Question

Explain how redeemable preferred shares are used in succession planning for small business corporations.

Answer 1

Succession Planning with redeemable preferred Shares for small business corporations:

In case of family business, the parents are interested in transfering their part of the holding to their successors,but an outright sale of business to successors may be possible but the new generation arent financially sound position to buy out.So they use the concept of Estate freeze through prefferd shares through which the owners usually pass their business to family members. An estate freeze makes the value of our business fix to its present value , so that any future growth will benefit the successors and not to be taxed to parents untill death. In order to implement the Estate freeze we need to calculate the current value of the business and then exchange parents shares for new freeze preffered shares.

As per the tax laws , Parents must receive Consideration equivalent to Fair Market Value of the common stock at the time of transfer .but in order to pay back the FMV price to parents the company may not have liquid cash so they settle by issuing preffered stocks to the parents .So in major cases of small business corporations , the parents will transfer the common stocks in the successors name in return they accept the preffered stock as settlement for the transfer .These preffered stock may have voting rights , dividend rights ,redeemable at the option of the share holders ,right to convert to another class of shares.

In case of succession Planning ,when preffered stocks are issued in place of commen stock to the parents the tax rules require that preffered stocks be redeemable at the shareholders option . this rule is placed to avoid a benefit being conferred on the next generation when a company is transferred. The parents taxation is deferred untill the preffered stock are redeemed . so this helps the parents protect their preffered share investment by avoiding potential detrimental financial and operating decisions to the successors.