CSP Family Business Succession 2 — Questions and Answers
Question 1: Which document formally grants a family member authority to manage business operations in the event the owner becomes incapacitated?
- Buy-sell agreement
- Durable power of attorney (Correct answer)
- Operating agreement
- Letter of intent
Correct answer: Durable power of attorney
A durable power of attorney remains effective upon incapacity and grants a designated agent authority to manage business and financial matters.
Question 2: In a family business context, what is the primary purpose of a 'family council'?
- To replace the board of directors
- To manage day-to-day operations
- To provide a forum for family communication and governance decisions (Correct answer)
- To distribute profits to family shareholders
Correct answer: To provide a forum for family communication and governance decisions
A family council serves as a structured forum where family members discuss shared values, policies, and governance issues separate from business management.
Question 3: When a founder transfers business interests to children at a discount using a Family Limited Partnership (FLP), which IRS concern is most commonly triggered?
- Step-up in basis
- Lack of economic substance or sham transaction (Correct answer)
- Passive activity loss rules
- Generation-skipping transfer tax
Correct answer: Lack of economic substance or sham transaction
The IRS may challenge FLPs if they lack genuine business purpose and appear to exist solely for tax avoidance, citing lack of economic substance.
Question 4: A sibling who works in the family business full-time is most likely to feel inequity when the succession plan treats all children:
- Equally regardless of contribution (Correct answer)
- Proportionally based on ownership stake
- Based on seniority of employment
- Based on education level
Correct answer: Equally regardless of contribution
Equal inheritance regardless of contribution creates perceived inequity because active children often believe their sweat equity warrants greater compensation.
Question 5: Which succession strategy is most appropriate when no family member is willing or capable of leading the business?
- Management buyout (MBO)
- Internal promotion of a non-family key employee
- Employee Stock Ownership Plan (ESOP)
- Sale to a strategic third-party buyer (Correct answer)
Correct answer: Sale to a strategic third-party buyer
When no qualified family successor exists, selling to a strategic buyer is often the best option to maximize value and ensure business continuity.
Question 6: What is the main risk of relying solely on a life insurance policy to fund a cross-purchase buy-sell agreement among five co-owning siblings?
- Life insurance proceeds are taxable as ordinary income
- Each sibling must own policies on all others, creating an administrative burden (Correct answer)
- The insured parties cannot be family members
- Cross-purchase agreements are prohibited for family businesses
Correct answer: Each sibling must own policies on all others, creating an administrative burden
With five owners, each must own four policies, resulting in 20 separate policies total, which creates significant administrative complexity and cost.
Question 7: Which valuation method is generally preferred for a closely held family business that generates stable, predictable cash flows?
- Liquidation value method
- Book value method
- Discounted cash flow (DCF) method (Correct answer)
- Replacement cost method
Correct answer: Discounted cash flow (DCF) method
The discounted cash flow method is preferred for stable cash flow businesses because it captures the present value of expected future earnings.
CSP Family Business Succession 2
Which document formally grants a family member authority to manage business operations in the event the owner becomes incapacitated?