The Interplay Between the Funding Mechanism And the Valuation? 

What happens when life insurance proceeds are part of the funding vehicle of a buy and sell agreement (BSA).    

 Example 

 When a stockholder owner dies and life insurance payments are made, is the valuation of the stock being redeemed as part of the value of the company?   

The way life insurance benefits are treated in the buy and sell agreement (BSA), could lead to different estate treatment and income tax.    In both areas, the results can be dramatic.     

 Does the agreement tell the appraisers how to treat the life insurance benefits in their valuationDoes the agreement provide for the company to issue a promissory note to a deceased shareholder, and what are the terms? 

 Keep in mind, the agreement is no better than the ability of the parties and/or the company to fund any required purchases at the agreed upon price.    An agreement that is silent on this issue is like not having an agreement.  

 Life insurance  

 Generally, life insurance premiums are not deductible, and the pass through of non-deductibility can create pass-through income for the shareholders of S corporations, and the owners of partnerships and limited liability companies.  Knowing how to treat the life insurance premium for tax purposes would be important information for you.  We suggest you discuss this with your CPA.  

 Although the life insurance premium is not deductible, the death benefits generally are tax- free, notwithstanding the alternate minimum tax treatment for C corps.  

Keep in mind the funding mechanism is not actually necessary to define the engagement for valuation purposes and has nothing to do with appraisal standards or qualifications. It provides the funding for the company to afford the value, and to make sure the selling stockholder receives the value.  In essence, it’s the mechanism to fund the liability of the contract, or at least part of it.   

Wants and Needs of the Buyer and the Seller- The normal push and pull!  

The seller wants the highest price and the buyer wants the lowest price.   Without a doubt the best time to set the price would be prior to a triggering event, when both parties are in parity and neither is the subject of the trigger.  It is the best time when both parties will be the most reasonable in setting the rules of the agreements as they are both fair minded in the negotiations.   

 Funding Methods 

  1. Life InsuranceIn most cases life insurance will be the most inexpensive method for funding the death benefit part of the agreement, when comparing, self funding, and loans (including corporate promissory notes) to fund the liability, notwithstanding the ability to get a funding loan from a loaning institution.    In most of the comparisons I have done over the years, life insurance is the least expensive, most guaranteed, and the easiest method of funding for death benefit purposes. 
  1. Corporate Assets: They would have to be accumulated for this purpose, and would likely be included in the valuation, and also would be subjected to taxes during the accumulation stageWhat if the death of the stockholder occurred early after the agreement?  Would there be funds available to fund the liability of the agreement, as there would be a lack of time to accumulate the necessary net profits for the funding?   
  1. External borrowing: Depending on the company’s financial position, it may be possible to fund the purchase price by borrowing.  However, this should be negotiated in advance and before its needed.  Remember, the time to requests funds from an institution is when you don’t need them.  Also, on the other side of this funding element, is the possibility the loan covenant requesting the outstanding note balanced to be called in when there is a dramatic change in ownership and management.    The lending institution may be questioning the ability of the company’s future financial position and the ability to stay profitable.   
  1. Promissory Notes:  If this is going to be used, the terms of the notes should be in the agreement.  Although cash payments are preferable to the seller.   
  1. Combination of cash and promissory notes: Important to note:  Anytime capital is being used by the corporation, it is important not to unreasonably impair the capital of the business. Many state laws prohibit transactions that could impair capital and raise the question of insolvency.  

Without the mention of what funding mechanism is being used in the agreement to repurchase shares, lessens the value of the agreement.  Also, with stated funding, the economic or present value of the redemption price set by the agreement can significantly be reduced, because of inadequate interest or excessive risk leveled on the selling shareholder.   

  

Weak terms in the agreement of the funding mechanism diminishes the value of the agreement from the sellers prospective. However, terms that are too strong can taint the future transactions. What is clear is that it is essential for the parties to discuss the funding mechanism for the triggers of a BSA, keeping in mind both the sellers value position and the purchaser’s ability to fund the costs. 

Designing a buy and sell agreement can be a challenge to not only the advisor but also the owners of companies! 

Factors to consider when selecting the type of Buy and Sell Agreement for your business.(I) 

Before you can design a buy and sell (BS) you need to consider the following:  

  1. Number of owners: the greater the number, the more likely the BS will be a stock-redemption. 
  2. Nature and size of the entity: As a rule, a larger company will call for a redemption BS, or hybrid do to the fact that ownership interests will probably be worth more.   
  3. Value of the entity: The higher the value, greater chance of a redemption BS. 
  4. Relative ownership interests: Because of larger interest in ownership, greater likely hood a redemption or hybrid because of the cost to purchase. 
  5. Ages of owners: If there is a wide disparity in age between owners, greater chance of using a stock redemption or hybrid BS agreement?  
  6. Financial conditions of the owners: The more questionable an owner’s finances are the more likely a redemption/hybrid. 
  7. Enforcement of buy-sell agreement:  If there is a question as to the likelihood of partners reneging on the BS, or unable to fulfill the purchase obligation, the more likely a redemption/hybrid. 
  8. Desires for new cost basis for the purchasing owner: Chances are a cross purchase arrangement would be used if surviving purchasing partner wanted a higher cost basis.  
  9. Health and insurability of the owners: When there are younger or unhealthy partners, the disparity in premiums will tend to adversely affect the other owners, consequently, redemption will be used.  
  10. Commitment of owners to business: Cross purchase or hybrid can be used so the more committed partner can purchase the non-interested partner directly.  
  11. Availability of assets inside of the entity for redeeming the interest: Since some businesses have minimum-asset performance-bonding, a cross purchase BS would be used. General Contractors would be an example.  
  12. State law with respect to entity redemptions: If lightly capitalized, use cross purchase.  
  13. Existence of restrictions under loan agreements on the use of the entity’s assets to redeem equity interests: Loan agreements may have restrictions on the use of assets as they are the collateral for the loans, usually would use cross purchase. 
  14. Family relationships within the business:  Maintaining equal ownership between family members can be a challenge, normally, a cross purchase agreement works the best, unless the business is capitalized to have different classes of stock. 
  15. Professional licensing or other qualification requirements: Licensing and professional designations with, (professional corporations) will have an impact on the type of redemption agreement.   
  16. Type of entity: If a family C corps, there would be concerns that a redemption would be treated like a dividend, if so, they would opt for a cross purchase, if that was an issue (attribution).  

 As you can see, depending on the situation and circumstances of the company, the type of Buy and Sell agreement is not a random decision. Planning and insight must be used.  This comes down to asking the right in-depth questions when discussing the designing of the buy and sell agreement.

(1) Paul Hoods great book:  Buy-Sell Agreements

If you would like to receive a free report on the 19 questions you need to ask yourself to have an efficient Buy and Sell Agreement, email me at:  tperrone@necgginc.com, request: 19 questions.  I will send this to you immediately,

Critical Questions That You Need To Answer If You Own A Business!

Building a business is hard work. Protecting and preserving it is even harder and overlooked by business owners.

While many owners expect family members to take over the business (69%), very few have actually made plans to make sure their wishes are accomplished (26%), even though they realize the importance of estate and succession planning as is an integrated part of that planning.[i]

A succession plan is complex, time consuming and involves attention to details along with many hard questions which need to be answered for a comprehensive and effective succession plan.  It is also the key element in maximizing the return on the investment of your business. This is the big financial payout, the sale of your business.[ii]

SOME MAJOR QUESTIONS AND ISSUES TO ASK YOURSELF!

What if a shareholder wants to sell their interests?

  • Is there a right of refusal for the other owners?
  • What are the financing arrangements?
  • What are the recourses if you fund the buyout especially if the funding is over a long period of time?
  • What is the arrangement if the business fails, how will you get your money if you financed the sale?

 Who steps in your shoes if you want out? 

Not everyone has the luxury of leaving a business when and how they want to.  Things like death, disability, and situations are uncontrollable.

  • What are your contingency plans when a trigger occurs (death, health, non-voluntary situations)?
  • Do other members of the firm have access and authorization to use funds to keep the business going if there is such an event?
  • Does your family take on personal obligations for financial notes and loans you have signed personally to fund your business operation?
  • Do you have estate documents and health care directives, should you have a disability or become incapacitated?

Taxes- and the planning for them Continue reading “Critical Questions That You Need To Answer If You Own A Business!”

The Story! The Cost of Funding Your Buy and Sell Agreement! Options!

The Story! 

The Cost of Funding Your Buy and Sell Agreement! Options!

Over many years I have experienced many business owners in total denial about the cost of funding their buy and sell agreements, thinking they can come up with the liability when the trigger of death occurs.

The four listed ways are compared below.

  1. Cash
  2. Borrow
  3. Sinking Fund
  4. Life Insurance

Let’s take the one by one.

Cash: This is assuming the company has the cash at hand, idle. Rarely is this an option. Growing companies reinvest in their company and only keep enough cash reserve as needed.

Borrow: A company just lost a valuable member of the company. Most bankers would probably want to see how the company will fair after the death of a key person and would want to know how the liability which has just been created will affect the cash flow of the company before loaning more money. There probably is a good chance that outstanding line be pulled in by the bank (probably a covenant in the loan agreement).

Sinking Fund: Mostly just theory! In 48 years, I have never seen a company try to develop a sinking fund. If the company was putting money in the sinking fun, they are losing the opportunities this money could create by investing in the business rather than on the sidelines. Not reasonable as the actual amount of money needed is available should death occur prior to the target date of accumulation. The least appropriate method.

Life Insurance: At its simplest benefits, it is immediate, tax free and the funding level is immediately known. Also, the cost is only 17 cents on a dollar rather than the much higher costs of the other three options.

Summary: While we don’t know when a death or disabilitymay occur, the company should at least be prepared for this trigger. Today the price of life insurance is low-cost. There is no reason not to purchase at least temporary life insurance (10-30 years), such as term insurance. The cost of life insurance in the example is using cash value life insurance.  Increased Sales To Fund Cost: Another measure of effectiveness of funding the buy and sell is to measure how much more in sales the company has to do to pay for the funding method.

Costs:  Funding over 15 years. 

Cash; 1,039,464 Loan: 1,306,085. Sinking Fund: 901,613 Life Insurance:  171,512

Also, what do you need to have in sales to pay for the method: 

Example, with Life Insurance Cost, @20% profit, sales would be $857,560

With Cash: There would have to be $5,197,320

 

 

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Living the Dream

What People Are Saying About Tom!

Tom’s ability to plan a strategy and its implementation accurately and quickly have contributed immensely to the success of many clients over the past several decades. Tom goes out of his way to service clients. He made sure we understand the planning process and is extremely patient. His talents are that of an educator and planner. We benefit from his pragmatic approach to our business and personal planning needs.       Carl Bonamico, Liberty Bank Commercial loans

When Tom says he will do something, he does it. He’s a very dependable person and is extremely honest. He looks at all the options possible in your overall planning. If he sees something which doesn’t fit, he tells you. James W Cowan Jr. Life Planning Consultants

Tom has all the qualities that I look for in an advisor– Integrity, knowledge, patience and his follow-through can’t be equal.       Brent Berti, Reverse Mortgage Broker

 I have worked with Tom in the insurance and estate planning business for the better part of 25 years. I have always found him to be hard-working and extremely knowledgeable in his areas of expertise. I have full confidence that when I refer clients to Tom, he will be thorough, clear, and recommend the proper products to offer solutions to their problems.    David Isenstadt, owner New England Group Insurance

Tom has guided my business and personal finances for 35 years. He has always been honest, dependable and readily available. The Shredding Source has benefited greatly from his approach and talents as a business and benefit planner. I continue to avail myself of his proficiency and expertness through my retirement… William A. Young, The Shredding Source.. A Veteran Owned Company

 Having dealt with Tom for over 20 years I can say he is unique in his hands-on approach with his clients. With the Ebb and flow of individual finances, he always presented programs that make sense for the time and circumstance. I have faith in his approach and recommend him highly. Ronald Finocchio, Owner of The Shredding Source, A Veteran Owned Company

Tom is been invaluable to me and my clients in the areas of advanced life insurance and estate and business planning. He has extensive knowledge in this field and his ideas and solutions are creative.   Tom Maercklein, Insurance broker

Tom goes out of his way to understand his customers and their unique needs. Tom can listen to his clients, understand what it is that they truly need and want, then deliver to them a great solution.   I highly recommend Tom.   Joe Perrone, Co-Owner- New England Collision

Tom’s financial education has given us a path towards a rewarding future. This was especially important when we had a financial setback. Tom worked through it with us and took many meetings and financial input to put us back on a strong footing.  His confidentiality is above reproach and he is clearly a most compassionate man with the utmost integrity. We have considered him a friend for years now.  Wayne and Ginny Klinga, Owners of Park City Valve and Fitting, Bridgeport, CT

 We have worked with Tom for number of years and he has given us professional and well thought out assistance with our retirement planning. In addition, we have owned a business for over 30 years and the eventual sale of that business was a very important part of our plan as we moved on with our lives. We had to think about employees, timing of the sale, how best to accept and invest sales proceeds and how this stressful and most complicated process would fit into our retirement strategy. Tom worked with us on this important part of our plan not only with his own advice, but also steering us to literature written by experts to guide us on our journey. We always looked forward to and felt comfortable in our meetings with Tom. His constructive advice was a key part of our retirement transition. Frank and Diana Byrne, FORMER BUSINESS OWNERS

 

Good Luck You Are Now In Business! Now What?

Chances are that the moment you started your company you felt the need to be in charge of everything (the control thing).  Tasks such as ordering stationary, trips to Staples, talking to the utility company, dictating messages and a sundry of other things. You did pretty much everything including the bookkeeping, sweeping the floors and taking out the garbage. 

 You were proud of your new business and wanted to make sure it did well from the very start and in in every aspect of your business. Even if it meant you had to work 80 hours a week to keep it going to be successful.   

 Then you started to make more money, enough to hire employees to help you grow the business.  As you moved forward so did your business commitments.    Your mindset however, is control, just like when you started the business.   A natural reaction since you started and created your business, the tendency is to protect it, this is your baby! 

THE NEEDED CHANGE IN MINDSET! 

The problem comes when you have to change your mindset as an entrepreneur. When you started your business, you had a talent and believed that your talent could make you profit and grow your business. However, as your business and commitment to the business grows, there needs to be a new way of thinking on how you should run the business.  

 For example; I have a brother who is a great mechanic.   If he were to open his business, he would be the best mechanic you could find.  His work would be impeccable, and everyone would enjoy working with him.  However, the minute my brother had to start thinking strategically about how to lessen his working hours, grow new markets, start a branding campaign, hire people to do some of his tasks, he would become very stressed and would definitely lose interest in running his business.  He is a great mechanic but didn’t think about the other parts of running a business.  All he ever wanted was a place to go paycheckand a position. Little did he realize that it would take more than being a good mechanic to run a business.   He didn’t realize that some of the things he liked to do would have to take a back seat or be delegated to someone else, so he could focus on the details that will allow him to grow his business.    

Continue reading “Good Luck You Are Now In Business! Now What?”

Insider Transfers! Ready Or Not!

Transfers to and insiders group appears to be the most   traveled paths for succession planning by business owners today, which are being successfully used by business owners.  

This is the method by default because of the lack of essential value drivers and systems developed by the business owner.  Because of the lack of transferrable value, insiders are the key market for the business owner.   However, it is possible that even though the employees might have the capital to purchase the business, they don’t have the necessary ability to run the business without the owner.   Consequently, this scenario may lead to an inside sale at a depressed value, or the owner becomes a semi-passive owner.   

Typically, The Transfer To The Insider:   

In many situations, the employee will put very little money down, because they don’t have what is needed, or is unwilling to finance a large part of the sale.    The Owner usually will take back paper and finance the sales price.  Typically, the buyer will default because there is not enough cash flow to support the operating expenses and pay the note payment.  

Even with that scenario, there are many employers who take the path of transferring their business to key employees. Even though in many cases the arrangement is ill-fated, and the business will fail.    The actuality is the transfer to insiders is the exit path most traveled by business owners. The point being is that there still needs to be planning done in advance, even if the transfer is two key groups.   

Benefit’s For The Key Group Becoming Owners:  

  1. The key group is acknowledged for helping to build the business; The owner wants the key groups to ultimately own the business, especially since they have been part of the success of the business.  
  1. Goals of the owner: The owner can see his legacy remain unbroken and his business culture continue. The business represents the owner’s value in the community, and the company’s consistent values.  
  1.  It enables the owner to plan their retirement and exit over a longer period of timeSince the process of transferring the business to the key group takes , the owner has the ability to plan their post retirement activities.  It gives the owner the chance to start delegating more responsibilities to the new ownership, testing the group’s ability to run the business. 
  1. It gives the owner a chance to share in the excess cash flow to build wealth outside the business.  This helps in transferring the business at, a lower net amount to the buying group, as the owner would have accumulated the wealth outside the business, but with business dollars.    
  1. The process of transferring ownership and control to the insider’s takes a period of time, anywhere between five and twelve years. This allows the owner to start adapting to a post business life. It allows the owner to start picking up other activities of interest. It allows the owner to contemplate his new life and start making plans well in advance. This is very important especially if the business owner has only singularly most of his business all his life.  The time gives the owner the ability to create new activities with interest, to test the waters.  
  1. Motivates employees: To stay with and grow the company if the owner has a properly planned internal transfer the owner can start this well in advance of their exit. The key employee becomes an owner through their purchases of non-voting stock. This is part of the powerful incentives for the employees to create an increased cash flow. It also motivates talented employees to see the future opportunities in the company, allowing them to stay and grow with the company.   
  1. Maintain senior control; The owner will not lose control of his company until he completely cashes out. Usually stock acquired by the employees is non-voting. Employees acquiring   the stock should be asked to sign covenants such as a not to compete, and non-solicitation agreement. This protects the owner from having the key person leave the company and take customers, trade secrets, and current employees with them.  
  1. Flexibility: A properly design transfer plan helps the owner maintain control until the owner can cash out. It gives the owner the ability to abandon the internal transfer so they can sell to an outside company, or a third-party at some point.   All ownership previously transferred would be subject to a buy and sell agreement requiring the employees to offer their ownership to you for repurchase at a predetermined price if the employment is terminated. 
  1. Business continuation at the owner’s death. By transferring ownership to insiders, it creates the succession plan should the owner die. The hope is that the key group has been trained well enough, to run the business without the owner. 

CHALLENGES AND LANDMINES!  Continue reading “Insider Transfers! Ready Or Not!”

Drop Dead Business & And Personal Planning Questions!

These are questions I believe everyone should be asking themselves when you start their planning. Not all the questions may relate to your situation, however, many of them will. It is important that you take time in evaluating your outcome in your planning as it relates to theses questions!

1. Have your wills and associated trust documents been updated in the past three years, if not, why not?

2. Do you have the following: declaration for desire of natural death, power of attorney, and health care power of attorney? If not, why not?

3. Does your testamentary documents make sure your family’s business and estate is private after your death?

4. Are your assets titled properly between you and your spouse in order to take maximum advantage of the estate tax laws?

5.  Do your testamentary documents specifically address the disposition of your family business/family assets?

6. Do your testamentary documents agree with other business arrangements such as buy and sell agreements?

7. Do you pass ownership of the family company/estate assets to your spouse in your testamentary documents as a tax avoidance measure? If so, is will that;

Make practical sense, and is that consistent with your wishes of your spouse? If the business ownership does go to your spouse, is there a potential for your children to inflate his/her estate thereby increasing their estate tax burden during his/her surviving lifetime?

8. What are your testamentary provisions for treating your employee and non-employee children fairly and equitably?

9. In your “drop dead” planning, do you have insurance proceeds includable in your taxable estate?  If so, why? 

10. For your real estate; do you use family limited partnerships or limited liability companies? If not, why not?

11. If there is more than one shareholder in your family enterprise, do you have a binding, modern buy sell agreement? If not, why not?

12. Does your agreement cover typical items such as disability, “bad boy” behavior, windfall sale, non–compete provisions, etc.?

13. Do you have a written plan for when your family members get home from your funeral to lessen the burden on them? If not, why not? In the future will your business go to family members some of whom are employed in the company and some of whom are not? If so, what provisions will you make to balance the interests of employees’ shareholders versus non-employee shareholders?

14. Your CPA, attorney, and other advisors have probably been after you for some time to address the issues of your exit, future management of the company, your estate planning, etc. What are the barriers that prevent you from tackling these tough family business and estate issues?

15. Children inherit too much in the way of assets too soon? What do you see as the downside of “affluenza”?

16. Will your children inherit the business/estate assets in equal proportions, or would one child be designated the prize, and take and receive a larger portion.  What are the pros and cons of each course of action?

17. What do you have too much of in your business?

18. What do you have too little of in your business?

19. What do you have too much of in your family?

20. What you have too little of in your family?

21. If you had a magic wand, what will be the one thing you would change about your family or business?

Getting Ready To Sell Your Business Even Before You Thought About Selling It!

Business owners who have the ability to hire, train and retain excellent employees do themselves a great favor when it comes time to sell their business. Recruited employees who sign on to the company culture, are potential purchases of the company.  They get involved in all aspects of the business when given the chance.  The ability to nurture these employees not only creates a great long-term employee, but possibly future owners of the company.   The investment in good employees has the by-product of creating a potential market for the business owner’s business. 

Over time, these owners can create   employees who become extremely loyal, and feel part of a group and the business itself.    They observe how the current owners treat the business, the employees, and learn the long-term elements needed for a successful growing business.  They become clones of the current ownership, and start to think like owners, while taking on more responsibilities.

While the owners at some point need to make the commitment to the potential employee(s) purchaser to sell the business to them, it also means the employee or employee group needs to be able to commitment to the purchase of the business.  To the purchasing party, this means committing to taking on risk and financing for the purchase of the business.  In most cases this is something they never have done before.

The commitment to sell the business to key people, or key person is a long-term process.  The owners have to make sure the key person (s), have the ability to think like employees, and the abilities to run the business with expectations of the company being profitable.  The owners will spend time training and assessing the abilities of the key group to prepare them for the business takeover There is a commitment on both sides as to arranging this type of sale.

Financing the Sale: 

A sale of the business to an outside group usually is a cash sale.  Or, a combination of cash and stock of the new owner.  (Usually when a larger company buys a smaller company).

It is here that the advisors need to make sure the selling owner maximizes his sales with tax efficient transactions.  Many business owners sell their firms only to be surprised at the after-tax results of the sale.  Keep in mind that when you sell the business, usually there is a low-cost basis, the consequence paying higher taxes on the gain, means less net profit!

If it is an asset sale, there may be a low-cost basis   of the assets being sold, consequently creating more tax exposure, and more taxes.

Take for example, an asset being sold after it has been depreciated, it may be taxed as ordinary income.  Usually the asset is owned by the corporation.  If the company is a C corporation, the sale is taxed at the corporate level, then taxed at the personal level.  The combination of a low-cost basis, C corporation tax, ordinary tax rates, and double taxation can erode gross profits to a point where the owner wonders why they sold the company for the next. 

If the owner sells their company to a publicly traded company, and takes back some of the  purchaser’s stock, there should be pause as the consequences should the stock value fall because of the transaction, and the uncertainly of the value when the selling owners wish to cash out.

It has happened more than once when selling owners, ended up with much less in their pockets after the taxes and expense of the sale were taken out!

Selling to a key group or a key person is usually a different arrangement.   Usually the employee does not have the financial ability to purchase the company, thus a loan from the small business association or bank is needed.  Sometimes, the employee comes up with money by refinancing their home or borrowing from the family.  In many cases, the selling owner usually takes back a note expecting payment from the cash flow of the business.  It’s common to have a combination of refinancing, a promissory note, and possible deferred compensation payment to the selling owner.  In any event the selling owner usually has some skin in the game as to the financing of the sale.  Because of owner financing, the ultimate payoff might be extended over a longer period of time.  Not necessarily a bad thing, as the owner can spread the tax liability over a period of time.  The owner will also have a security interest in the stock, assets, and receivables of the company, until the loan is paid off.

Continue reading “Getting Ready To Sell Your Business Even Before You Thought About Selling It!”

Business Succession Planning Is  A Necessity For Every Business! 

Business Succession planning for businesses, especially private companies, should be on the a top propriety in the planning area.  Whether the sale will be to top management, middle management, family or to outside sales, it should be an ongoing planning concern.  

A number of private established company’s do not have any such planning, and newer companies in where the owners have no family to take over have the same problem.  In both situations there is a challenge to create a succession plan.   

Business succession planning could be the hardest planning of all.  However, it is a must in planning.  It is the only way the current owners can guarantee that the wealth of the company will either be passed on and continued, or the wealth is transferred to the families through the sale of the business.  Without the succession plan, the largest potential of business wealth can be lost forever.   

The lack of a Succession planning is the reason why many stockholder owners walk the floors at 2am.  They have a true concern for the successor of the firm and the protection of the wealth of the firm.   

 Some of the questions that the owners of firms have:  

  1. What if I die or become very sick?  
  2. What if I lose my key person or key group?  
  3. What if don’t want to do this any longer?  
  4. What if there is an economic downturn and I can’t recoup?   

Other areas of concern are:  

  1. If I want to sell, when do I sell?  
  2. What is the business worth?  
  3. Does the senior management want to leave and retire, or stay active?  
  4. Can the main group of owners afford to retire without creating a cash flow crunch?  
  5. How vulnerable is the company if key people leave and take the secrets with them, or even start their own business, using the company’s business model, or share vital business secrets?  

 The questions discussed above along with many other questions, are the basis of the planning and will help the planning team of advisors guide the owners through the maze of planning traps and opportunities as they walk the path together.    Continue reading “Business Succession Planning Is  A Necessity For Every Business! “

Shift Corporate Income For Your Personal Retirement! 

 If you own a business, using a split dollar life insurance plan can help you shift business income to you on a tax effective basis, without involving other employees!

 Split dollar life insurance refers to the concept of two or more parties splitting the benefits and costs of a life insurance policy, such as the premium, death benefit and cash value.   

The most common type of split dollar life arrangement involves an employer and the employee or owners, with one part owning the policy, one or both parties’ contribution to the annual premium, but both parties having a vested interest in the policy benefits.   

Split dollar plans are inexpensive and easy to administer as an executive benefit arrangement.   

Here is how it works:  

One party establishes a cash value life insurance contract under the ownership of the key executive.   

The employer receives a “collateral assignment” against the policy, entitling the corporation  to receive the lesser of the policy cash value or the outstanding loan balance.   The loan is based on the premiums contributed by the company.   The same assignment entitles the employer to a portion of the policy death benefit, equal to the outstanding loan balance.   

 The key executive pays the taxes each year on the foregone interest on the loan from the corporation to pay the premium.   

At some point in the future, the split dollar arrangement terminates when the employer’s loan is repaid (typically from the policies cash value), leaving the executive “free and clear” ownership of the accumulated gain in the life insurance policy.   

 The executive can access the accumulated gains in the policy by borrowing against it, which will typically allow for tax-free access to the values.  The policy loan is repaid to the insurance company at the death of the executive, and any residual death benefit is paid to the executives’ named beneficiaries.  

Split dollar is an easier benefit to implement than deferred compensation, and less expensive for the employer.   

 Advantages:   

  • Easy account entries 
  • Recovery of the cost for the employer 
  • Performance objectives to trigger the funding for employer 
  • Very little if any impact on company balance sheet 
  • A “golden handcuffs” for the employer and ability to set restrictions when cash value can be accessed  

 Today’s newer types of life insurance policies enhance the benefits of a split dollar plan  Continue reading “Shift Corporate Income For Your Personal Retirement! “

Business Valuation After The 2017 Tax Cut And Jobs Act

Because of the Tax Cut and Job Acts of 2017, the marginal rates are lower.  The impact of the recent tax cut is very straight forward.   Lowering the rate, means a higher after-tax cash flow which translates into higher value for businesses.

Business owners know their business better than anyone.  That being said, you would also assume they would know the value of the businesses? Not so fast!

Knowing your business and knowing what you think it is worth in reality can be two separate issues.  If it were that simple, appraisers would not be needed, but they are, and they play very key role.  They arrive at a fair market value after taking many facts into consideration.

Valuations; “The Walk Way Number

The “country club” concept of a business owner having a number in his/her head as to what they would take, if offered, offers some interesting conversations during happy hour!

Over the years I have spoken to business owners, and periodically I have been told that the owner has a figure in their head, and if they were offered that figure for their business, they would take it!  They seem to know their business better than anyone, so it is reasonable to believe they have a handle on the value of their company.   In more cases than not, that figure would allow the owner to go and do what they want in life as it would give them the capital needed, and the can walk away from the business.

However, there are some different sides to this concept!   A more logical way of knowing the business value!

Continue reading “Business Valuation After The 2017 Tax Cut And Jobs Act”

The “What If’s”of a Business Owner’s Life!

The Four Life Changes Of A Business Owner

What is it that you think about the most as a business owner?   Chances are they are one of four things:

  • What if I don’t want to stay in business and I want to drop out?
  • What if I get sick, disabled, or die?
  • What if my key person (s) decides to leave me?
  • What if I can’t increase and improve my cash flow (life blood of the business)?

Besides running the day to day of the business, and the stress that goes with this, the four items listed above are probably the biggest stressful thoughts business owners have.   Let’s break them down.

Continue reading “The “What If’s”of a Business Owner’s Life!”

How the “Wait and See Buy And Sell” Works !

The Wait and See Buy and Sell arrangement is a combination of using a Stock Redemption and a Cross Purchase arrangement.  It affords both the company and the continuing owners the option to purchase an owner’s interest with great flexibility when a buyout situation presents itself .  Usually the company gets the first opportunity to purchase any  or all of the transferring owner’s interest.  Any balance of interest not purchased by the company, can be purchased by the continuing owners.  If the owners don’t buy the  remaining interests, the corporation must purchase them!

The “Wait and See” agreement gives flexibility to the owners in areas of:

  • Financing the purchase of interest
  • Cost basis positioning
  • Estate planning
  • Other planning areas
  • Changing the percentage of ownership

The biggest advantage however, is the ability of not having to make a decision until there is a trigger event. 

The Scenario

When a notice is received by the company of an option to purchase, whether it’s by a Notice of Intent To Transfer, right of first Referral, or notice of a business-disrupting event such as the retirement, divorce, disability, or death of an owner, the procedure for the option to purchase an Owner’s Interest in an agreement is triggered.  No matter how informally the notice may be given, it’s important to understand that the amount of time the company has to decide whether to purchase (the option period) starts to tick only after the company knows that the triggering event has occurred.  For example, if the company does not receive a formal notice that an owner has filed for bankruptcy.  Only when the company becomes aware of the bankruptcy does the buyback right get triggered, and the option period starts to run.

Company’s Option to Purchase

After the company receives notice, the company’s owners should meet with their tax advisors and each other to decide if it’s in their best interest for the company itself to buy the available interest.  The agreement will normally have a period of time in the agreement which stipulates the period of time the parties have to decide individually whether they want to purchase the available interest or not.  If the owners decide the company should buy all of the available interest, the company must exercise its option by delivery a written Notice of Intent to Purchase to the transferring owner within the designated time period.

 Notice of Intent Contents (THE NOTICE):

If the company or anyone of the continuing owners exercise their option to buy the available interest, the company sends out a collective notice to the transferring owner, or the current holder of the interest, regarding the company’s and /or continuing owner’s intent to purchase a part, or all of the available interest (called a Notice of Intent to Purchase).

Generally, the Notice is sent to the person who provided the original notice to the company of a proposed transfer, or the occurrence of any of the triggering events that give rise to a buyback.  Example:  NOTICE is sent to the interest of a deceased owner will go to the representative of the estate.

 THE NOTICE CONTENTS;

The name and address of the company and the name, title of the officer or employee who can be contacted at the company regarding the NOTICE.  A description and the amount of ownership interest to be purchased by the company/party, along with name and address of each party.  The total amount of interests to be purchased by the parties. The terms of the purchase are based on the agreement Copy of the buy and sell agreement. If the interest to be purchased is represented by certificates, such as share certificates, a request for surrender of the share certificates is made to the company.

Continue reading “How the “Wait and See Buy And Sell” Works !”

Characteristics Of An Effective Buy –Sell Agreement!

Creating a buy-sell agreement requires foresight about what could, might and will happen to the business if certain situations occur to the equity owner’s/stock holders of the company. This article looks at some of the important elements of the buy-sell agreement (BSA).

First of all, what is the purpose of the BSA?  Simply, an agreement between, interest holders, and the corporation as to what will happen to the company and interest holders should there be a disruptive and harmful occurrence in the future.  These are called triggers; death, disability, divorce, departure (voluntary and non-voluntary), bankruptcy, retirement, and others.

It is important that the agreement be entered into when parties are aligned and before triggers events occur.  It usually is a time when the relationship is aligned for the good of the interest holders and the company.  In short, they usually are of the same mindset that any of the triggering events could happen to them in the future,

This is a time where advisors should encourage interest owners to complete and sign the BSA, as it is the best time when their attitudes are in synch concerning future event happenings.

Interest owners know that when there is a trigger event, each party will have a different perspective as to outcomes for each person.   Terms and pricing transactions can become difficult or impossible to achieve if the issue was dealt with without an agreement in advance.

 Some of the characteristics required in the agreement;

  1. It should be in writing and signed by all parties. (good time to have spouses sign as to their witnessing and understanding of the agreements, although they are not signing as a party to the agreement)
  2. Trigger events should be defined and funding and price adjustment; Each event should be discussed as to what will happen as to the price, and the terms. Also, the definition of the trigger event should be in the agreement.  Example: definition of disability? What happens if a person is fired? What happens if a person decides just to leave?  What happens upon a divorce, or bankruptcy, retirement, or death?
  3. Determine the conditions that cause the triggering events.
  4. Determine the price (price per share) at the time of the triggering event.
  5. Methods of Valuation
    1. Fixed price; usually never updated with changing markets, and company condition.
    2. Formula: with all the variables of economic conditions, company conditions and market conditions, it is hard to find an accurate formula for any given company or industry.
    3. Single Annual appraisal (updated annually or bi annually); Suggest the initial pricing of the company by a single appraiser, and then update yearly or every other year.
  6. Define how the triggering event will be funded.
  7. Creating a buy-sell agreement takes future thinking by all the interest owners. There is always the “what if’s” of the future, but owners need to be aware of them and protect themselves.

The BSA is the most important document owners of a business can have.  They must have one.  Without it, there are no instructions as to what will happen, how much they will pay, and how to fund it.  There ends up being chaos, arguing, and lawsuits, not to mention the costs of fighting in the courts.

(Some great resources:  Buy-Sell Agreements for Closely Held and Family Business Owners by Z. Chris Mercer, and Buy and Sell Agreements, Paul Hood)

 

Your Business Worth

What is your business really worth?  If you don’t know this figure, don’t feel too bad, many business owners don’t know their real worth!

Why is knowing your worth important?  Think of it this way.

If you were to invest in the stock market, wouldn’t you want to know the current value of the company you are investing in, and the potential of it’s growth?

Business owners put time, money, and in most cases, most of their wealth in their business.  At some point you will want the wealth in your business.  It may because you want out of the business, you retire, you die, or a number of other triggers.

This blog is dedicated to sharing ideas about growing your business while putting you in the position of extracting your wealth…

Enjoy…

 

Tom Perrone

Life Insurance Proceeds In Business Valuations

If life insurance proceeds are considered as the funding vehicle, then the proceeds of the policy received following the death of a shareholder would not be considered a corporate asset for valuation purposes.(1)

It would be recognized that it was purchased for a specific purpose of funding the buy-sell agreement (BSA). IF it were considered a corporate asset, it would offset the company’s liability to fund the purchase of shares, added back as a non- recurring expense.

Treatment 1: (used as a funding vehicle, not a company asset)

Example: A company with a $10m value, has two shareholders, owning 50% of the company. The company holds a $6m life insurance policy on each owner (assuming no alternative minimum tax issues).

RESULTS: At Shareholder #1’s death, the company collects $6m of life insurance benefits. The surviving partner will receive $10m company value, and $1m of net tax-free proceeds, a total of $11m value. The deceased stockholder receives the $5m for the business.

Treatment 2: (A corporate asset)

Treating the life insurance as corporate assets for valuation purposes.

The proceeds are treated as a non-operating asset of the company. This asset along with other net assets, would be available to fund the purchase the of shares the of a deceased shareholder. Keep in mind that the expense of the deceased stockholder might be added back into income as a nonrecurring expense.  (2)

The treatment type can have a significant effect on the net position of a company or selling shareholder. There is also an affect in the ability of the company to purchase the shares of the deceased stockholder, and impact of the position of the remaining shareholders.

Company $10m, before $6m of life insurance. When you add the $6m into the value, the company value is $16m. The deceased shareholder entitled to $8m, the company pays $6m in life insurance proceeds and takes out $2m in promissory note.

RESULTS: The surviving owner, owns a company with 8 million and a note of $2 million.

Which treatment is fair? One owner ends us with $11m while the deceased owner, ends up with $5m. In treatment 2, the surviving owner has to carry a $2m debt to purchase the business. Two dramatic differences. A good reason, why the discussion should take place with your advisors.

More importantly, all parties should understand the ramifications of adding the life insurance proceeds in the valuation or using the life insurance as a specific vehicle to fund the BSA.

——————————

1. Mercer: buy and sell agreements for boomers

2. Non-reoccurring expenses: Non-reoccurring expenses can be somewhat more complex. These are expenses which is  specifically  designated on the company’s financial statements as an extra ordinary or one time expense.  The company does not expect to continue the expense overtime, at least not on a regular basis. Non-reoccurring expenses can be somewhat more complex. 

Succession Planning: 6 Key Questions You Must Answer!

THANKS TO CZEPIAGA DALY POPE & PERRI, LLC, author of this article. (written, March 22, 2019) 

*I came across this article last year and I thought I would pass it forward.  I thought it was written very well and had a great message to it.  Should you have any questions, give me a call.  Thank you Czepiga, Daly, Pope and Perri.  

Building and growing an independent family business is an accomplishment to be proud of. It takes an enormous amount of passion, ingenuity, and downright grit. Preserving and protecting your business also requires some effort, but it’s a task many business owners overlook or put off. 

Business succession planning, like any kind of estate planning, is something that should be addressed with the help of a professional well in advance of the actual event. Unfortunately, the majority of family business owners are missing that window of opportunity. According to a 2016 survey from Price Waterhouse Coopers, while 69% of family businesses surveyed expected the next generation to take over the business, only 23% had invested in creating a robust and well-documented business succession plan. 

It’s not difficult to understand how business owners find themselves without a succession plan. It’s a complex and time-consuming process that involves addressing hard realities and tough questions. But, it’s also a task that’s well worth the investment of time and money in the long run. 

If you own a family business and have not yet developed a thorough business succession plan, you may want to consider the following list of questions. These cover just some of the issues a good plan would address. It’s really never too early to start thinking about what’s next for your business, and these questions will put you on the right path. 

Who will take over when you’re gone? 

  • Whether you’re taking the precaution of planning in case of unexpected tragedy or simply doing due diligence in advance of a planned retirement, one of the biggest questions you need to answer is who will take the reins when you’re no longer in charge. 
  • If you were to become incapacitated or die unexpectedly, is there someone ready to step in to run the business? 
  • In such a situation, would your family or other business stakeholders have fast access to funds that would allow them to hire any necessary resources to keep the business going? 
  • Is your family protected against financial risk if you should pass unexpectedly? 
  • Do you have a detailed management succession plan that clearly defines who will take over which roles? 
  • If you face a temporary disability, do you have a business Power of Attorney in place to manage financial affairs related to the business? 

How much control would you like to retain?  Continue reading “Succession Planning: 6 Key Questions You Must Answer!”

A Great Benefit Every Business Owner Should Be Aware Of! 

Over the years in the small business arena, when retirement is mentioned, the discussion usually focuses on programs like 401k, Profit sharing, SEP’S, and Simple Plans.   

 They are all very good plans and every business should offer one of them to their employees for the purpose of having a benefit plan where employees can save for their retirements.   

 However, not every employer wants to take on the burden of funding retirement for their employees for many reasons.  The reasons range from a lack of cash flow, employee groups who would rather take the money home.   

 In situations where the employer feels they would like to use their company to create a benefit for themselves, and not the employees, they should look into an executive compensation plan called the CEEP (Corporate Executive Equity Plan).  The CEEP is a hybrid of a few types of benefit plans used for the higher paid group in companies and for the owners.   

 The term “non-qualified “, refers to a plan that normally is not used for the masses, but used for a selected group of people.  As an example:  Employer A can decide that they want to put a plan in for employee B, C but not employees D-Z.  In most cases the plan itself would not be tax-deductible as a “plan”, however, it can be tax deductible under certain conditions. 

How the CEEP works!  

Mr. Jones owner of the Big Dip Donut shop decides that he wants to allocate $25,000 a year into a retirement plan for himself and no other employees of the company.  For the most part, he can’t have a qualified retirement plan without offering it to the employees.  Even a “Simple Plan”, which is the easiest to implement would have drawbacks.    Continue reading “A Great Benefit Every Business Owner Should Be Aware Of! “

A Road Map For A Succession Planning  Essentials For Planning   Creating Your Team Of Advisors 

Who Are They 

Their Role 

Accountant 
  • Develops financial statements 
  • Provides tax advice 
  • Assists in Estate planning 
  • Assists in Business value 
Attorney 
  • Negotiates agreements 
  • Tax Advice 
  • Prepares estate documents 
  • Advises on business structure along with implementation 
Management Team 
  • Manages the ongoing operation  
  • Operational advice and expertise for new owner 
  • Enables business continuity 
Business Appraiser 
  • Estimates fair market value of Business  
  • Provides the credibility of asking price 
  • Advice on how to maximize business value 
Business Broker 
  • Finds buyer and market insight for value 
Financial Advisor 
  • Facilitates and council’s family goals and value 
  • Plans for the future of the estate and distribution 
  • May have the capacity to help fund Buy and Sell Agreements and Deferred Compensation situations 
  • Offers financial advice to all the members 
  • Helps project future financial needs 
Banker-Commercial 
  • Financing options for acquisition 
  • Access to other experts that may be needed 
  • Supports the business transition before and after the acquisition 

Exit Options: 1 

  • Transfer the business to a family member; This represents about 42% 
  • Sell to partners or your employees (directly or through ESOP); This represents about 17% 
  • Sell to a third party; 19% 
  • Partner: 10% 
  • Wind down business -3% 
  •  Don’t know -8% 

Questions To Consider 

  1. Are there one or more family members who want to take over the business?  
  2. Does the family successor have the skills to operate the business and guarantee the return on your investment?  
  3. What are the qualifications and skills someone would need to purchase your business to guarantee the successful transition?  
  4. If you transitioned to your family member, how will your employees, suppliers and customers react?  
  5. What is the most tax-efficient way to pass ownership to family members?   
  6. Will you continue to have a role in the business? 
  7. How will this succession option impact the rest of the family? 

Selling to partners or your employees 

  • Which employees or partners are best suited to purchase your business?  
  • Do they have funds or access to funds?  
  • Will you have to finance part of the sale?  
  • Do they have the management capability to run the business successfully?  
  • Can the business take on debt for this transaction long term?   
  • Where will the purchase price come from?  
  • Do the purchasers have assets as collateral?   

Third party  

  • Who are likely candidates in your industry that would be interested in your business?  
  • Do you want to sell the whole business or only part of it?  
  • Will the potential buyer have the entire financial resources to purchase the business, or would you be prepared to partially fund their acquisition?  
  • What is the most tax-effective way to sell your business?   

 

Case Study#5 Using Corporate Dollars To Keep Wealth Out Of The Business But In Your Pocket

This is the case of Joey Bag of Donuts and his pursuit of keeping wealth outside of his business.  You see, over the years working with Joey Bag of Donuts we told him that leaving too much of his wealth in the business can be problematic, especially when the time came when he needed to exit his business.  He heard me tell him many times, that someday he will leave his business by either a death, disability, or retirement, and taking the wealth with you when you need it the most, can be a problem, if you don’t have the right exit strategy.

There are many reasons wealth gets lost in a business when it is sold.  It can range from bad planning to bad luck, but Joey Bag of Donuts always remembered to keep as much of his personal wealth outside of the business as possible.  By the way this is why he purchased his company building and put it in a separate LLC.  Joey Bag of Donuts also believes in putting as much of his income to the company pension plan, again, outside of the business.

We also taught him to have his company support whatever it can legally towards his personal lifestyle.  For example, his cars, gas, some entertainment, health insurance, retirement, and other things are paid for through company.

Joey Bag of Donuts wanted to put more money away for himself and his family’s future, but didn’t want to use his own funds, so why not have the company support more retirement contributions?

We already had a profit-sharing plan, and he was sharing company contributions with his employees.

We decided that a non-regulated plan was the best way to go, so we developed a plan for only him.  The plan is a combination of two concepts.  We call this the CEEP PLAN (CORPORATE EXECUTIVE EQUITY PLAN).

The plan is a discriminatory plan, so Joey Bag of Donuts can pick himself or anyone else he wants, unlike a profit sharing or 401k plan, which is a regulated plan.

THE PLAN:  As you can see, the company made all the contributions, and took the deductions for them.  Joey Bag of Donuts was the sole participant of the plan. His cost was “0” out of pocket and he ends up with almost $800,000 of cash at retirement.  He also could turn the cash into a tax-free income stream.  In this case it was $67,500 tax-free income. The stream of income is worth more than $1,215,000.  Along with that he has a death benefit of $2,300,000 payable to his family tax-free.

THE BOTTOM LINE:  Joey Bag of Donuts gets retirement income using corporate funds.  All the contributions can be applied to just his account.  He also has the use of the account before retirement, like a  “family bank”, along with the ability to withdraw funds tax-free.[1]  There would be no 10% penalty if withdrawn before 59 ½.  Continue reading “Case Study#5 Using Corporate Dollars To Keep Wealth Out Of The Business But In Your Pocket”