When modeling an existing estate freeze in Voyant, it is important to represent both the company's existing assets and resulting book value and the redemption value of the preferred shares.
These values may be similar when the estate freeze is initially established, but they represent two different parts of the structure.
What does the redemption value represent?
In an estate freeze, the redemption value generally represents the fixed value assigned to the preferred shares when the freeze occurs.
For example, if a company has a fair market value of $4 million when an estate freeze is completed, the existing shareholder may exchange their existing interest for preferred shares with a $4 million redemption value.
This effectively "freezes" that shareholder's interest in the company at $4 million. New common or growth shares can then be issued to other shareholders, such as a family trust, allowing future growth in the company to accrue to those shares.
The $4 million redemption value therefore represents the shareholder's frozen interest in the company. It does not, by itself, represent the underlying assets owned by the company.
Why do I also need to enter the company's existing assets?
The preferred shares and the company's underlying assets represent two different parts of the structure.
The redemption value of the preferred shares generally reflects the value frozen for the shareholder based on the company's fair market value at the time of the estate freeze. The assets entered within the company in Voyant, however, establish the company's starting book value based on the assets it actually owns.
These amounts do not necessarily need to be the same. A company's fair market value may be higher or lower than the book value of its underlying assets.
When creating the plan in Voyant, it is therefore important to represent both:
Corporate assets: The assets the company actually owns, which establish its starting book value in the plan.
Preferred-share redemption value: The value of the shareholder's interest that was frozen when the estate freeze occurred.
If an existing company's assets are omitted from the plan, Voyant will not have an accurate representation of the company's starting book value. This can affect how corporate value and distributions are projected.
Why might my dividends not distribute as expected?
If a significant redemption value is entered for the preferred shares but the company's existing assets have not been included, you may find that planned dividend distributions do not begin immediately.
For example, suppose you enter:
- Preferred-share redemption value: $4 million
- Corporate starting assets (non-registered account): $0
- Ongoing corporate income: $400,000 per year
The plan has been told that there is a $4 million preferred-share interest in the company, but the company itself starts without any of its existing assets represented in the plan.
As corporate assets and retained income accumulate over time, you may therefore see dividends delayed because Voyant is building the company's book value from a starting value of $0, rather than beginning with the assets the company actually owns.
As corporate assets accumulate over time, you may therefore see dividends delayed while the corporate value builds toward the value represented by the preferred shares.
If the company was already had a book value of $4 million when the plan began, this would not accurately represent its starting financial position.
Instead, the existing corporate assets should also be entered. You can reflect these in the company's underlying non-registered account.
How should I model an existing estate freeze?
Start by determining the company's actual financial position at the beginning of the plan.
For example, assume:
- The company currently holds $4 million of investments.
- An estate freeze has been completed.
- The existing shareholder holds preferred shares with a $4 million redemption value.
- A family trust owns the new common or growth shares.
In Voyant, you could model:
Company non-registered investment
Starting value: $4 million
Preferred shares
Redemption value: $4 million
Common/growth shares
Owned by the trust, as appropriate
This allows the plan to recognize that the company already has $4 million of underlying value while separately showing that the existing shareholder's interest has been frozen at $4 million.
Once the estate freeze is established using the option in the What If section, the preferred shares retain their fixed redemption value. Future increases in the company's value, including investment growth, ongoing business or corporate income that is retained, and other appreciation, can then accrue to the common or growth shares based on the share structure being modeled.
Am I double-counting the $4 million?
No, provided the entries reflect the client's actual circumstances.
The $4 million corporate investment and the $4 million preferred-share redemption value represent different things.
The corporate investment is an asset owned by the company.
The preferred shares represent an ownership interest in that company.
A useful comparison is owning shares in a corporation that owns a building. The corporation records the building as an asset, while the shareholder owns shares in the corporation. Recording the building does not eliminate the need to record the shares, because they represent different levels of ownership.
The same principle applies when modeling an estate freeze.
Should the corporate assets always equal the redemption value?
Not necessarily, provided the entries reflect the client's actual circumstances.
Where the corporate investment and preferred-share redemption value happen to be the same amount, they still represent different things.
The company's starting assets should reflect what the company actually owns at the beginning of the plan. These assets establish the company's starting book value within Voyant. You should not enter an artificial asset simply to make the company's book value equal the preferred-share redemption value.
The preferred-share redemption value, by contrast, generally reflects the value frozen for the shareholder based on the company's fair market value when the estate freeze was established.
Fair market value and book value are different concepts and may differ significantly. Likewise, redemption value, adjusted cost basis, paid-up capital and the value of the company's underlying assets are separate concepts and may not always be equal.
The goal is to accurately represent both:
- The company's actual assets and resulting book value; and
- The shareholder's frozen interest represented by the preferred shares.
Example
A company is worth $4 million immediately before an estate freeze.
The existing shareholder exchanges their interest for preferred shares with a fixed redemption value of $4 million. New common shares are issued to a family trust.
At the beginning of the Voyant plan, the company still owns its existing assets. These assets should be entered to establish the company's starting book value, which may or may not equal the $4 million fair market value used when establishing the estate freeze
The plan should therefore reflect both the company's existing assets and the $4 million preferred-share redemption value.
As the company's assets subsequently grow and it retains additional investment or business income, its book value within the plan can increase. The preferred shareholder's interest can remain frozen at $4 million, while value above the frozen interest can accrue to the common or growth shares based on the structure being modeled.
This is the key purpose of modeling both values: The corporate assets establish the company's book value within the plan, while the preferred-share redemption value represents the value that was frozen for the preferred shareholder.
Note: In this example, the company's starting assets and preferred-share redemption value happen to be the same. This will not necessarily be the case in every estate freeze.