Case Study Business Valuation

How to Succeed in Business Succession

A new client came to us with a familiar problem. A father and two sons owned a company, and Dad was ready to retire. He wanted to give a significant share of his stock to the sons, but he needed retirement income from the business.

We carefully studied the entire family's financial and personal goals, including the needs of the father's spouse and a child not involved in the business. Then we came up with a plan:

We performed a business valuation to determine the fair market value of the business. We adjusted the fair market value to reflect the shares' lack of marketability, which discounted the price. We also calculated a minority discount on the shareholder's interest since no individual was buying a controlling interest in the corporation.

The father sold his interest to his sons at a discounted amount for a note that was due over 10 years at an interest rate acceptable to the Internal Revenue Service. The sons were able to comfortably pay off the note from the business cash flow, and the spouse and third child had after-tax credit outside of the business.

Our plan accomplished five important things:

1. The father had the cash flow he wanted for 10 years.

2. Because the payment was made over 10 years, he did not have to pay taxes on the principal all at once.

3. The income was taxed at a capital gains tax rate, which is more favorable than the father's income tax rate.

4. The interest income was comparable to what the father would have received from other investments.

5. The difference between the business' fair market value and the discounted value was removed from his estate. It also eliminated taxes on any future appreciation of the business. This will result in significant estate tax savings in the future.

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