To minimize taxes and maximize the benefits for both your family and company,it's never too early to think about succession planning

Few owners feel psychologically prepared or financially motivated to contemplate ownership and management succession, particularly for a business they started from scratch. Unfortunately, if a company changes hands after an owner's death, lack of planning can result in steep estate taxes and management upheaval.

Cecile and Lester Fein decided to tackle the issue early. The cofounders and co-owners of Weight Watchers in New Jersey Inc., a fast-growing $5-million to $10-million franchise operation, concluded 12 years ago that their long-term goal was to pass the reins of the business to their daughter, Stephanie, then the company's director of public relations.

Some succession strategies can be wildly complicated and costly. But the Feins adopted the kind of basic plan that can be set in place with just a little input from a lawyer or accountant. Their approach has been the slow-but-steady transfer of Weight Watchers in New Jersey's stock, timed to maximize benefits from yearly exemptions from the Internal Revenue Service's gift-tax laws.

For most company owners, succession planning is a three-step process: first and usually toughest is the decision-making stage; next, the gradual transfer of minority stock holdings; and finally, the majority transfer of ownership and management responsibilities.

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Decision making. The decision-making stage includes several important steps. Among them: establishing financial priorities for both the company and its owners, evaluating their strategic options, and working up a timetable for the ownership transfer. At Weight Watchers in New Jersey, this process occurred over several months, during which the Feins, who were then in their early sixties, met with their attorney and accountant to discuss their personal and corporate goals.

Ideally, this first stage of planning should occur when owners are in their fifties or early sixties and their companies have reached fairly stable levels of operations. But don't start too early: when owners are in their thirties or forties or their companies are still volatile, it makes better sense to buy life insurance as a precaution against estate taxes and to retain the founders' ownership stake.

Here's the plan the Feins worked out with their accountant: every year they would transfer company stock to Stephanie valued at up to $20,000. Why that magic number? Because the IRS permits every individual to give away up to $10,000 per year per recipient -- that means a married couple can give away up to $20,000 per recipient -- without incurring any estate or gift tax. That's quite a savings, since gift taxes may reach 55%, the same onerous level as estate taxes. (There are no limits to how much a person may receive in gifts.)

This is where accountants come in handy. "We valued the Feins' stock based upon factors like net income, net asset value, and a multiple of earnings," explains George Weinberger of J. H. Cohn & Co., an accounting firm in nearby Roseland, N.J. "Then we used what was known as a blockage factor to discount the value of the stock being transferred to Stephanie, since it was a minority holding that was fairly illiquid." In private companies such as the Feins', blockage can reduce the share price of transferred stock significantly from its book value -- just so long as the recipient remains a minority stockholder.

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Minority transfer. The second stage of succession planning, which at Weight Watchers in New Jersey has lasted eight years, is the transfer of stock up to -- but not exceeding -- 50%. The timing of this stage varies according to the magnitude of a company's value, number of children involved in the succession plan, and, of course, how quickly owners are willing to transfer the company. Stephanie Fein received her first gift from her parents in 1982 and now controls, by her estimate, 49.5% of the company.

The stock transfers have been simple, to put it mildly. Each year, Weight Watchers' attorney fills out the necessary paperwork to indicate that Stephanie has been given a larger stake in the company. Weinberger then files a gift tax return, signed by the Feins, to notify the IRS that the transaction has occurred.

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Majority transfer. Tax savings are the main incentive behind the majority transfer. That's because, although one spouse can leave a company to the surviving spouse without incurring any tax liability, heavy taxes get assessed when it passes to the second generation.

Here's the advantage of moving into this stage expeditiously: if a person dies owning a minority interest in a company, the beneficiaries owe far less in taxes than they would if the deceased had owned a majority stake. That's because the IRS applies the same kind of blockage discount to this minority situation that had paid off for the Feins so nicely in stage two of their succession planning. All stock gifts from the Feins to Stephanie exceeding the 50% ownership mark will not be eligible for the blockage discount and thus will incur higher tax liabilities when they are made. But there are ways to keep the taxes on nondiscounted gifts manageable, including staggering them.

Cecile and Lester Fein are convinced that a majority transfer makes sense for them. After about a year of evaluating their options, they expect to carry the transfer out, complete with the appointment of Stephanie as the company's president this summer. The strategy they're considering is known as a GRIT, short for grantor retained interest trust. "If the Feins adopt a GRIT, they will put their stock shares in a trust that will pass along to their daughter," explains Weinberger. "But for as long as the trust is in operation -- which could be up to 10 years -- the Feins will retain their interest income from their shares as well as the voting power."

Meanwhile, the GRIT also provides a valuable tax benefit to ease the pain of the stock transfer. The IRS taxes GRIT gifts only according to their discounted present value calculated on an actuarial chart. "If the Feins decide to transfer stock worth $100,000 into a 10-year GRIT, they'll only have to pay tax on a $38,000 gift, which they pay at the inception of the GRIT," says Weinberger.

In fact, the Feins can save those gift taxes entirely if they each apply some of their $600,000 lifetime tax exemption to their GRIT gifts rather than having the exemption for estate tax purposes. There's only one risk: if you die during the lifetime of the GRIT, its assets pass back into your estate so they're once again subject to full taxation. To avoid that, adjust the lifetime of your GRIT to fit comfortably within your age expectancy.

With the process nearly behind them, the Feins are satisfied with the results. "If we hadn't passed the company on to Stephanie, we'd probably have sold it by now," admits Lester. "But we've been able to stay involved and keep growing the business."


Meetings Galore

Succession planning can be overwhelming sometimes, particularly for children wary of stepping into management or ownership roles or entrepreneurs afraid of losing control. Here are two resources Stephanie Fein recommends:

* The Center for Family Business,
headed by Leon Danco, offers twice-yearly seminars on managing succession without conflict. For information, contact: CFB, P.O. Box 24268, Cleveland, OH 44124 (216-442-0800 or fax 216-442-0178).

* Second Generation Clubs. A cross between educational seminars and group therapy sessions. Fein has joined two. To find nearby groups, check with your accountant, lawyer, chamber of commerce, or professional associations.


Lay the Groundwork

Here's how to begin one of the most important business decisions an owner can make: planning for succession.

* Figure out your priorities. If you don't care about long-term involvement with your company, you may be better off eventually selling it to investors or key employees. But if family succession is important, make a dream list of your ultimate goals: tax benefits, a target retirement age, or even a financial payout.

* Discuss matters with your children. Find out whether they're even interested in one day owning your company. And make certain they're patient enough to adjust to the kind of moderately paced transition that will provide the biggest advantages for your company's bottom line, management stability, and your own psyche and pocketbook.

* Analyze the current state of your business. If it's not fairly stable financially, postpone succession planning and beef up your "key man" insurance instead.