On-Demand Webcast: How Does A Roller Coaster Economy Impact Your Decision to Sell or Stay?

November 05, 2020

Speakers from EisnerAmper and Blank Rome LLP discussed how family business owners can navigate the current turbulent environment and make decisions about the future of their businesses.


Transcript

Good afternoon everybody. My name is Paul Dougherty and I'm the partner in charge of EisnerAmper's Philadelphia office. EisnerAmper is one of the premier accounting firms in the United States. Our clients include individuals, closely held businesses, startups, middle market companies, not-for-profits, and multi-national corporations. Our firm provides a full menu of audit tax advisory and compliance services to clients in various sectors.

Paul Dougherty:I would like to welcome everyone to today's program, How Does a Rollercoaster Economy Impact Your Decision to Sell or Stay? I think you will find the program to be both interesting and informative. We have a great panel of speakers lined up for you today. I would like to start by introducing you to Fred Lipman. Fred is a graduate of Harvard law school and a senior partner at Blank Rome, an international law firm. Fred is the author of two books on family businesses, The Family Business Guide and Business Exit Strategies, and both books are available for sale on Amazon. Fred has lectured on family businesses widely both in the United States and internationally. Fred is a corporate lawyer with over 50 years experience representing family businesses. Fred, I'm going to turn it over to you now.

Frederick Lipman:Thank you, Paul. Blank Rome has offices throughout the United States, as well as Shanghai, and we tend to concentrate in middle market M&A. Our speakers today are, in the order of the topics, first Lisë Stewart, who is principal-in-charge for the center of family business excellence at EisnerAmper, among other positions. She has also spent her entire professional career helping privately business owners to make tough decisions, build strong companies, and secure their personal and professional futures. She loves to share her knowledge and expertise about wide variety of topics, including today's, helping to understand the psychological challenges of a significant life change.

Our second speaker today is Bob or Robert Esposito. He's the managing director and co-leader of EisnerAmper's transaction advisory services group. He has 45 years of experience, including planning, management, execution of in excess of 650 buy and sell transactions for strategic corporate clients, as well as financial clients. He has significant experience with mergers, acquisitions, private equity, strategic alliances, corporate partnerships, public offerings, and joint ventures. Prior to joining EisnerAmper in 2013, Bob was a senior partner at KPMG, a big four accounting firm, where he served over a 34 year career as a national partner in charge of ABM's pharmaceutical, biological, and medical device area group and was a partner in charge of various positions for KPMG.

I am the third speaker today, and the fourth speaker is Larry Chane, who is a co-chair of the Blank Rome tax benefits and private client practice group. He has spent his entire 38 plus years at Blank Rome, where he concentrates his practice in the areas of estate and tax planning, primarily for owners of closely held businesses, executives, and professionals. He advises clients on federal, state, and local tax issues that affect them and their businesses and the transfer of wealth from one generation to another. He is past president of the Philadelphia Estate Planning Council, a fellow of the American College of Trust and Estate Counsel, and internationally recognized, and has been ranked in private wealth law by Chambers High Net Worth.

Our last speaker is Cory Jacobs, who, although he does not have a formal speech, is available along with Paul to answer any tax questions you may have. He is the co-chair of Blank Rome's benefits and private client group. He primarily represents clients in structuring the sale or acquisition of businesses in a tax efficient manner. He has represented numerous family owned businesses in full and partial sales of their businesses to private equity firms. In addition to being a tax lawyer, Cory is also a certified public accountant. I'm now going to turn the program over to Lisë Stewart.

Lisë Stewart:Great. Thank you so much, Fred, and I'm really, really happy to be here. As Fred said, I'm the principal-in-charge of the center for family business excellence and I've been working with privately held companies for over 35 years. And I get to talk about one of my most favorite subjects. So today we're really talking about the psychology of the whole strategy and thinking about the future and really trying to tackle this idea about why is it so hard to start to think about our future plans and particularly how we may want to, or not want to, leave the business someday? There's a saying that I use a lot, it's from Sugar Ray Robinson, and this just really sums up my conversation with so many of my clients over the years. "You always say, 'I'll quit when I start to slide,' and then one morning you wake up and realize you've done slid."

So I'm sure I'm not the only one that finds as we get older that things just aren't always as easy as we thought they were going to be. So what we really try to do is to encourage people to start doing their thinking about the future as early as possible. In fact, it's never too early to start. But we do know that most people don't take that advice, and these are conversations that we're just not having. And I've always been curious as to why that is, especially because right now we know how important it is. The statistics tell us that over the next, say, five to seven years, somewhere between 55 and 65% of business owners are going to transition their business. They may sell it. They may pass it on to the next generation. There's lots of different things that might happen. And yet we also know that many of them report that they're really not ready to do that. They don't feel prepared.

So the question is, why is it so hard? Why do we wait too long to have the conversation and to consider our options? And what can we do to start to change that? Well I think it's helpful to understand the trajectory, the pattern or the path that we as business owners often move through. What does this look like, and in what stage of our business development should we be considering these things? So I like to use this model. Really it's an offshoot or from the original, from Leon Danco, who was considered the father of family business consulting. And he talked about how we all get very excited when we start up a business. Maybe we bought a business and maybe we've taken over a business from a family member, or maybe we've started it from scratch. It's a very exciting and engaging part of our business lives.

However, all businesses hit those second stage wobbles. This may mean that they figure out that they're under-capitalized or they don't have the right people, or perhaps that product idea just really isn't suiting the marketplace. Whatever it might be, we know that fewer than 14% of businesses actually make it through the second stage wobbles. But if you do, then you enter into that nice long stage called the third stage of growth, and this stage might last 2, 3, 5, 10, 15, 20 years. And this is the stage where we really need to be doing this important planning. Because, again, the research tells us is that as we get older, once we approach 55 plus, we start to become more concerned about our financial future and what our lives are going to look like as we get older and potentially retire.

And at that stage, as we're older, we stopped reinvesting in the business. We start keeping some of that cash to make sure that we've got enough to live on. Most business owners believe that really the key to their financial success is the value of that business. And yet, just at our time of life when we should be investing in the value of that business, we start hoarding cash or holding it back and not reinvesting because we believe we're going to need that cash to be able to live on, to fund the next stage of our life and whatever that retirement's going to look like. However, those businesses and business owners that start to do that planning early are far more likely to have multiple options in the future and therefore are not forced to sometimes keep that cash back or stop reinvesting in the business just when we want it to be worth as much as it possibly can be.

There's another aspect of the pattern of business development and business growth, and that's really knowing that the phase, or what I sometimes refer to as the personality of your business. All businesses start out in that big pink circle that we see there called the entrepreneurial phase of business. It's such a famous phase. People write whole books, if you've ever heard of the book The E-Myth, about this phase of business. The reality is that many business owners actually live and die in this space. That pink circle takes up the entire slide. They never move into any of the other phases. The entrepreneurial phase of business is really distinguished by the role of the entrepreneur. He or she tends to be the one place where people go to for decisions, solving problems. They're really the key to the success of the business. They often have a lot of the professional contacts with people. Sometimes they're a key sales person. They're just core to what that business really is. They tend to surround themselves with fellow helpers. These are people that can help them to bring their own vision to life.

Unfortunately, businesses that stay in that entrepreneurial phase are really in the worst position to pass a business onto the next generation or to sell that business. Entrepreneurial businesses tend to be less stable. They're exciting, but they're just less stable. And they're rarely a turnkey business, which would make them easier perhaps to sell or to pass on to somebody else. So what we try to do is to encourage our business owners to start to push that business through to that third stage, or sorry, the durability stage, and the durability stage, that means that there are more documented systems and processes. The company tends to operate according to a strategic plan. Instead of just surrounding ourselves with great helpers, we surround ourselves with fellow leaders, people who have the ability to be, one, our successors, and two, can make decisions for themselves and they take full responsibility for those decisions.

This is a way in which we empower and strengthen the rest of the company. We build that strong bench. If we can move the company to that durability stage, then we have a company that's more likely to realize its full potential in a potential sale, and it's also in a better position if you do choose to pass it down to the next generation. You're passing down something that has a higher likelihood of success. And then a few businesses actually get to the legacy building stage. That means they're strong, they're secure, they're stable. Owners really have a lot of options as to what they're going to do with the business. And in legacy building phase, they're looking at how they're going to impact their communities, maintain a solid organizational culture, whether they pass that business on or they sell that business.

So we really want to help business owners to start doing that planning where they're perhaps still on the entrepreneurial base, but really with the idea of pushing it through to the durability phase. And when we do that, we open up options. But it's also important to start asking yourself some questions about what you want that next stage of life to look like. It used to be, if you look at the dates that we have here, back in the olden days, 1935 to 75, the retirement time that people had was relatively short. We just didn't really live as long. We weren't as healthy. And then therefore, even if we were alive, we may not have felt like doing a whole lot. But that started to change. We're now living longer, we're healthier, we're stronger. And in fact, we don't want to just give up and do nothing just because we leave our business origins.

So as we moved into that late part of the 1970s and right up to 2010 and actually even beyond, if we look at 2011, we've got people who are really looking to find ways to utilize their skills and give back to their communities, keep their minds fresh and strong and make sure that they're taking full advantage of our healthy state of mind and healthy physical state. So what should you do? How do we start to do this? What does it look like when we start to plan? How can we make sure that as we age, we're able to continue to add value and then we can transition to whatever the next phase of our life is with our dignity intact?

Well, one of the first things to do is to ask yourself a really important question, and that is what does an ROI, a return on investment mean for you? Because the return on a lifetime of work means different things to different people. I was interviewing a company not too long ago, this was a manufacturing company, a husband and wife that started it. It was really successful in the Midwest and they didn't have any children, so they didn't have any family successors to pass the business onto. So I was supposed to be interviewing both of them, but the husband was called away to deal with a customer issue. So I was talking to the wife and I asked her, "What would a net return on investment look like for you?"

And she said, "You know, Lisë, we don't have any children. We've really invested in our employees. They mean so much to us. We just really want to make sure that they're happy and healthy. We don't need to make a lot of money out of this business. We're strong, we're stable. But we really want to make sure that we're creating an opportunity for our employees to be able to live on and to earn a living from this company." I thought was just lovely that she thought of it like that. A little while later, I had a chance to ask her husband the same thing. He looked me right in the eye and he said, "Money dammit. I've worked my whole life doing this and I want to get money out of this." So I said, "Well, I think the two of you should actually talk." Because as I said, a return on investment means different things to different people.

So start thinking about what does it mean to you? What would you like this to be? What is the legacy that you want and what do you need out of the business in order to help you with the next phase of your life? Here's some conversation starters. What I mean by that is these are questions that you should be asking yourself, but also involving your family perhaps in the conversation too. I love the magic wand question, what it means is to remove all of the constraints or obstacles from your mind as you start thinking about the future and ask yourself, if you could wave a magic wand and create the future that you would really like, no holds barred, no constraints, what would it look like? And just jot those ideas down on a piece of paper to start thinking about what would really make you happy.

And then what do you need from the business to fund whatever that next stage of life could look like for you? Some business owners actually do need cash and some even quite a bit of cash, because perhaps they've not put aside a lot of money outside of the value of their business. So that might mean that selling the business either to an outside buyer or bringing in an investor or having to sell that business to the next successor, whoever that is, is going to be important. Others may not need that cash, but they might want to have some involvement in the business. So what do you need from the business in order to fund or take care of that next stage of your life? What do you want to do with your life after you exit the business? Have you ever thought about other things that you're really interested in.

You might start thinking about, in your current role, which is the last question here.,What do you love doing? Where do you believe that you truly add the most value? Are there elements of the role that you play today that you'd like to be able to maintain? When you start thinking about an exit strategy, it doesn't mean that you're necessarily going to have to leave the business full stop. There are different ways to be able to carve this out. You may want to design a smaller role, and we'll talk about that in just a few minutes, about mentoring or coaching or being on the board, whatever it might be. Or maybe there is something outside… you'd like to start a new business. Maybe you'd like to travel or learn a new language or teach, whatever it might be. But start to think about where do you find the most joy in your job or your role today, and what of that would you like to carry forth into whatever the next phase of your life is going to look like?

Other questions. What are the expectations of your family for you and for your time? I can't tell you the number of times when particularly my male CEOs will say to me, "My wife is a lot more keen on me doing gardening when I retire than I am," or whatever it might be. You need to make sure that the people who are important to you in your life, those people you're going to be spending time with, have a similar view of what the next phase is going to look like. So please don't plan that next phase of your life all by yourself. If you've got family members, begin to include them in the conversation. Also what role would you like to have as maybe a partial or a non-owner.

So as a partial owner, let's say that from the conversation, you're going to hear my partner talk about in just a few minutes, Bob Esposito, maybe you bring in an outside and an investor. What would you like to do in that role? How much influence do you need or want to have? How much are you willing to step back? What kinds of people would you really like to be able to work with? What should that partnership look like that would make you feel happy and satisfied? As a non-owner, perhaps you just simply want to be able to be involved in an advisory board position or maybe no position at all. Maybe you'd like to just mentor other new business owners. And then what are the values that guide your life and how you want to incorporate these? So if giving back to the community is something really important to you or giving to a particular cause is important to you, think about what those values are and how you can incorporate that into your planning process.

Some other things just to be able to consider as you go is how you're going to transition. So this is really important because I think a lot of business owners and the people who are consulting with those business owners make some really tragic mistakes, and that is that they look at the current state, what your life is like today, the fact that you're doing a lot of work, fighting a lot of fires, really involved in the business. And what's the future state? Maybe that future state is to be completely disconnected from the business, to be fully retired and doing something else. And then believing that somehow you're going to go from the current state to the future state virtually overnight. That is literally a death sentence. We know, and the statistics bear this out, particularly for men, a quick retirement like that, a change from one way of life to the next, means that you increase the likelihood of having a significant health event or even dying by almost 65%. So please don't do that.

Instead. Look at this as a phased approach. Think about the current state, what are you doing now, what do you really love to do, what would you like to maintain, and what would you like to delegate or get rid of? Then begin to think about and design what that future state is. But most importantly, go through and identify some interim phases. So perhaps what you can do. So think about in the next six months to a year, how might I change my role? How might I change the way in which I'm working with others who are involved in the business, that will take me a few steps toward that future step? A year after that you might think of the next interim stage. So that you're doing this in a well thought out, phased approach that protects your mental health, your physical health, your relationship with the business, and preserve some new opportunities for the future. Super important.

 I'd also like to mention the fact that many business owners, leaders, and founders make wonderful mentors and coaches. However, sometimes they don't know what those roles are. What does this actually mean? So to become a coach or a mentor, and these are two distinctly different roles, this is an opportunity to pass on a lot of your knowledge and skills and to be able to bring out these talents and skills in others. So first of all, if you decide to be a coach, what coaches do is they don't necessarily tell other people what to do. In fact, they never do that. Rather, in this case, as a business coach, you're pulling from the person that you're coaching. You're asking them a lot of powerful questions about how they might solve the problem. How have they approached things like this in the past? How can they apply past experiences to current or future experiences? How can we create new learning opportunities? So you're really learning how to help another person pull from within, solve their own problems, and know what to do next.

Now, as a mentor, you're more likely to share of your knowledge and experience, not telling people what to do, but rather saying, "Here are the top five things that worked well for me when I was trying to solve that similar problem. What could you take from that? How could we work together to be able to solve that problem?" These are really distinct skills, and I truly believe that so many business owners have a tremendous amount of information and knowledge to share. They just need to learn some vital skills for imparting that to others. Unfortunately, when they do stay in the business, they tend to like to tell other people sometimes what to do or how to do it, and then the next generation of owners feel as if they're being micromanaged, and that can lead to a lot of conflict. So we want to change that dynamic.

If you're interested in learning how to be a good mentor, for example, we can talk about this encore career idea. One of my favorite organizations is called SCORE. Some of you may have heard about it. That stands for the Service Corps of Retired Executives, and they're a wonderful organization because if you want to become a SCORE mentor or volunteer, they'll train you as to how to do it. People don't get paid to do this. This is something that you do as a volunteer basis, but it's a wonderful way to be able to share all of this experience and knowledge that you've gained over many years of being a business owner with other people, younger business owners, people who are new to the field, and they really need this kind of help. So if you're looking for a way to give back and you want to get some training as to how to do it, you might consider SCORE.

Other things that you can do. As I said earlier, some of my clients are out there starting new businesses, which I think is super exciting, or perhaps they're investing in other smaller businesses. Sometimes they're really giving back through a volunteering capacity. They're getting onto boards and they're working in their local communities. Others want to travel. Others are up for a big adventure. They're not ready to slow it down. They're physically fit and they're happy and healthy, so they're looking to do something completely different.

Just a quick word, though, about volunteering for non-profit organizations. I do a lot of work with boards, both for-profit and non-profit, and I come across this problem a lot. This is where we have really successful business owners, men and women alike, who decide that they're going to spend this next part of their life by doing a lot of volunteer work and they get on these boards and they try to operate like they did in business. They try to overlay a lot of those business skills and experience, but in the non-profit world, that's not always what people are looking for. So sometimes our business owners become really frustrated and the volunteer people on the board become frustrated with them. It's just not a good dynamic.

So here's what I suggest. If you're putting your toe in the water and trying to figure out what you like to do as you consider moving away from your business, and remember you're doing this early, just get on a few small subcommittees. Don't just join a board, find other ways to get involved and just test and see is it really a good fit? Can they truly use the knowledge and skills that you have to offer? Are these people that you'd enjoy being around? Do you understand their mission and vision and the direction that they're going? So don't just jump in all at once.

In fact, that's probably really the moral to my whole story. Don't jump in all at once. Let's start early and start thinking about this, because in the end, what we really want for all of you, anybody that's on this call that's considering maybe trying to plan for the exit out of their business or for a different sort of future, we want you to be able to do this with confidence, competence, moving forward with your dignity intact. As I said before, you've worked really hard. You deserve to make sure that the next phase of your life is something that's truly satisfying. So let's start early to generate some of these options.

If you can imagine what you'd like to do in the future, then when you start thinking about, do you want to sell the company? Do you want to bring in outside investors? Do you want to liquidate and walk away? Do you want to pass it down to the next generation of family? Whatever you want to do, when you start to do that planning early, you create options, and that's what's so vitally important. So I'm really hoping that with all of the conversations that we have today, you're going to be able to find some ideas that support this early planning that you're all now going to do.

So I have a few minutes before my next speaker is going to be coming on and I see that I've got just a couple of questions here. So let me just go through. I've got somebody who was curious about when should you start talking to your family or the next generation about your retirement plans? Very good question. As early as possible. And remember, you don't need to couch this necessarily as retirement plans. These are your future plans. Retirement, it's kind of a bad word. Very few of us actually really retire these days. Instead, what we do is we plan for the next phase. So talking to your family members early, making sure that they understand that you've got a vision or some dreams.

Or let's say you decide that you'd like to work in this company until the day you drop. It's your business. You can choose to do that. But what you want to do is to make sure that if you're there for the long haul, as you can no longer add value just simply because we're getting older and older, that you're not undermining what's happening. You can create a space for yourself within the business, but the next generation of ownership or leadership has to really be in sync with what it is that you're trying to do. So have those conversations early.

I just worked with a company in the deep South not too long ago. I have a dad who started this business, a lovely little family owned manufacturing company, and he doesn't ever want to leave. But he was getting older and doing some of the tasks that he was doing before becoming a little bit harder, but he's a great guy. He's got a lovely personality. His staff and a lot of the clients, they just love him. So what we did was we set up the opportunity for him to learn CAD, computer assisted drawing, which he likes to do, and we gave him a-

Computer assisted drawing, which he likes to do, and we gave him a couple of interns to be able to work with in a small office. He comes in every day. His son is now running the business, and they've got a very copacetic relationship. Had they not had that conversation, I can tell you, the son was starting to get really frustrated because he couldn't see a place for himself in the business as long as his father was there, so we just had to reconstruct it. We had to create a different position.

So start talking to your family members early. And remember, you're talking about the next phase of your life, so it doesn't have to be perfect as you start these conversations. Play with some ideas. Put a range of different scenarios out there. Talk about the pros and cons. Think about what sort of training or background. Or what is it you're going to need in order to make this a reality? The key is just to start early.

Okay, so let me just check here. It looks like I have ... Okay. So I've got another question about a board. And the question is, I don't have a board, but this sounds like a good way for me to be able to transition. How do I start this? Well, if you don't currently have a board, I think boards can be one of the most cost effective ways to be able to help a business owner, particularly those of us in the small and middle market. So start out with simply forming a small advisory board. It's not a fiduciary board, so they're not directors. They're not going to be telling the CEO, or you, or anybody else what to do.

An advisory board is simply there to advise you as to how you can realize your strategic vision and dreams. So start out with an advisory board, and you're welcome to be active on your own advisory board. And this is someplace where, as your advisory board becomes more familiar with you and with the business and the future, over the years, you could decide to change it into a fiduciary board or not. And this is a place where you can transition from a more active role in the business to being something more involved in the advisory board position.

Doing that though, you've got to make sure that the roles and responsibilities for advisory boards are really clearly spelled out. If you want more information about this, we certainly have plenty on the website at EisnerAmper, or send me a note, and I'm happy to share some additional information with you. So let me just pause there a minute and see if they've got any other questions coming through, as I scroll.

Frederick Lipman:I don't think so. Yeah, Lise, I have a question for you. It's Fred.

Lisë Stewart:Sure.

Frederick Lipman:Last couple of family business transactions we've had, it's always the result, or have been a result of a dispute within the family, brother against brother, brother against sister, father against son, et cetera. And it's very difficult to resolve those disputes. How do you go about in terms of your work, resolving that kind of dispute?

Lisë Stewart:Right. Thanks, Fred. So first of all, as you're going to hear me say over and over again, especially if you spend any time with me at all, is start early. We have a saying in our team, and it is deal with the emotional issues before emotion is the issue. And when you've got that level of conflict, it means that a lot of the conversations just didn't happen early enough. So at that stage, what we've really got to try to do is to get family members around the table, and to have a conversation about several things. One, what is the future that they'd like to see? How different is each person's view of what's possible in the future? What's advantageous in the future? What are the outcomes or impacts that they're hoping to be able to achieve?

So we've got to get everybody's perspective out on the table first. And we always begin by looking at the commonalities. One of the problems sometimes in advising family businesses is that we tend to look at how people are different first, what the problems are first. That actually pulls people apart in the conversation, as opposed to bringing them together. So always start by identifying: Where is our common ground, the commonality, first and foremost? And list that.

Then we start to work backwards from there, the things that we don't have common ground on. What are the things that we need to be able to work with, clarify, data that we need, and so on? So after we're working toward that, then we begin to identify: What are the various options that are going to meet the needs of the majority of the people that are here? And there again, constantly focusing on what those outcomes might be. I will say, Fred, after 30 some years of doing this, this is an iterative process. We sort of start out by trying to find that common ground. Then we work through in trying to find out what might be the barriers to being able to reach some of the common ground on other subjects.

We look at the preferred options and outcomes over several different meetings, and then finally come up with a desired plan. And it's very interesting. Sometimes the plan that we all agree with in the end is very different from what the family had originally were looking at or exploring. So I see I'm at the end of my time, and I want to make sure I've got plenty of time for everybody else. So if you have extra questions, we're going to take those at the end of the session. I want to pause here and just introduce my colleague and friend, Bob Esposito, because he's going to be talking a little bit about private equity and what that looks like, and what those options might be. So Bob, let me turn it over to you.

Robert Esposito:Thank you, Lise. Appreciate that very much, and good afternoon, everybody. I will be speaking to you this afternoon for a few minutes regarding some planning considerations that you might want to consider while taking into account a possible transaction with a private equity firm. Some of the topics I hope to cover with you today include perceptions and misconceptions of private equity transactions, the pros and cons of working with a private equity firm, a wish list, evaluation drivers that private equity firms are looking for in terms of doing a transaction with a family owned business, and some of the basic requirements, milestones and tasks that you might undertake if and when you are ever able or wanting to do a transaction with a private equity firm.

And if time permits, I have a few real live case studies that I'd like to share with you in how to best work with private equity. So in terms of perceptions and misconceptions, we're in an unprecedented time right now, where there is a significant amount of funding available at very low cost of capital. And in anticipation of potential changes to the future tax code, we're seeing an unprecedented number of transactions, especially sell side transactions. Private equity is an alternative source for equity to monetize a family owned business, but there are a lot of misconceptions and what I believe are wrong perceptions of private equity.

In fact, our recent experience over the last few years has been that working with private equity has been a win-win situation in virtually all the transactions that we have been involved with. So some misconceptions I'd like to share with you as it relates to private equity, again, each company's different, there's always exceptions to the rule, but I believe in general a lot of these principles are misconceived about private equity. First, private equity will come in and strip and flip the investment. They're not in for the long-term. They're in for the short-term gain.

They will come in and take over your business, and founders, family members will lose control over the business, that their emphasis will be on short-term investment and realizing a high rate of return as opposed to allowing the company to mature and evolve into a longer term entity, that PE firms to not support the management teams or their cultures, but really try to come in and take over, and lay out their own cultures and governance structure, that they'll drain all the cash and liquidity out of the businesses, that they're too difficult to work with, that they do not provide value added operating advice, support, and resources, that they only care about the financial results and not about management, the employees, the customers, the products, or the services.

I believe that these misconceptions were well grounded in the past, and to a great deal, applied to some of the really large, global private equity firms that are more so into the investment side of things, but more the middle market private equity boutique, private equity firms that would be more interested in working with family owned business really want to do this in a collaborative way. Now of course, if you're interested in working with a private equity firm, it's truly important that you do due diligence on them before they get to the point of doing due diligence on you. And there are many ways of doing that. There are many professional advisors, accountants, lawyers, bankers, consultants that work with PE firms that you could discuss the background of a PE firm with.

Talk to portfolio managers. Talk to fellow companies that have worked with these PE firms. Talk with limited partners or operating partners that have had some experience with private equity firms, plenty of opportunities to do research on companies, so you can decide for yourself whether or not it does or does not make sense for you to do business with them going forward in the future.

Now private equity investment can take many different forms. This is just a sample list. There are many more beyond this, but a couple of different scenarios that you might find yourself in. You might want to deal with private equity in a minority investment or a majority owned position. Now most of the deals that we see are primarily minority owned positions in that they're looking to come in and maintain the family owned business, the operations as is, but they're bringing in additional capital, financial capital, human capital, intellectual capital, to grow the business. But there are some situations where companies are in drastic need of financial help and support, and they really do need to bring in so much money that it results in a majority owned position.

Private equity firms are also, in some cases, they're looking for new investments in businesses that they have no prior experience in, but they believe are in markets that they would like to build a platform on in the future. Or there are situations where they already have companies in their portfolio in an existing platform, and they might be looking at your company to add to that existing platform and build a broader based network. They look at transactions that could either bolt-on transactions to an existing platform, or standalone investments, where your company might be the first company in what might be a series of follow on investments and acquisitions that might build a bigger business.

The stage of your evolution of a company will also potentially dictate the type of private equity transaction you might look at. There are certain private equity firms that love to get involved at the very early stage of a company's maturity, some during the growth stage, some at the point where the company's reasonably mature, but they need some mezzanine equity, or in some cases, very late stage companies that are at the back end of their evolution, and this last tranche of financing gets them over the end line and potentially takes them to bigger and better things, such as an IPO or potentially an outright sale to another larger company or other private equity firm.

Now most of the time, private equity firms are dealing with equity investments, but there are many private equity firms that also provide a debt component to their investment. And that could be in the form of a line of credit, or working capital line of credit, some form of mezzanine financing, acquisition financing, companies, private equity firms that will come in and provide that extra layer of funding if you're a business that would like to do further bolt-on acquisitions before you make that ultimate transition out of the business. Asset based financing, all types of debt equity, or debt capital that oftentimes will have some form of options or warrants to give the private equity firm some equity involvement and interest in the company. And in many cases, these instruments are convertible into equity downstream. So there are many different forms that you might find your equity investment.

Now there are many potential pros and cons for a family owned business to consider when contemplating the potential business relationship with a private equity firm. Many of these pros and cons can be evaluated by considering the specific operational and investment philosophy of the company and the culture of the PE firm, and to see how that meshes with your business and your operating style. So I just want to highlight a few, there are many. This is a short list. We could go on for pages, but I just wanted to give you a few examples of things to consider as you're looking at potential private equity relationships.

One is private equity can, if not negotiated properly, be an expensive source of capital. In some cases, although in most cases, we're not seeing it, but in some cases, there can be a loss of inherent day to day control over the business. Ultimately, there's going to be increased reporting responsibilities, financial, operational, strategic reporting responsibilities on a monthly, quarterly, and annual basis. Some cases, they might even require you perform an annual audit, which you might not currently be doing. There will be frequent interaction, and at a minimum, board meetings generally on at least a monthly or quarterly basis, and continued oversight. But again, this is all part of how you negotiate the deal upfront to ensure that it does not become overbearing on your business.

Another factor to consider that could potentially be a con or a negative would be additional burdensome fees that you might not be accustomed to. When you bring private equity in, there's oftentimes certain transaction fees, monitoring and governance fees that are incurred, professional fees, et cetera, change of control fees that are also potentially part of a transaction. There could be culture clashes if you don't do your due diligence upfront and really know the parties that you're getting into your relationship with. There could be differences in philosophy in terms of the ultimate growth and future strategy to the company and exit plans timelines, as well as adherence to the operating philosophies and infrastructure and culture that the PE firm is accustomed to working under. These are all factors that can be mitigated by doing your homework upfront.

Now on the other side of the coin, I wold say there are probably, in my opinion, more pros than cons. And I'll say that out of all the transactions we've worked on over the past five plus years, I would say I've rarely, if ever, heard of the company that has entered into a transaction with a private equity firm that we've worked with that has had anything but positive things to say about that relationship. A few examples, in most cases, founders, family members, retain some, if not majority ownership of the company during the first round of financing. It's an opportunity for you as a family owner to grow your business without substantial investment risk. Instead of putting all of your capital on the line to grow the business in the future, you're in essence leveraging off of the capital of the private equity firm, less of your capital, and potentially more of the ability to leverage debt capital and leave your equity capital with minimal risk.

Private equity firms certainly bring financial sophistication, and to a great degree, operational sophistication that could enable you to bring your company to a different level. They provide growth capital, growth equity, and something that most companies don't consider, which is contingency capital. Most mid market private equity firms will in fact have extra capital, what I would call dry powder, off to the side. So if they're making an investment of $10 million or $15 million in your business for a 20% equity ownership, in many cases, they will or have additional capital in their funds set aside for contingencies. It could be an acquisition. It could be an opportunity to develop a new product. It could be an opportunity to move into the new global market.

And that money could potentially be available, has to be negotiated at the right valuation that affords you potentially the opportunity of accessing more capital without introducing new players into your family, if you will. Multiple monetization events, there's the opportunity for you to not only realize some monetization value during the initial investment, but also downstream when you might be looking to say, take the continued majority investment that you own and sell more of it, or all of it, to private equity or a third party at the end of the day. So there's multiple shots at realizing the ultimate valuation of your business.

Another thing that family owned businesses do not consider is the business and commercial development opportunities in work with private equity. Private equity firms generally have tremendous networks, infrastructure, the ability to bring to you ideas, acquisition opportunities, corporate partnerships, strategy alliances because they're out in the market. They're looking at many other companies. And although you might know your industry very well, they might have more of a global reach than you do. And we see many of our portfolio companies where the private equity firm has brought business development opportunities to help them grow.

They certainly bring a level of governance and leadership and risk assessment to the practice. They obviously need to protect their money, and they will help work with you to bring your business to an even higher level of governance, leadership, and risk assessment. They'll work with you in most cases for an orderly and efficient succession planning, and again, leveraging their capital network, their finance network, their network of executives, their network of other investors, private equity firms, debt capital. Again, some pros to consider.

Some other pros, again, most private equity firms will take some role in the board of directors. Might not be a majority role if they have a minority position, but they might have one or two spots on your board. And they will serve as a truly valued advisor. They will work with management in most cases on a day to day basis, and as a mentor, and bring their experience to the table where and if you need it. Again, this is all part of your upfront due diligence, making sure that you're aligned with their culture. These are people that you want to work with. That's so critically important for all these pros to be realized.

They are very active in terms of originating and managing future capital infusion into the company, so there's an opportunity for you to grow with more capital, either with their own money, putting a syndicate together, or potentially going out and leveraging their debt relationships, or if necessary, going to other corporates, or into the public market if that's the strategy that you collectively want to undertake.

Acquisition opportunities, we see many situations where private equity firms are bringing our clients that are portfolio companies new ideas for acquisitions. And we can give you many examples of where that has proven to be a very successful formula to enable you to grow not only organically, but also through very strategic industry focused acquisitions, and then certainly, working with you on exit and transition strategies.

Now certainly, private equity are looking for certain traits when investing in businesses. They're very interested, most middle market niche private equity firms really welcome the opportunity to work with family businesses and founders. They have great respect for what you've accomplished, your expertise in your own little niche. And they like to leverage off of that. They also like to work with strong management teams that have the ability to grow, but are bootstrapped from a capital perspective, and they can bring their financial capital and their experience and leadership to help you continue to grow the business under your leadership.

They provide gap financing, whether you're at a very early stage, or mid stage, or later stage, they can provide that interim financing to get you from one stage of your evolution to the next. They're generally very industry focused, the mid market private equity firms have specific industries that they're interested in. They are interested in what stage of development you're in. They want to understand your position in the market, your market resilience, your market dominance or lack thereof. That's all something they consider when evaluating doing a deal with you.

They're very interested in working with management teams that have strategical and operational excellence. It's not just about the money. It's about your ability to run your business, and they take this very seriously. They're very interested in unique services and products, especially those that might have proprietary protection and are unique to the marketplace. And again, as I mentioned to you before, they're very interested in bringing you new opportunities to grow, not only organically, but through doing transactions.

And again, they will bring in many cases, the opportunity, if appropriate, for you to leverage your business with other portfolio companies in the platforms that they might also have in place in their portfolio, or if in fact, you're the initial company in a particular platform. Yours might be the foundation upon which they do future deals, which is very exciting. Now you might say to yourself, "Well, how can I make sure that my valuation is at a maximum when I go and talk with a private equity firm?" Well, some of the valuation drivers that are critically important, some of these are self evident, but we can't underestimate these. Revenues and margins on those revenues are critical, as well as your EBITDA, and the overall quality of your earnings. That's critically important to really flush through your earnings and present the business that they're actually buying, not necessarily historically how things have operated.

They're obviously interested in cashflow and normalized working capital because that in essence helps them to measure the return on their investment. They're very interested in companies that have revenue streams that are recurring, that are annuity revenue streams. That's far less risky for them, more definable. They can forecast better when you have a defined revenue stream versus businesses that are always having to go out and recreate their business and their revenue streams.

Management experience, continuity, the way you operate your business with your customers, employees, and stakeholders is a truly important intrinsic value to private equity firms, something that they place great value on. They're very interested in your customer base, the diversification of your base, hoping that you don't have 75% or 80% of your revenues concentrated in one or two customers, but rather, more broad based customer base that has the ability to grow and expand.

We talked briefly about their interest in proprietary technology, investing in R and D, and making investments in capital expenditures. And although many family owned businesses tend to be more regional, they are also interested in those that can be leveraged for a more national or global footprint.

Now if you were to undertake a transaction with a private equity firm, there is certainly a very well defined process. In order for you to realize a very significant monetization of your interest in the company, there's a lot of work that has to be done, including things in the very early presale side of things, in performing your own due diligence on yourself to ensure that anything that needs to be cleaned up before you go into negotiations has been evaluated both on the accounting, tax, legal, HR side, et cetera, environmental, all different aspects of your business. You're going to want to perform some level of internal valuation analysis and tax structure and analysis, so you know where you want to go with your negotiations.

You want to make sure that your business plan is developed and in place, as well as building a dependable and supportable forecast and projection model. When you have a lot of that and other things in place, you're then going to want to identify the right private equity firms to deal with, and then move toward a nonbinding letter of intent, which will really set out the intentions of the parties and the overall structuring of the potential deal. That's a very important document, one which we as advisors to companies use as our roadmap for helping support them through the transaction process.

Then you're going to be looking to start preparing all of that information necessary for private equity firms, the bidders. It could be a confidential information memorandum, management presentations, quality of earnings analysis, potentially very strong financial statements, including potentially audited financials, although that's not necessarily the norm, especially if you have a quality of earnings analysis, pulling together a very comprehensive and qualitative electronic data room. Eventually then, you will move more toward the closing side of the negotiations, where you'll be working on a sale and purchase agreement, the negotiation, the execution of sale and purchase agreements with your lawyers and all of the bankers that are involved in the transaction, and starting to think about pre-closing and closing financial statements, working capital analysis, closing balance sheets and the sort.

And even when the deal closes, there does continue to be more work, whether you continue with the business as a continued management team member and owner, or if you sell out eventually, there is always post-closing adjustments that you have to go through, including integration and synergy assessment, transitions service agreements, and the like. So these are some of the to dos, or milestones, that you'll have to go through in order to complete a transaction with a private equity.

I only have a minute or two, so I just want to very quickly talk about a few case studies. Again, I'll do this on a confidential no names basis, but these are real life stories. First one I'll talk about is Project Equis, which was a pharma services deal, family owned business owned by one individual. His father turned the business over to him. He had a little bit of the equity in trust for his kids, very successful business. He was a young entrepreneur. Could've stayed in business for a long time, but he had other priorities in his life and decided to test the water.

About four or five years ago, he hired a banker. He hired us. We started working on it. But what he came to realize when he started looking at potential investors, private equity or corporate, that he needed to be at a larger scale. He happened to be under $100 million in revenues. He needed to be above $100 million in revenues to really attract the really serious players, decided to pull the transaction and wait and grow. So they continued to grow organically. And this transpired over a two plus year process. We continued to keep all information live, everything was ready to go. And eventually, they hit a point where private equity firms started lining up to want to do this deal. They eventually found one firm that happened to have the most lucrative deal on the table, one that they felt culturally they would be able to do the deal with.

They ultimately ended up closing the deal, but there was a lot of work that had to be done. The private equity firm hired two big four firms to come in and do not only by side due diligence, but also audit work. There was a lot of closing work that had to be done. But the postmortem of it all was that the owner and his family realized 100% of the value they'd set out to realize, he continued to maintain a small minority position. The CFO, the COO, and the entire management team and employee base continued with the company, and they are now the CEO and COO respectively of the businesses, running the business. The former owner is the director. And it's been a very successful model now a year and a half later.

They've done two follow on acquisitions and are using that company as a platform for the future. The other transaction that I wanted to mention is what I'll call projects flight and launch. And this was a private equity firm that basically had an interest in the aviation services industry. And basically what they did was they went out and found a software company that they decided to invest in, which turned out to be very successful. Then they found some additional companies that were also in the aviation repair industry and other sectors.

What ultimately happened was they did a series of separate private equity deals with these individual companies, and including one of them simultaneously was making ... They were all minority investments, simultaneous with one of these aviation service companies, the aviation service company actually did a bolt-on acquisition with the monies that were coming in with the private equity. All these transactions ended up being very successful. They formed a platform under the umbrella of the private equity firm. All of the previous management teams continued in place. They're running their businesses. They're growing at record rates. And they've had an incredible positive relationship with their private equity firm. And they're bringing the business development opportunities. They're opening doors for them, that management of these family owned businesses could not have done on their own because they're so busy running their own business.

I can give you many more examples, but I am reaching my limit. My overall message is that if you properly evaluate and perform the right due diligence on a private equity firm, there's a great opportunity for you to leverage off a private equity both financially, operationally, their resources, their experience, other portfolio companies, and components of the infrastructure they bring to the table while still being able to manage your business, maintain majority ownership, and have a more orderly and efficient transition into the future when you might ultimately look to sell out completely.

[Due to transcription issues, Fred Lipman’s transcript is unavailable. However, excepts from his book,  Business Exit Strategies: Family-Owned and Other Business, can be found at the end.]

Lawrence Chane:Thanks. So overriding all of this discussion is the estate planning for the client who's looking and planning to sell the business. And as others have stated earlier on this webinar, the sooner, the better in terms of planning, and the sooner, the better in terms of transferring interest in a closely held business out of the estates or gifting before the transaction, well in advance of the transaction. Once you've signed a deal, you're talking to investment bankers, it's starting to get too late to get an appropriate valuation discount on a gift of a minority interest.

What I'm going to cover today is how this fits into the planning that fits into what has  been very busy  year for estate planners, which I call the perfect storm for estate planning in 2020. And then talk about some best strategies to make [gifts?]CORRECT in this context and in this environment. Earlier this year, Blank Rome published a client alert, which I'm happy to provide to anybody who requested the perfect storm for state planning. This came out probably in May, June. You have a confluence of factors, first, starting with the economic impact. COVID-19, for many businesses, we have to press that asset back. Earnings are down. Obviously, some businesses are doing great.

Commercial real estate obviously has been impacted. Another factor is that we also have historically low interest rates, and virtually all the effective estate planning techniques revolves around IRS sanctioned interest rates that are reset monthly. A third factor is that built into the law is a change that was enacted  in 2018, which is the scheduled 50% reduction in the gift, estate and GST exemptions in 2026. And finally, we have the presidential election. Now, obviously we don't know the results yet but the concern is that a democratic controlled Washington will increase taxes. But  even if Republicans stay in power  the question is, how are we going to pay for all of this COVID stimulus spending? And that points to the income and estate tax and focus on “low hanging fruit” In other words, there may be some things that are easier than others to change. And one of them may be that the reduction in the exemption levels might be accelerated from 2026 to as early as next year and may  even be reduced by more than half.

The estate tax rate is now 40%. It's been as high as 55 and 60%. Will that be increased? And whenever there's a change in administrations tax lawyers  to other ideas and proposals that have been put forth in the past that could be taken off the shelf and enacted as part of tax reform. And these include, restrictions on GRATS, grantor trusts, limits on dynasty trust and curtailing valuation discounts, all of which  be put on the table. In 2018, when the largely income tax changes were put in place, there was also an overnight doubling of the estate and gift tax exemption, generation skipping tax exemption, from what was then close to... A little under $6 million to what is now $11.58 million per person, or 23.16 million for a married couple.

And that has created a lot of opportunities, especially because, due to congressional budgetary restraints, those increases in the exemption level, sunset in 2026 as to a lot of the income tax changes that went into effect in 2018. For married couples, any unused amount of the first spouse to die is inherited by the second surviving spouse. And there's no longer a need. If it's for estate tax purposes for the creation of a credit trust, the first spouse's death or what has been called AB planning.

There is a marital charitable deduction exempt gift to spouses and charities. And some States impose their own state taxes. For example, in  Pennsylvania, there is an inheritance tax, while  New York imposes its own estate tax as do a few  other States. Connecticut even has still a gift tax. And again, these exemption levels that are set to expire in January 1, 2026, are what we are focused on and why people are doing planning this year and trying to get them for many people, trying to get it done before the end of the year. And one of the reasons is the tax laws can be changed retroactively. And they can be changed retroactively even through a date before a new.

Actively even to a date before a new president is inaugurated. So, normally when a tax law is enacted, the date of enactment is the effective date going forward, it's a perspective thing. Sometimes the effective date will be the date that the provision was first proposed, but there are exceptions to that. Most recently, in August 1993, the estate and generation-skipping tax rates were increased. In August, retroactive to January, which was before Clinton was inaugurated, and that was upheld by the Supreme Court.

A lot of this is being driven by some of the proposals that were made during the primary season. And most notably the Bernie Sanders proposal to lower the exemption to as low as three and a half million and raise the tax rate to 77%. I don't think anybody thinks that's going to happen, but I think that's what people focused on. And it's important to note that, that's not part of the Biden platform. The Biden platform only talked about getting rid of stepped up basis on inherited assets. And it's not even clear what that means, whether that would be in addition to an estate tax, or in lieu of an estate tax, which is the Canadian tax on death, that there is a gain recognition income tax purposes on death.

So this next slide shows some of the differences potentially between the Republican and Democratic platforms. Again, the focus is the concern that the gift and estate tax exemptions will be reduced in 2021 instead of 2026 If this does not occur, the 2021 inflation adjustment will automatically increase the exemption amounts in   2021 to $11,700,00 per person or $23,400,000 for a married coupleNow assume we we have a client, Fred who's never made any taxable gifts and wants to make a gift to his daughter. And he wants to use up his full exemption of 11.58 million in 2020. What are the tax implications to Fred if he makes the gift to his daughter this year or he waits till next year. And obviously if he is, whether there's a change in the law.

Frederick Lipman:I want you to know I don't have a daughter!

Lawrence Chane:I didn't mean you Fred! The I-R-S has already announced in a statement that when the exemption is reduced whether in 2026 or earlier, someone who has used up the exemption by making gifts will not be penalized and will not pay either an additional estate tax or gift tax when later the exclusion amount is reduced to the pre 2018 levels. So roughly in 2026, if nothing happens by then, let's say we're at $12 million exemption, it'll be reduced to $6 million. So gifts made this year are safe.

And the cost of using the exemption before it goes down is roughly $4.2 million for a married couple. That's a significant savings. And that's, what's driving all of the planning this year, but for that reduction and many people don't really realize this. When you make a gift against your exemption amount during your lifetime, you're not removing that asset from the estate tax base, you're removing the future appreciation with respect to that asset out of the tax base. But if you make a gift while the exemption level is high and it later goes down below that amount, that is a pure tax savings at 40%. And that's roughly where that $4.2 million comes from.

So are there other benefits of making gifts? And again, like I just alluded to the future appreciation of the gift is what escapes estate tax. That's what the focus has been for years. This year, it's magnified by the possibility or maybe not this year, but even in the coming years, it's magnified by the opportunity to use the exemption before it goes down and realize that higher tax savings that I just mentioned. So what are some of the best strategies for making gifts in 2020? Here's an example of clients that are worth a $100,0000 they both are in a substantial salary. They have more than enough wealth for the rest of their lives, and they've never made any gifts. They have two children, and they're concerned about the tax ramifications of the reduction in the exemption. They both liked to make gifts that would utilize that exemption this year.

What strategies would they be looking at? First thing is that, and this is something that I mentioned earlier on is the historically low I-R-S interest rate. Those rates and by the way I have to note there's a typo on this slide. The rates that I'm showing in the middle of that slide are actually for November, they change monthly and they're based on the term of the transaction. So the short-term rate is for a transaction or a loan up to and including three years 0.13%. Three years and less than nine years 0.39% more than nine years and above 1.17%. And these are very, very effective transacts or techniques that can be used to remove significant Wealths from an estate. And people are doing it to the tune of tens of millions of dollars.

One is very simple intra family loans. Parents can lend money to their kids or to trust for their kid at these low rates. And if the money is invested at a rate of return exceeding the low rate of interest that has to be charged that removes that much appreciation out of parents' estate on a gift tax free basis. Similarly, grand tour annuity trust is really economically speaking like a loan to a trust where the parent or settler of the trust paid back the original principal plus interest at a rate in the range in this case, it's called the  7520 rate, which I think is 0.4% in November. Again, the hurdle rate in terms of the interest factor that has to be paid back to avoid a gift is so low that there's a tremendous amount of opportunity to remove assets out of the state.

And the name of the game, always in estate planning and gifting is leveraging. Levaraging shifts appreciation out of the estate to the next generation, whether outright or in trust. And there's an additional component of the generation skipping tax, which prevents a taxpayer from leaving too much to a generation below their children's generation and thereby skip a state path in their children's generation. But that exemption level has also the same number as the state tax exemption, which is again 11.58 million per individual, 23.16 million for a married couple. So there are a significant room to make gifts that would benefit children perhaps, but not be taxable in the children's estate. Then go on where the grandchildren not be taxable on their estate. And so on down the line trust in many States can now be perpetual. So this is something that can happen today and is over a period of time is a very effective way to move wealth down the generations.

A cap on the length of a dress like this, which we call a dynasty type trust, is one of the things that has been proposed in the past and could be brought off the shelves to prevent this kind of activity. Also, I mentioned graphs before there have also been proposals to curtail the use of graphs, not by eliminating them altogether, but by requiring a long term for the graph, which would effectively make it lose its utility for all intents and purposes. Something simple is which in the context that we're talking about today, perhaps of a business planning to transition is to divert new business opportunities or perhaps investment to a trust or to the next generation down right at the beginning, before they have any value, a new division is being open. A new property is being heard. That could be funded by loans from the parents and the children or their trust or an L-L-C that they form buys that investment or makes that investment.

And it's never in the parent's estate, except for the requirement of the payback of the loan Plus a minimal interest rate. Also in the business context gifts of non-voting stock or non-controlling L-L-C or limited partnership interest. So as to obtain valuation discounts on the gift. Discounts are currently at least, and it's been proposed in the past, they'd be eliminated or curtailed are available for interests that lack control and lack marketability. And a large component of that is structuring the capital structure of the business so that non-voting equity can be transferred while the parent or an older generation keeps the voting control.

And as I said earlier, it's critical that all of these things, the planning completed well in advance of any kind of a liquidity event. Also, independent valuation reports are essential because they have to be attached to the gift tax return so that the statute of limitations on the gift tax return is running. This is one of the reasons why you can't wait until you've hired your investment bankers and you have a book out on the street etcetera or even further down the road because the valuation folks are going to find out about that. And they need to take that into account.  A formal professional valuation of the business  should be done well in advance of any activity towards today

Lots of clients have asked, how can I have my cake and eat it too? I'm sure in many areas they ask that of their professionals, but where this comes up is perhaps a couple who's on the cost or just over the threshold of the $23.16 million, that state tax exemption. They fear that if they do nothing and the exemption levels are reduced, they are going to be subject to estate tax. Beause, their state's going to be over the limit. What can they do? And what can they do when they're not sure that they really can give up a huge chunk of their capital to their children, irrevocable.

And there are two things that I want to talk about today. One is a lot of spousal lifetime access trust, or a slab. It's a trust that spouse A grades for the benefit of spouse B and perhaps for the benefit of their children and grandchildren, spouse A makes a completed gift to the trust uses up exemption. The future appreciation of those assets are out of the estate tax system. We purposely do not qualify this for a marital deduction so that we can use up the exemption. The trust will have an independent trustee, in most cases with absolute discretion to make distributions to spouse B during his or her lifetime and perhaps to the children and grandchildren as well.

And so what does this do? If spouse A needs the money back or balances A and B is a couple needs this money because it turns out they gave away too much. The trustee can make distributions, whether of income or principal to spouse B and together A and B can use that for their transfers between spouses or give tax-free. So there's no problem with spouse B giving money back to spouse A, the day they came out of the trust. We don't recommend that people go into this with the idea that they're going to be taking money out. We try to get them to fund this trust with an amount that they think that unless everything else goes down the tubes they'll be able to maintain and let it grow inside the trust because the more growth inside this trust, the more estate that they're saving.

One question about this is that, this only works if spouse A dies first because if spouse B dies first, the beneficiary spouse, spouse A who created the trust will lose access to that trust income or assets in the trust. So it is something that needs to be carefully thought out. Some of the key considerations are this should be done only if there's an intact marriage with no possibility of divorce, at least no large probability of divorce, maybe. And the trustee, although independent, meaning not related not subordinate, not a beneficiary should be a friendly trustee. So that if that couple spouse A and spouse B actually do need to take out of that trust. They know that the distribution will be made.

And an additional feature that we can put in these trusts and often do is to give spouse A who created the trust, the ability to replace a trustee with somebody else independent. And real quickly, the next item of having your cake and eat it too, is to what's called a domestic asset protection trust.

Now there are only 19 States that permit someone to create a trust for their own benefit and be protected from creditor claims. And the key here is protection from creditor claims, a third party trust one that's created in my last example, a created for B, B is protected for these creditors cannot get at that trust, but if A creates a trust for A in all but 19 state aged creditors can get at that trust. So what this requires is a trust that in a state, one of the States that provides asset protection or that has asset protection litigation, there must be a trustee that is resident in that other state. So for example, one of the main States or some of the main ones are Alaska, North Dakota or South Dakota, rather Delaware and Nevada. And typically there is a trustee it's resident in that state.

It's usually a corporate trustee and the duties of that trustee can be limited to largely administrative duties with another person, an individual independent of the client who created the trust, having the discretion to make distributions to the trust creator or the family of the trust creator.

This provides a way of somebody to be a beneficiary of their own trust, but there are a lot of areas of unsettled law, most notably what happens where you live in a state that doesn't recognize these trusts and you're forming it in a state that does that's beyond the scope of our discussion today. And I'm going to turn it over to the moderator for questions that have been posted to the group.

Lisë Stewart:Great. Thanks Larry. This is Lisa everybody. So, that was really interesting. And we do have a few questions that have come in. Let's see, I'm going to actually scroll back to some of the beginning of the questions, Bob. I believe this one is came in when you were speaking. So the question for you is how common is it that the private equity investors are willing to initially invest as a minority and to the company? This is really how often or how commonly do you see that?

Robert Esposito:That's a good question. I would say that's very, very common. That's probably the majority of what we're seeing, especially with middle-market boutique private equity firms that are looking to invest in family businesses. I would say that is the majority usually ranging anywhere from 15% to 30-35%, and then potentially, maybe downstream two to five to seven years later, maybe they take over the whole business or there's some orderly transition. So I would say it's definitely the majority of the cases I did mention in my presentation that I did have one case that I did not have time to get to, but there are some situations where companies are really bootstrap and they really are in financial stress and they are in a more desperate need to bring in private equity capital. In those situations, there might be a situation where you would see more of majority investment or in a situation where the founder, the family member wants to sell out and move on with their lives.

But we find that the majority of the companies want to continue to run their businesses when it gets some liquidation event and then want to be able to have that firepower behind them. That's private equity firm to grow the business and then sell it downstream when they're a bigger business with a higher enterprise value.

Frederick Lipman:I like to add something to the spread, many times when they take a minority position, they're going on a lot of restrictions on what the company can do, including salaries, mergers, borrowings to banks, etcetera. So to a large degree, even though they don't have technical control, they do have control through their confidences and warranties and representations that are buying the company.

Lisë Stewart:Great. Thank you. So, Larry, I think this is a question for you can or should a grantor act as an investment advisor on adapt. That is, is a completed gift.

Lawrence Chane:So the answer is yes, the grantor can I prefer that the grantor does not just out of an abundance of caution, but no there's nothing that would preclude the grantor as being an investment advisor. The grantor just can't control distributions from the trust.

Lisë Stewart:Right, there's also a question about you Larry sharing your slides, but I do know that a PDF of the slides I think were sent to the people who had registered, if you did not get a copy of those, let us know. And we'll try to make sure that everybody gets a copy of the slides. Fred I think that this question probably goes to you. So it's a little bit longer. I'm going to read that out. If parent owners of a company think that they did everything to keep their children and their in-laws children in the business together, but upon their death, their child throws out their two in-laws from the business. What went wrong? Is there a way to keep the second generation together in business?

Frederick Lipman:Well, you can provide some legal protection for the second generation. The question is whether that is a wise decision to try to control something from the grave. While the parents are alive usually you could influence the decision, but typically after the one or both of the parents are gone, there is a breakup of the business and the best you can do under those circumstances to protect the next generation down, is to put some form of agreement together, which would apply in the event that happened.

Lisë Stewart:Right, thank you, Bob. Here's a question for you. I'm worried about our organizational culture and getting the right fit with the PE firm. Is it acceptable practice to ask, to meet with other companies that are in say the PEs investment portfolio, I guess, to see what their experience is like?

Robert Esposito: Certainly! I think that was one of the points that I tried to make the presentations today upfront, the presentation where we talked about doing due diligence in a variety of matters, talk to professionals, talk to portfolio companies, portfolio managers. I think you'd want to be upfront with the PE firm that you're doing that to ensure that you maintain that positive relationship. But our experience has been that they're very open and transparent. And again, honestly is just the trend that we're seeing, but we're seeing very positive relationships. We're seeing portfolio companies refer PE funds, be willing to stand up this references so that, would absolutely be an acceptable thing to do. Yes. And advice...

Frederick Lipman:I have a supplement to that. It's not only advisable I think it's absolutely necessary to make sure you're dealing with the right PE side from the talking to the other companies that are in there. You might want to find the ability, maybe be more difficult to talk to people who had left the business. People who, particularly who are principals, who are no longer there to see their reaction because many times the PE firms are well aware of the fact that someone's going to ask where the ability to talk to other portfolio companies and use the best way of finding out what I call the real truth is to talk to people who are disaffected, who have left a cup.

Lisë Stewart:So let me just make a final call to see if there are any other questions that anyone would like to have answered here. And if by any chance, we may have missed you along the way, please feel free to reach out to any of us.

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About Paul Dougherty

Paul Dougherty, EisnerAmper Tax Partner and Partner-in-Charge of the Philadelphia practice,has dedicated much of his career to building and enhancing a specialized expertise in corporate taxation, high net worth individuals and IRS controversy.

About Lisë Stewart

Lisë Stewart is Principal-in-Charge of EisnerAmper’s Center for Individual and Organizational Performance and the Center for Family Business Excellence within the Private Business Services Practice. Lisë has experience in organizational development, strategic planning and training, and human performance management.

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