Closely Held Business

Question 1

What are key areas of focus for planning for closely held business owners?

Answer 1

Taxation, valuation, succession, and exit strategies.

Question 2

Name common financial issues across the business lifecycle.

Answer 2

Financing, growth, tax planning, succession, and exit strategies.

Question 3

Who are angel investors?

Answer 3

Individuals or groups providing equity financing to start-ups in exchange for a share of ownership.

Question 4

What is venture capital?

Answer 4

Financing for high-growth companies in exchange for significant equity, often with a 3-7 year exit horizon.

Question 5

Define mezzanine financing.

Answer 5

Hybrid financing that combines equity and debt, junior to senior debt but senior to equity.

Question 6

What is a leveraged buyout (LBO)?

Answer 6

Acquiring a company primarily with borrowed funds, often targeting high returns through resale or going public.

Question 7

What is distressed debt?

Answer 7

Investing in debt securities of financially stressed companies, often under bankruptcy protection.

Question 8

What are the main business entity types?

Answer 8

C-corporations, S-corporations, LLCs, partnerships, and family holding companies.

Question 9

What is a family holding company (FHC)?

Answer 9

An entity managing assets of another, often structured as an LLC or LP with voting and non-voting shares.

Question 10

What are the tax advantages of Section 1202 stock?

Answer 10

Exclusion of 50-100% of gain from the sale of qualified small business stock held for over 5 years.

Question 11

What is a buy-sell agreement?

Answer 11

An agreement among business owners to purchase and sell interests upon triggering events.

Question 12

Name triggering events for buy-sell agreements.

Answer 12

Death, disability, retirement, bankruptcy, divorce, or termination of employment.

Question 13

What is an entity purchase agreement?

Answer 13

A buy-sell agreement where the business buys back an owner’s share using life insurance proceeds.

Question 14

What is a cross-purchase agreement?

Answer 14

Partners buy life insurance on each other to fund the purchase of ownership shares upon a partner’s death.

Question 15

What is the formula for capitalized earnings valuation?

Answer 15

Value = Earnings / (Discount Rate - Growth Rate).

Question 16

What are common valuation methods?

Answer 16

Discounted cash flow, comparable public company, and comparable acquisition methods.

Question 17

Name common valuation discounts.

Answer 17

Minority interest, lack of marketability, and control premium.

Question 18

What is the role of a terminal value in valuation?

Answer 18

It represents the value of all future cash flows beyond the projection period.

Question 19

What are common exit strategies?

Answer 19

Private/public sales, ESOPs, SCINs, private annuities, and seller financing.

Question 20

What is an ESOP?

Answer 20

An employee stock ownership plan, a tax-advantaged way to transfer ownership to employees.

Question 21

What is a self-canceling installment note (SCIN)?

Answer 21

A sale structure where payments terminate upon the seller’s death, avoiding inclusion in the estate.

Question 22

What is a private annuity?

Answer 22

A transfer of ownership in exchange for lifetime payments, avoiding gift tax if structured correctly.

Question 23

What is the difference between asset and stock sales?

Answer 23

Buyers prefer asset sales for depreciation benefits; sellers prefer stock sales for capital gains treatment.

Question 24

What is an IRC Section 338 election?

Answer 24

Treats a stock purchase as an asset purchase for tax benefits.

Question 25

What is IRC Section 303?

Answer 25

Allows capital gain treatment for stock redemptions to pay estate taxes.

Question 26

What are the tax benefits of converting a C-corporation to an S-corporation?

Answer 26

Avoids double taxation but triggers built-in gains tax if gains are realized within 5 years.

Question 27

What does Section 6166 provide?

Answer 27

Allows deferral of estate taxes attributable to closely held business interests.

Question 28

What are common sources of liquidity for business owners?

Answer 28

ESOPs, bank loans, leveraged recapitalizations, and equity partners.

Question 29

What are ESOPs classified as?

Answer 29

Tax-qualified defined contribution plans under ERISA.

Question 30

What are the tax benefits of ESOPs?

Answer 30

Deduction of purchase payments and deferral of gains on the sale of stock to the ESOP.

Question 31

What are key family conflict issues in succession planning?

Answer 31

Fairness, control, and differing visions for the business.

Question 32

What is the role of trusts in family business transfers?

Answer 32

Minimize taxes, protect assets, and ensure control over succession.

Question 33

What is the role of recapitalization in exit strategies?

Answer 33

Restructuring a company's capital to facilitate ownership changes or sales.

Question 34

What is the purpose of management buyouts?

Answer 34

Allow existing managers to acquire ownership using external financing.

Question 35

What is a Dutch auction in business transfers?

Answer 35

A bidding process to determine the best price for ownership interests.

Question 36

What are the key financial issues for closely held businesses throughout their lifecycle?

Answer 36

Taxation, valuation, succession, and exit strategies.

Question 37

What is the significance of buy-sell agreements?

Answer 37

They provide a framework for ownership transfer due to triggering events like death, disability, or retirement.

Question 38

Who are angel investors, and what do they provide?

Answer 38

Individuals or groups offering equity financing to startups, often with local focus and industry expertise.

Question 39

What are venture capitalists' primary goals?

Answer 39

High growth potential companies with significant equity stakes and a target return within 3-7 years.

Question 40

What is mezzanine financing?

Answer 40

Hybrid financing combining equity and debt, offering lower priority than senior debt but above common equity.

Question 41

Define leveraged buyout (LBO).

Answer 41

Acquisition of a company using borrowed funds, repaid from the target’s cash flow or assets.

Question 42

What tax benefit does Section 1202 stock provide?

Answer 42

Exclusion of 50-100% of gain on qualified small business stock held for over five years.

Question 43

What is the primary purpose of valuation discounts like minority interest and lack of marketability?

Answer 43

To reflect reduced value due to ownership restrictions or limited liquidity.

Question 44

What is the capitalized earnings approach in valuation?

Answer 44

Valuation based on expected earnings divided by a capitalization rate.

Question 45

What is a self-canceling installment note (SCIN)?

Answer 45

A sale mechanism where payments cease upon the seller’s death, avoiding inclusion in the taxable estate.

Question 46

How does an ESOP help in business succession?

Answer 46

It transitions ownership to employees while providing tax advantages for the seller.

Question 47

Define 'private annuity.'

Answer 47

A transfer of ownership in exchange for fixed lifetime payments, often used to defer taxes.

Question 48

Compare C-corporations and S-corporations in taxation.

Answer 48

C-corps face double taxation, while S-corps pass income through to owners, avoiding corporate tax.

Question 49

What is a family limited partnership (FLP)?

Answer 49

A structure allowing centralized management and estate tax advantages through gifting.

Question 50

What is the advantage of using LLCs for family businesses?

Answer 50

Flexibility in taxation and limited liability for members.

Question 51

What is a zero-premium collar?

Answer 51

A strategy buying a put and selling a call to hedge price risk without upfront cost.

Question 52

Define 'prepaid variable forward.'

Answer 52

A contract monetizing a concentrated stock position by agreeing to future stock delivery.

Question 53

What is the primary objective of using exchange funds?

Answer 53

To diversify concentrated stock positions by pooling shares with other investors.

Question 54

What does Section 6166 allow?

Answer 54

Deferral of estate taxes attributable to closely held business interests.

Question 55

How does a charitable remainder trust (CRT) benefit business owners?

Answer 55

Provides income, estate tax reduction, and portfolio diversification by liquidating concentrated positions.

Question 56

What is the difference between a charitable lead trust (CLT) and a CRT?

Answer 56

A CLT pays income to charity during its term, while CRT provides income to the grantor.

Question 57

What are triggering events in buy-sell agreements?

Answer 57

Death, disability, retirement, or bankruptcy.

Question 58

How is a cross-purchase agreement funded?

Answer 58

Partners purchase life insurance policies on each other to fund ownership transfers.

Question 59

What is the advantage of an entity purchase agreement?

Answer 59

Simplifies funding by having the business purchase insurance for buyouts.

Question 60

What is the IRC Section 303 rule?

Answer 60

Allows capital gains treatment for stock redemptions used to pay estate taxes.

Question 61

What are the benefits of making a Section 83(b) election?

Answer 61

Elect to pay taxes at grant, reducing future taxation on appreciation.

Question 62

What does the built-in gains tax apply to?

Answer 62

Gains on assets held by a C-corporation before its conversion to an S-corporation.

Question 63

What are common sources of family conflict in succession planning?

Answer 63

Differing visions, perceived fairness, and control issues.

Question 64

How can trusts mitigate family conflicts?

Answer 64

By clearly defining control and distribution of assets.

Question 65

What is the role of a family council in succession?

Answer 65

To establish governance and address disputes in family-run businesses.