Succession and the Key Employee
Mr. Tan is 58 and owns 100% of a 40-employee trading corporation. His wife is 55. Their daughter, 32, is the company’s CFO and wants to take over; their son, 29, works abroad and has no interest in the business. The company is worth about PHP 80 million on a book-value basis, but the key sales manager, 50, controls the top five client relationships. Mr. Tan’s personal assets are PHP 30 million, mostly in the company and a family home. He has no buy-sell agreement and no key-person insurance. He proposes to give 40% of the shares to his daughter now, 20% to his son, keep 40%, and later give the sales manager a 10% stake as an incentive. He wants to “avoid estate tax” and keep family control. He asks whether he should sell the shares instead of donating them and how to protect the business if he dies suddenly.
1. Compare the tax consequences of donating the shares now versus selling them or transferring them at death.
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A lifetime donation of unlisted shares is subject to donor’s tax at 6% of the net gift above the PHP 250,000 annual exemption. If 40% is worth PHP 32M, the donor’s tax is roughly PHP 1.9M; a later 20% gift worth PHP 16M would add roughly PHP 0.95M, assuming no other gifts. A sale at fair market value shifts the shares for consideration; if the shares are unlisted, the seller generally faces the 15% capital gains tax on the net gain, and a sale below fair value may be treated as a partly gratuitous transfer. A transfer at death is subject to 6% estate tax on the fair market value at death, but the estate may use the standard deduction, family home deduction, and other deductions. Donating now freezes value and may reduce future estate tax, but it uses donor’s tax now, requires a defensible valuation, and may weaken control.
2. Evaluate Mr. Tan’s proposed share transfers and control plan.
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Giving 60% to the children now would leave Mr. Tan with only 40%, so he could lose control of the company immediately. The son has no interest in the business, so his 20% creates a passive shareholder who may disagree with the daughter. Promising 10% to the sales manager later creates a key-employee retention issue but also dilutes the family. A better structure is to separate ownership from control: transfer shares gradually, use a shareholders’ agreement with voting provisions, and give the daughter an option or right of first refusal over the son’s shares. The sales manager’s incentive could be phantom stock or a profit-sharing plan rather than direct equity. Any transfer should be supported by a valuation and documented in writing.
3. Design a buy-sell and key-person protection plan for the company.
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The shareholders should sign a buy-sell agreement that defines the triggering events-death, disability, retirement, or voluntary sale-and a valuation formula, such as a multiple of earnings or book value adjusted for goodwill. Fund the agreement with life insurance: either cross-purchase policies owned by the other shareholders or an entity-owned policy, depending on tax and control objectives. Confirm whether death proceeds are income-tax exempt and whether the insured retains incidents of ownership that would pull the proceeds into his estate. Add key-person insurance on the sales manager and a retention plan that ties him to the business during the transition. Review beneficiary designations, corporate minutes, and the estate plan so the buy-sell does not conflict with the intended inheritance.