the enterprise. Of course, that might not be so popular with the children doing the paying. And depending on the structure, related party sales can cause tax problems for the parents.
Selling out. If the family isn’t going to keep the business going, then the owners will need to find someone willing to buy them out. Sometimes a group of managers can put together an attractive offer. Often, though, a sale to an outside buyer is more promising. Should an ESOP be considered? Sellers only get one shot at the sale process, so they should proceed carefully and consider bringing in professional advisors who have been through the process.
Getting ready either way. Whether or not you want the business to stay in the family, fate sometimes disregards your plans, as King Zog well knew. That’s why businesses should have contingency plans for an unexpected change of leadership. If a family patriarch is running the business, illness or accident might leave the business leaderless. If the business is managed by a strong professional manager, they might be tempted away by a better offer. If plans aren’t in place for a transition, the survivors may find themselves having to choose between a hasty sale and the prospect of an irreversible decline of the business.
King Zog had an exit plan, and it worked out reasonably well for him, all things considered, even if it did require some help from Ian Fleming. Business owners can also plan their exit without the complications King Zog faced. They can start by consulting their fellow owners to learn about and take into account everyone’s exit goals. They should visit with their outside advisors to make sure it’s realistic. And they should do it while there is time to prepare.
| Joe Kristan