Selling Your Business To The Younger Generation!

I am old enough to remember the many small businesses in my hometown. There were all types of businesses such as, meat markets, hardware stores, small groceries stores and many specialty stores. Large shopping centers and malls were just starting to appear, as they would be the future home of many of the smaller stores along with the big chain stores.    

FREE OFFER:  Receive my free E-book;  “Unlocking Your Business DNA” to learn the strategies of growing, protecting, and transitioning your business for greater value” CLICK HERE 

It was the fifties and small business was booming. There were many reasons for the business boom, but mainly it was the population of the baby boomers which gave way for opportunities to buy or start a business.   

Now over 60 years later, things are changing. The boomers that started the businesses are now older and would like to retire and sell their businesses.   

Baby boomers own 2.34 million small businesses and employ more than 25 million people (about the population of Texas)i. This represents about 100 million citizens when you consider family members.   

Incomplete Plans 

A recent surveyii shows that 58% of small business owners have not only failed to complete a succession plan, but many haven’t even considered a transition plan. The significance of this figure is the potential catastrophic effect on our economy as the boomers burn out, die, or become too ill to work. Other studies tell us that only 30% of business owners have a succession plan, and 50% of them are incomplete plans.  

The impact of this lack of planning not only affects the consumer, but also employees, family members, partners, independent contractors, part time workers, down the line suppliers, an endless road of dependence on each business.   

Even the younger generation business owners are affected by the closing of these businesses, as the younger business owners have a type of dependence on the success of the boomer’s generation of businesses.   They rely on these established businesses as suppliers, mentors, etc. 

Receive my free E-book;  “Unlocking Your Business DNA” to learn the strategies of growing, protecting, and transitioning your business for greater value” CLICK HERE 

Younger Generations 

Interestingly, many younger generations are not interested in running the family business. They have seen the sacrifices their parents and other family members have made over the years; they don’t want to spend all the time necessary to run the business.   

This generation, beginning with the babies of 1965 and continuing through 1984, is a big problem for Boomers, who are preparing to sell their businesses. The issues are three-fold: numbers, values and choices. 

A major reason for the potential problems for baby boomers is in the pure number of them. From 1945-1964 there were many baby boomers born during that period which stemmed the growth of the economy. However, the next generation is about 23% less in population. This means there are less people in the younger generation to purchase businesses.   

In the next 4-6 years, when the last of the boomers hit 65 years old, almost 5 million fewer people (23%) will be turning 45, and entering their prime business buying years. This shortage of buyers will create the worst imbalance between small business sellers and buyers in history, and it will continue for the next 20 years.iii 

Values 

Boomers have a vastly different work ethic than the Generation X’s. Not that they are lazy, but their values of working, when and why, are very different. Because of these values there are many Generation Xer’s who don’t wish to have the same work schedule their parents had.   

Generation Xers want to define the “work-life balance”.  Their observation of life watching their parents work all the time, didn’t really make sense to them. Consequently, they want to create more of a balance in life.    

Generation X’s, by and large, doesn’t equate material comfort directly with work. Their “balance” is oriented towards separating work and life. Unlike most Boomers, who live to work, the X generation only works to live. Work isn’t their identity, it’s merely the thing that allows them to pay for what they really want and their living standard. 

Many Baby Boomers’ attitude was, “live to work”. Working a 50–60-hour week was part of their business. Based on data, the Xer’s don’t agree with that lifestyle and are not interested in having a business where the cost is many hours of work.  

Planning for the Boomers and Their Business  

Because there is a shrinking number of future purchasers, small business seller’s must take all the necessary steps to prepare their company for an ultimate sale. In most cases they will need help in preparing for the sale of their business.  

There are professionals who can recommend to you how to prepare for the sale or your business, and to help you create the key strategies to implement for a greater potential value.  

Past Problems  

Many of the strategies needed to create value in business need time. You normally can’t wake up one day and decide to sell your business next week and expect to get the highest potential value.  

However, with the right coaching, you can start working on the strategies that can increase the potential value of your company. Even if you are years away from thinking about selling your business, business owners should engage with professionals to start the process of implementing the right value drivers early, with the end game being to increase the potential greatest value of their company.  

Point to be made  

By kicking the “transition of your business can”, down the road, owners are putting themselves in a terrible position. Not only are they not prepared to sell, they don’t have the systems in place that create the potential highest value, but also there may be a limited number of buyers in  the younger generations.  

If you are a business owner interested in discussing the future of your business, we would be happy to have that discussion with you.  

To aid you with the conversation, we have created an assessment tool that it easy to use. It takes about two minutes to complete, and it will give you an idea of your strong and weak points in your business planning. It’s a free tool called the “scorecard”.  Once completed we will send you a free analysis report of your strong and weak points of your business planning. We will also offer a free phone conference to discuss the results with you. Once you submit your scorecard, we will send you an assessment report in approximately 72 hours (about 3 days).  

Receive my free E-book;  “Unlocking Your Business DNA” to learn the strategies of growing, protecting, and transitioning your business for greater value” CLICK HERE 

Business Owners Essential Planning Tools! Part 2!

Good planning can often begin with owners transferring ownership interest to family members, without giving up control of the business. This type of planning sets the stage for the future passing of the baton and can be highly effective.

The long-term plan of business transition can also focus on who can run the business operations once the senior guard leaves the business. Just because a family member has worked in the business, it does not mean they can run the business effectively.

Business Transition And Succession Planning requires many years to develop the right plan. It starts with finding the right employees to train for the job, and the right people to run the business (this includes family succession situations).  

I have found that “Passive Ownership” can be a particularly good possibility for many business owners. They stay in control and slowly give away the duties over time while running the business, but at the same time slowly disengaging from the business. It gives them time to help prepare the junior successor for the job.

The procedure for “Transition Planning” is critical for a long-lasting understanding amongst the family members, both in and out of the business. Without clear communication to the family members, conflict and bad feelings may occur. 

Business Succession Planning  (Click to receive full report and guide; R-1)

  • What would happen to the business if one of the partners died? 
    • Who will buy your interest in the business?
    • Will the company, shareholders, or the heirs keep the right to own the shares. Are the party’s mandated to buy your shares? 
    • Where will the capital to buy the shares come from? 
    • Do you want the deceased shareholders/beneficiaries to have the choice to run the business? 
    • What is the funding mechanism to buy the business? 
    • How is the life insurance structured to help fund the purchase price?
    • Is the same true for a disability? If so, what is the definition of a disability to trigger the sale. Is the disability funded?
    • What are the rules if a partner wants to sell to a 3rd party? 
    • Is there a “put” right; to have the company buy the shares of a disputed share holder? 
    • What are doing concerning incentives to key employees?
    • How are you supporting retirement through the company? 
    • What are you providing in executive compensation to the key people active owners, and officers of the business?

There are many more questions that need to be answered. The elements of your business succession plan will normally be in your business succession agreement and incorporated in the operating or stockholder’s agreement.

CLICK TO Request our Full White Paper and Business Guide Free request (R-1)

Operating Agreement:  

An agreement which regulates the company and manages the relationships between the members of the company.

Buy-Sell Agreement

An agreement between the business owners to buy and sell interest in the business at a specified price upon a “triggering event”, such as death, disability, divorce, voluntary withdrawal, non-voluntary withdrawal, bankruptcy, and retirement.

This document is important and serves to obtain a fair price for the stockholder and a path for a smooth transition for the parties involved.

Type of Buy and Sell agreements:

  • Cross purchase: This is between stockholders to buy departing stockholder’s shares
  • Redemption agreement:  The entity (business) buys the shares
  • Hybrid/ a combination of above: A “wait and see buy and sell[1]

Provisions in the buy and sell agreement

The sale price of the departing owners’ interest and how it will be paid

  • Installment
  • Sinking fund
  • Cash 
  • Life insurance[2]

Other Methods To Transfer Property:

Although the buy and sell agreement is an effective method to transfer property, other methods, such as ESOPs, compensation plans, and pension plans have a place in funding.

There are other areas and issues in your business planning that need to be addressed at some point and redefined over time.

The valuation of your company should be done by a qualified and certified appraiser. Business owners seem to think they know the value of their business, however, in more cases than not, they are incorrect.

Having A Team Of Financial Experts Will Help You Plan Your Business And Your Estate.

My suggestion is to create a team of advisors who can meet periodically and report on the status of the business to the “team”.

I have found this to be a valuable tool as everyone gets on the same page in the planning process and understands what the owner wishes to accomplish. 

Over the years I have created the team consisting of the CPA, attorney, banker, investment, insurance and other professionals who come together and review what the status of the planning is up to that point for the business owner. Normally, the team consists of the professionals who have a relationship with the business owner and are currently doing planning for them. Unfortunately, each professional has their own agenda, and rarely knows what the other professional are doing for the business owner.,

In most cases this is the first time the advisors have communicated with each other. I have always thought this was in the best interest of the business owner and was prudent to use these resources. Putting the business owners’ advisors in the same room once a year could be the best planning strategy, they can employ. 

The Bottom-Line Thought

The solutions and strategies are in abundance to solve the issues. The problem is defining what the owner wants in their plan.

CLICK TO Request our Full White Paper and Business Guide Free (CODE R-1)


[1] A combination of the redemption and the cross purchase. Usually, the stockholder or trust owns the life insurance on the partners.  Normally driven by tax issues and positioning.   

[2] Life insurance is normally the least expensive way of funding the death benefit when compared to alternatives. The life insurance can also play a role in providing funds to help stockholders purchase interest in the company. 

Ode To Mr. Business Owner!

Dear Business Owner,  

We’ve never met, but I know some things about you.   

I know because I have met and served many business owners like you in my 50 years.   

Here’s what I know about you:  

You have a successful business, but it comes with a significant investment of your time, time that you want to start taking back for outside interests.   

You pay the IRS a large amount every year.  

You wear all the hats; therefore, you are the value of your business.  You know that it would be worthless without you.   

You desire time to mentor someone, or better yet, a group of people to run your business so you don’t burnout. Your problem is, there is no time to do this because you are so busy.   

You feel trapped within the four walls of your business.  

You dread having the quarterly conversations with all of the people that you pay to do the work for you.  Accountants, Bookkeeper, Financial Advisors, Attorneys etc. In fact, these “professionals” probably have never met.   

If you died tomorrow no one would have a clue what to do.   

You have no escape plan.  

You think there is no other way.   

Hi, I am Tom Perrone and I want to virtually shake your hand, give you a pat on the back, and tell you “I Get It”.   

You, like many business owners that I have worked with over the last 50 years think that there is no other way than the same old song and dance that has always been done.   

No one listens to you, the one that makes all the plates spin and it upsets you.   

You are up at night pacing the floors wondering how this machine that you created has overtaken your life.   

That wasn’t your goal when you started, in fact, you have no idea how you got here.  

You need an escape plan.   

Like I said, “I get it”. 

I’ve put together a team to help business owners like you enjoy more time doing what you love outside the business while the machine runs itself.   

I’m passionate about teaching intelligent business owners like you how to get all you can out of your business before it takes all it can from you.   

You run your business…Your business shouldn’t run you.  

As a way of saying thanks for taking the time to read this,    

I’ve included a copy of my book:  

Unlocking Your Business’ DNA”- Cracking the code to a better business, bigger profits and more time on the beach!  

Click reply and let’s learn more about each other.  

Your escape plan awaits…  

Talk soon,   

Tom.   

Business Owners Essential Part 1 Of 2

Introduction 

As professional planners, one of the most important services we can do for business owners, is to communicate to them the importance of the planning of their personal and business   assets in a coordinated effort.   My experienced is that business owners are so focused on running their businesses, they tend to neglect many parts of their personal financial objectives.     When you break it down, they have the same financial problems as individuals with the additional and complex areas of business transition and succession.    The purpose of this white paper is to discuss the various elements of their financial planning and highlight some of the critical areas.  “Key Essentials Elements” are financial areas which cannot be neglected. If the key essentials are neglected, owners are destined to financial failure, no matter how hard they work in their business, they will have a financial failure, with few exceptions.   

Many laws come out of Washington, which are relentless and never ending. There is no mercy for the taxpayer as the game keeps changing from one administration to another. Most tax policies change over time as new administrations are voted in. Consequently, taxpayers are always planning to maneuver around the tax changes to help avoid a financial disaster.  

A perfect example is the current estate and gift tax exemption which will sunset in 2025.   This will require more extensive planning, even though taxpayers have updated their estates and paid huge fees, when the exemptions were changed some years ago.  The reality is laws change all the time and taxpayers can either change with them or do nothing and face the consequences, leading to financial conundrum.     

A well-designed estate plan will consist of both the estate and business planning.   The business plan would not only consider business growth and distribution, but also, the ultimate transition and succession of the business, due to an event such as your death, disability, or retirement. 

Basic Planning documents:   

Power of Attorney, Health Care Proxy, Disposition of Remains Appointment (DORA), and Will. 

The use of a Revocable Living Trust (RLT) can be used, as opposed to a Will, for estate disposition. The RLT is a valuable tool. Assets are transferred into the trust and titled in the name of the trust.  The Grantor creates the trust, and is normally a co-trustee, keeping asset control.   The trust creates successive trustees to manage the assets in the event of your incapacity.  

A Limited Liability Company is an additional tool which may be used, in the context of your business.  

Advanced Directives Business Powers of Attorney:  

These documents deal with the unexpected disability, illness, or incapacity. It only makes sense that you should have these documents in place since the odds are great that you could have a long-term disability before age 65, and the odds only increase after that age.  

Request our Full White Paper and Business Guide Free 

Power of attorney (POA):  

This document names an agent(s) to manage financial affairs if one becomes incapacitated. Fiduciaries act on your behalf. They are called an “Attorney in-Fact”, and they manage financial decisions and transact business on your behalf. It is possible to have two separate power of attorney documents. One for your business, and one for your personal property. You can also appoint different people for each POA document. This makes sense because your personal representative may not have the business sense and experience to deal with some of the tasks needed when dealing with your busines affairs.  

The POA can be effective all the time or can be effective only under certain situations. This is called a “Springing Power of Attorney”.  An example of this is when the POA only springs into effectiveness when a doctor signs off on your incapacity to deal with your affairs. The person in that role should be aware of this.  

The purpose of the POA is to avoid costly and complicated court appointed guardians which is the procedure when there is no POA, and when someone is considered incapacitated. Since it is in place when executed, there is no delay upon the incapacity of an individual.  

Health care Proxy (HCP)/ also referred to Living Will.  

This appoints someone to make health care decisions if you are unable to do so yourself. Disposition of Remains Appointment (DORA): Provides a way to appoint, in writing, someone who shall control one’s final arrangements.  

WILL:  

The Will is to provide instructions on how your assets are to be distributed amongst your beneficiaries. A Will does the following:  

  • Outlines your distribution wishes- specific gifts of tangible personal property 
  • How your business is to be continued or distributed 
  • Names executive(trix) or personal representative responsible for probate accounting and filing, tax liabilities and the payment of them, and the disposition of the balance of your assets 
  • Appoints guardianships 
  • Establishes trusts to protect assets 

The Will specifies instructions regarding your intentions of the business; sold, liquidated, continue.   If your intention is to continue the business, your Will has instructions to do so. It would refer to any operating or buy-sell agreement if they exist.  

Through your Will you can establish a Testamentary Trust that will direct that your assets are managed and distributed based on your specific wishes. Assets can be managed for family members and distributed at the times you specify.  

For example, if you wanted certain property to go to certain members of your family, you can direct that. You can also preserve the principal of your assets for your children should your spouse remarry.  

Revocable Living Trust (RLT) 

A RLT can control your assets during your life and after your death. Once a RLT is set up you would transfer the title of your assets (stocks, bonds, real estate, life insurance, etc.) to the trust. You would then become of the trustee of the trust. This gives you complete control of the trust assets, and the trust. The RLT is not irrevocable until your death. You can change it anytime or collapse it if you wish. Property is not tied up in the trust, as you can change the title back to yourself in the future.  

At your death, there are no assets in your name, so, no probate. The successor trustee will gain control of your assets to distribute them according to your exact instructions. At your death assets will go directly to your heirs. No probate, so, lower estate administration costs, and no court delay in distributing your assets to your heirs.  

Along with the issue of distribution, the trustee will ensure continuity of assets management during a period of incapacity.  

Limited Liability Company.  

There are several advantages to using an LLC in the context of estate planning. 

  • Enables you to preserve significant control and management while reducing your estate costs 
  • Ability to transfer assets to family members, tax efficiently 
  • Can create significant valuation discounts using limited liability interests 
  • More income tax savings compared to estates and the double taxation of a C corporation 
  • No limit of number of shareholders   
  • No limit on the types of entities the interest of the LLC can hold 

Business Succession Planning  

The challenge of a business transition upon the death, disability, or retirement of the owner(s), is will the business survive?  This requires long term constant planning. Admittedly, transition planning is one of the of the most complex challenges in business and estate planning.  

Objectives:  

  1. Income for business owner’s retirement 
  1. Maximum but fair price for share of business 
  1. Smooth Transition 
  1. Could include compensation for family members in and out of the business  

Major Challenges 

  • Retirement for owners/income 
  • Reduction and payment of estate/State taxes 
  • Creating liquidity for the transition and new ownership 
  • Creating a formal business succession plan 
  • Family ownership and non-family ownership needs, communicated 

To be continued in Part 2 

Request our Full White Paper and Business Guide Free 

The Need for Effective Buy-Sell Agreement! Perspective On Value

Covering the Bases: 

I recently received a great article by my friend Ed Pratesi, AXA,CM&AA,ABV. Yes, Ed is very bright. So when he sends me an article he was involved with I make time to read it. I think this article is extremely clear and helps business owners and advisors have a clearer vision of what goes into the Buy And Sell Arrangement.

So, needless to say, I am proud to make this available to you. Enjoy!

Abstract: Every business with more than one owner needs a buy-sell agreement to handle voluntary and involuntary ownership transfers. This article explains why it’s important to update the agreement regularly and address all the valuation issues that may arise. 

This is a very good article concerning the need for an effective Buy-Sell Agreement.   

I would like to thank Ed Pratesi for contributing this fine article.  

CLICK TO DOWNLOAD THE ARTICLE 

Finally, A Way To Work On Your Business Without Giving Up Working In Your Business!

Give Me Two Hours A Month, And Your Problems Are Solved!

In my book, “Unlocking Your Business DNA”[1], I discuss a system called, “The One Page Blueprint Solution”, or “OPBS”.    This system is designed to help business owners solve specific problems in their business, effectively, efficiently and without giving up time to work in their business.  It is a way to finally have business owners “work on their businesses” and solve business issues important for the success of their business.    

The OPBS does many things, among them:

  1. Prepares the owner for the planning session in advance.
  2. Organizes what needs to be discussed.
  3. The business owners control the agenda discussed. 
  4. Covers the elements which need focus. 
  5. Allows owners to work at their own pace.
  6. Creates brevity in your planning, leaving more time to work in your business. 
  7. Planning time is 1-3 hours a month which 60% of the time involves a self-study review. 
  8. Issues get resolved very quickly.  
  9. Many other benefits…

I use 15-20 key areas that I feel most business owners need to address if they wish to maximize their business growth and create the highest potential value for their business.  Here are two of 15 as examples of what is needed in the planning. 

This is an example of two of the many areas of planning.  I work with about 15-20 areas.  Not every company needs to fix all the areas, however, over time without reviews, areas of planning which were up to date at one time, can lose their effectiveness when not fine-tuned.

The Sale of Your Business to The Outside: 

  1. This could be in two months or thirty years; it is different for each business. In this planning session there are several areas the business owner needs to focus on. 
    1. Systemized business
    1. Put business in growth mode
    1. Delegate to middle management and upper management
    1. Lock the key group into the company
    1. Attract several potential buyers 
    1. Receive maximum cash for the sale
    1. Prepare to leave when you want to leave (maybe stay only if you want to stay)
    1. Plan to do something the rest of your life
    1. If you start early, you can control the whole process
  2. Tools needed: 
    1. Value Drivers
    1. Systemizing the business
    1. Golden Handcuffs for management and stay documents, (disclosure, competition, non-compete)
    1. Controlled Auction for the sale
  • #Sale of your Business from Inside the business or to your family! 
  • Make sure the new owners can run the company without you 
  • Lock in non-owners’ managers
  • Delegate your responsibilities to management
  • Due diligence to make sure you don’t end up with the business after the sale
  • Put business in growth mode
  • Guarantee income stream from the sale
  • Minimize taxes to you
  • Minimize taxes to the seller
  • Have a lifetime plan
  • Teach employee to be employers

Tools needed:

  1. Market Value Drivers 
  2. Systemizing the business
  3. Golden handcuffs for management team 
  4. Well Designed transition Plan

With the help of “zoom”, phone conferences, and the cloud, we can discuss an array of topics without parties leaving their offices.  Our designed meetings are previewed before our discussions so questions can be prepared about the subject matter.  (This creates a great give and take of the subject) 

It is my opinion that business owners should review all the key areas of their business periodically to make sure they stay “a fine-tuned machine” and maximize their future potential value of growth.  

If you wish to participate in a one-minute business assessment, to see how ‘fined tuned” you are; 

 LESS THAN A MINUTE SURVEY

Trust me: (it takes one- minute to do).  I will send you a FREE report card and summary of where you may want to focus for your business efficiency.  ALSO, along with the completion of the survey, I will send you a copy of my newly published book: Unlocking Your Business DNA”.


[1] You can purchase this book at Amazon-kindle and paperback. Profits go to “Wounded Warrior Foundation”

Creating Legacy By thinking Creatively !

Many of us own qualified plans such as employer sponsored 401k and IRA. Over the years they have contributed to the plans and have created a great amount of wealth.  While creating the wealth they received a tax deduction by making   contributions to the plans which were tax deductible.  Sounds good so far.  

However, there comes a time when the governments gratuitous treatment of qualified plans must end.  Now they want their money, In the form of taxes on the withdrawal of 100% of the money, not just the accumulation, but also the contributions which you received a deduction for (I always wondered why they did not just tax the amount of your contribution when you withdrew them instead of the whole account). 

Many seniors when they get to age 72 find they do not need the money to support their lifestyle but are forced to take the withdrawal (Required Minimum Distributions-RMD) anyways.  Recently, the required minimum withdrawal rules changed, and instead of taking the distribution at 70 ½, the distributions will start at 72.   

The segment of the population that does not need the distribution of the qualified money, have a few options that might end up being more helpful than just taking the distribution, paying the taxes, and then reinvesting the money, only to be taxed on the interest once again.   

LET US TALK LEGACY.  

Option 1:  Take the distribution.  Pay the taxes and re-invest the money once again, only to be taxed.  Upon death the money is distributed to your heirs.  Depending on the inheritance tax laws in effect at the time of your death, you may have federal and state taxes to pay on that asset left to the family. Once again, taxes.  So far, I have counted three taxes:  Federal taxes/state on the distribution.  Federal/state on the invested after-tax reinvestment, and Federal and state taxes on the distribution of the asset to the family.   

Option 2: Take the distribution of the qualified money which is taxable. The net after tax withdrawal is gifted into   the irrevocable trust.  The trust will use the money to buy a “second to die life insurance policy”, on life of the IRA owner (the grantor), and the spouse.    At the death of husband and wife, the policy will pay a tax-free amount to the trust.  This tax-free amount can be distributed tax-free to your beneficiaries at a future date.  

Note:  If this were a qualified account (Like a 401k or IRA), the balance of the account would be considered an inherited IRA if left to other than a spouse. Withdrawals would have to be made within ten years of death.  The withdrawals are taxable.    

If it were left to a spouse, they could continue the account, however, they would pay taxes on the withdrawal of the funds. Also, assuming no marital deduction (if left to other than spouse), there could be a federal/state inheritance tax on the value.  

Option 3:  Set up option 2, however, the balance of the qualified account(IRA), payable to the children, or grandchildren could be used to buy life insurance on the parents’ life, again recycling the RMD’S to create a tax-free legacy for the grandchildren. The distribution could purchase life insurance on the life of their parents, to pay for the life insurance over a ten-year period (inherited IRA’s need to be paid out over ten years). The proceeds of the life insurance would be tax-free to the grandchildren. They would not have to make mandatory distributions from the life insurance, unlike the inherited IRA. The children, who may be the beneficiary of the trust in option 2, would also not have to take mandatory distributions from the life insurance. Consequently, both generations would save a lot of taxes, inherit much more, and have a plan which did not force them to liquidate inherited assets.  

THE NUMBERS:   

Option 1: Take RMD and invest the money 

Assume the IRA was worth $1,000,000 that dad owned:  Assume he takes out the mandatory distribution of $37,000. He paid taxes (35%) and net $24,000 (rounded down). Let us say he invested at 4%. In 20 years, he would have accumulated $743,000. His gain would have been $92,000, which he would pay tax on. His net value of the account would have been $650,000 to leave to his children and grandchildren. After tax, the net ROI would have been 2.81% before federal and state inheritance taxes.  

Option 2:  Take RMD and buy a 2nd to die life insurance policy and put into an irrevocable trust while living (there is no need to wait to age 72 to do this).  

The 2nd to die life insurance policy would be worth $1,000,000. At his and his spouse’s death, the beneficiaries of the trust would receive $1,000,000 tax free. None of the life insurance proceeds would be subjected to inheritance taxes (fed/state), unlike in option 1. The ROI on the death benefit would be the equivalent of a net of 6.56%, or pretax rate of 10.10% on investment, (we are assuming parents paid $24,000 for 20 years, then died). By having the life insurance/trust, he would have left $350,000 more to his children and grandchildren compared to if he had invested the money at 4% gross. When you take into consideration inheritance, federal and state on option 1, option 2 would have been even more of a gain.  

Note:  Any balance left in the qualified account at the parent’s death, could also be used by the beneficiaries (children or grandchildren) to buy life insurance on their parents, much like their parents/grandparents bought life insurance via the trust.  

Considering the new rules on inherited IRA’S, using the life insurance as leverage can make a lot sense. As mentioned, this strategy is highly effective for families in the situation where the RMD is not needed to fund their current lifestyle.  

Compensation of Business Owners! The Good And The Bad!

Owners of small private companies normally receive income as a salary, rather than dividends, and capital gain on the sale of their stock. They also receive other compensatory benefits. In many cases, the business owners can receive rental income from property and assets leased to the company and owned personally (either outright or in trust) by the business owner.  

Because of the tax structure of the company, business owners often find it more tax effective to pay the compensation, rent, royalties from their company to the owner, at the high end of the scale, rather than the low side (common in C Corps).  

A Detriment to The Owner When There Is an Exit 

Receiving this higher scaled income and rental, may have some advantages for tax purposes, and the creation of wealth.  

Having the tax advantages for the business owner, may be a detriment to the selling price during exit planning. This is because the rents and compensation paid to the owner on the higher side lowers the net income of the business.  

When rental and salary compensation are paid on the elevated level, they affect the net income/or net operating cash flow, which creates a downward impact on the selling price! 

At the Time of Exit Transition 

The owner must justify the payout of rental income, compensation, royalties, and other compensatory income. They need to justify the overpayment of this compensation. In a way, the owner must back track the justification of paying the enhanced payouts in the stated areas of compensation. This may put the owner in a position of receiving nondeductible “constructive dividends” paid by the company, resulting in a retroactive tax liability.  

Minority shareholders of the company could complain that the enhanced payments to the owner’s transgression of overpayments is a breach of a fiduciary duty owned to them. Since the over self-generous payouts to themself, there is an effect on the stock value. Consequently, minority stockholders are going to be affected by depressed value. This concerns stock bonus to minority stockholders and key persons.  

One of the solutions to this issue is to start to shift part of the enhanced payouts to more of a mid-level range of the fair market value. This will allow you to enhance the net income/net operating income for the company.  

Along with enhancing the net income and net operating income for the company the shifting of revenue to middle-management, will build a stronger management team.  

Your Key Group Has Great Value And Creates A Better ROI For Your Company’s Value!

Over the years I have written of the importance of the key group in your company is, and how they enhance your profitability and company value. Not only do they make you profitable while you are running your business, but this group is the key element to selling the business for the highest potential value in the future.  

 The inside key group creates the actions that help enhance value, such as implementing value drivers and making sure they are being applied correctly. Key management groups make sure the value drivers are implemented, working, and being enhanced constantly. 

The Key group learn about the business, in some cases better than the owner. They make business more valuable. They are so talented the competition is aware of their value, and in many cases would like to recruit them.  

It would be wise for the owners to recognize the value of the person or group (key person) and put in place strategies to keep them.  

  1. Incentive programs:  The purpose of this is to keep the key person around. To continue the growth of the person within the business. He may be the person who buys, or totally runs the company.  
  1. A vested incentive program:  This is to carry out #1, but also to protect the employer from the key person leaving.  
  1. Address the potential of your exit strategy in advance. This can be in the form of a discussion about a “stay bonus.”  The “stay bonus,” is used when an owner wishes to sell the company but would like the key person to stay on with the new owner. This enhances the value of the purchase price.  
  1. Keyman/group:  Potential purchasers of the company. It is also important to recognize that the owner may be thinking of becoming a passive owner, wishing to have the key group run the company while the owner peeks their head in occasionally.  

There are many ways to address the future knowing the key group is key to your exit strategy. This can range from incentive plans, to things like stock options.  

 Existing Key Employee  

Equity Based Incentive program:  

  • Stock Bonus 
  • Stock option 
  • Stock Purchase
  • ESOP

Cash based incentives 

  • Cash bonus 
  • Deferred compensation 
  • Phantom stock bonus 
  • Stock Appreciation Right 
  • Supplemental Employee Retirement Plan (SERP) 
  • Executive Coaching Program 

Awards based on 

  • Individual key employee performance 
  • Key employee group performance 
  • Company net income growth 
  • Company sales growth 
  • Vesting Formula 
  • Forfeiture Events 

      Agreements 

  • Non-compete 
  • Non-disclosure 
  • Non-solicitation 
  • Any other agreements that will protect the owner should the key person (group), leave 

Three Key Value Drivers  and Why Do They Matter? 

Value drivers are the elements of a business (systems and procedures), which create business value.   This post will cover  Next Level Management (NLM).  In part 2, I will cover  diversified client base  and  operational systems.  

Although there are nine transferrable value drivers, I am going to concentrate of three of them. Although all the value drivers are important, the three I will discuss are considered key drivers.  

The three value drivers are key in creating appeal to prospective purchasers of the business. They are important drivers, and at the very least, drivers’ businesses must have in order to grow.   

When a new business owner asks me when they should be thinking  about their future exit of their business, my answer always is, “the day theystarted their business is the time to start planning for an exit.”     

As you will see, the value drivers in most cases  need time to develop.  As we go through the three of them, you will see that they are strategies that can be implemented at once, but in many cases, need time to develop.    

Next Level Management (NLM):  Successful businesses with value, require business owners to delegate responsibilities to the management team.  NLM is particularly important because without a good management team, it would be hard to implement the other value drivers which are needed to create the maximum business potential value.i    

Finding and developing a  NLM  team is a challenge for many business owners. However, once the NLM is created, they usually become the team responsible to make the difference between where the business is now, and where the business would like to be.   The NLM is the key to  implementing the value drivers and the operation of them.   

Roadblocks for Business Owners in Developing Their Next Level Management

Many owners believe only they can keep and control the company’s success, since they built the business from infancy.   They  struggle  giving up even small types of control. The thought of not being involved in some of the daily business decisions, scares the daylights out of them, nor do they like the loss of control.    

Lack of installing the value drivers over time.   

 They spend their time working in the business as opposed to working on the business.   I call it their “Business DNA.”    Change is scary and thinking that someone else would be running the business is not consistent with their  fundamental  beliefs.  The possibility of someone else making decisions, which could build or ruin their business is too much for them to imagine.   

Fear of change.    Even if a business owner is not thinking in terms of an exit plan, they do like to think of creating business value. Once they are educated as to how value drivers affect the future value of their company, they become more open to  creating the value drivers, and making the changes.    

Misconception of owners:   Benefits derived to the business owners by installing value drivers is the result of the “full potential value of the business.”   The business grows as the business owner does less work, since the work has been handed off to the NLM.     However, owners have the common concern that installing value drivers will take too much of their time.  With proper planning, implementing the value drivers will create a more stable business, create better performance and scalability.   It is important that the owner understand the concept of developing the NLM team, so that team can create, implement, and manage  the value drivers, as opposed to the owner.     

It is possible for the owner to create the NLM where the owners have some control, and still can play a key role in the company.  Their leading role would be to delegate more responsibilities to the NLM, while focusing on other business responsibilities.    

 Many owners continue to do tasks they despise, just to keep a perceived control.  In many cases, the owner needs to take small steps in giving up control before they can start to feel more comfortable.  This is understandable since these are the things, they did to grow their business from day one of the business.     

The owner will see more growth in their company by implementing the value drivers, which will create more options for them when a future transition is a being considered.   

In my book, “Unlocking Your  Business  DNA,” I  discuss the problems business owners have working on their business as opposed to time spent working in it.  One of the factors missing is the value of creating value drivers for their business growth.   Once they realize value drivers create increasing company value, they get on board for future changes.  

 Through our discussions with business owners, we need to express to them that most future buyers will not want to buy the owner.   They want systems, management, and growth ability.       

Many owners think that they need to be involved with all the problems and issues of their company, thinking they have all the answers and the solutions.   Although this makes the owner feel in control and gives them  self-worth, it does absolutely nothing for the future value of the company, and in some cases may decrease the value.   

Success In Business Is Not Without Challenges!

DEFINITION OF BUSINESS GROWTH AND TRANSITION 

I often refer to my business planning as “Business Growth and Transition,” because I consider the business and the owner, as two separate and distinctive entities.  

For example, when the business is growing, the owner of the business needs to grow with the business and envision needed growth. As a business owner, he/she needs to continue to learn, ask more questions, depend on their instincts, experiment, be willing to fail, along with many other experiences to create the changes neededWithout the business owners’ creativity and involvement, the business will stop growing.  

Likewise, when planning for the business entity, we also plan for the owner personal needs. The business success creates personal challenges for the business owner, such as succession, estate taxes, family distribution, protection of the assets, and a host of financial and personal planning areas.  

STAGES OF A BUSINESS 

The business has two distinct stages it goes through which are critical; I define them as survival period and growth period 

Survival period is just what it means! Staying alive! This is where owner learns how to maneuver through the maze of “business savvy” strategies. “What doesn’t kill you, will make you stronger.” 

The survival period of business consists of: 

  • Excessive amount of time, sweat, and patience, luck, and much more.  
  • Bottom line:   Survive staying in business.  
  • Cash flow, Capital improvements, Inventory, client development create many challenges. 

The Growth Mode: 

 Not to simplify, but this is where the action is. It is up, up, and awayWhat needs to be done during this stage:  

  • Creates the opportunity for the future value of the business.  
  • To expand in all areas of the business. 
  • Inventing yourself and the company if needed, this includes building value drivers and transferable values. 
  • To become creative, reinventing of products, customers, process. 
  • To reinvent your markets and your clients. 
  • To build a customer base with loyalty, creating culture, and next level management. 
  • Much More… 

The expansion in Growth, (NOT ONLY) in markets and products, but also employees and the culture of the business. This is extremely important for the future of the business value, with the focus on growing your business value and to create transferrable value for the future. Owners need to start the process of giving up some of the control to middle management. This also means creating strategies which allow the owners to walk away and allow the business to run effectively and efficiently normally. This is my “Can you Take three months off” question, without an impact on your business profits?   

Disadvantages of Growth/ and letting Go 

You are giving up control to your management team! You are giving up things you controlled from the very infancy of the business. This is good because a future purchaser wants to buy your business as a running entity. They want a business that can run, and without YOU!  

When you start to delegate to others, things can happen. Your key people will learn how to run your business, and start thinking like an employer. They will develop greater relationships with your customers, advisors, and vendors. They will start to create profits for you, ease your time in the business, and allow you to enjoy more free time, however, there could be a price to pay!  

Tough Questions to Ask 

  1. What if your key people got to know your business so well, and they wanted to buy it from you, what would you do 
  1. What if you did not want to sell it to them at the time they want to buy? Will they walkWill they stay? Will the relationship change?  
  1. Will they go to a competitor 
  1. Will they take your customers and employees with them 

If this happened, what are you doing to protect yourself 

Consider this:  I recently had a client who went through this nightmare. The key people (2 key employees), left and started their own business. They also took other employees and customers with them.  

Unfortunately, the protection which we outlined to the owner three years prior was never implemented, and they are paying the price for it now.  

We told them to make sure they had programs in place to protect themselves from the business growth and success. 

Things Such As:   

  • Key person documents:  such as non-compete, non-disclosure and non-solicitation of customer and employee agreements.  
  • Benefits with Vesting:  We also suggested that they put in a vested benefit package for them and stagger the time where they would only have a partial vesting immediately  (we have found this to be a valuable motive to stay).  

Lesson to be learnedIf it happened to them, it could happen to you. Your key people will take over your business, which is good because as it creates transferrable value for the future. However, you must protect yourself from your business success.  

BEWARE FINANCIAL ADVISORS: THIS IS AN EASY TAX TRAP YOUR CLIENT COULD MAKE! LEARN A FEW EXEMPTIONS AND YOU WILL STAY OUT OF TROUBLE!

 Recently, we worked on a case which involved an endorsement split dollar plani, where the split dollar agreement involving the trustee   of an irrevocable trust was terminated pursuant to a “rollout. The agreement was between the employer and the trustee (endorsement split dollar). The result would have been a “transfer of value,” in which the death benefit exceeding the consideration would have been taxable income.  

If the split dollar plan were a collateral assignment split dollar, there would not have been a  “ taxable event”, as the sale of the policy would have been made to an exempt party, the insured, (grantor and the insured are one in the same).  Under the endorsement Split dollar, the company was selling to the trustee, not an exemption entity.  

Transfer for value jeopardizes the income tax-free payment of the insurance proceeds. Under the transfer value rule, if a policy is sold for consideration, the death proceeds will be taxable as ordinary income, more than the net premium contribution.  

Besides the outright sale of the policy, there can also be a taxable event if the owner is paid in consideration to change the beneficiary. This would be a transfer of value; thus, the death benefit is taxable beyond the consideration paid for the policy. The consideration paid to change the beneficiary can be any amount.  

Consideration does not have to be money, it could be in exchange for a policy, or a promise to perform some act or service. However, the mere pledging or assignment of a policy as collateral security is not a transfer for value.  

Transfer for Value Exceptions:   

  1. Transfer to the insured 
  1. Transfers to a partner of the insured 
  1. Transfer to a partnership in which the insured is a partner 
  1. Transfer to a corporation in which the insured is a stockholder or officer (but there is no exception for transfer to a co-stockholder.  
  1. Transfer between corporation in a tax-free reorganization if certain considerations exit.  

A bona fide gift:  is not considered to be a transfer for value, and later payment of the death proceeds to the donee will be paid income tax-free.   

Part sale and gift transfer actions are also  protected under the so-called “transferor’s basis exception”  which  provides that the transfer for value rule does not apply where the transferee’s basis in the policy is determined  whole or in part by reference to its basis in the hands of the transferor.   

Another transfer for value trap can occur in the situation when you have a “trusteed cross purchase buy and sell agreement”, to avoid a problem of multiple policies when there are more than just two or three stockholders. When the trustee is both owner and beneficiary of just one policy on each of the stockholders, a transfer for value may occur when one of the stockholders dies and the surviving stockholders then receive a greater proportional interest in the outstanding policies which continue to insure the survivors. This can be remedied by either using an Entity Redemption where the Corporation purchases the interest of the deceased stockholder’s interest.  

This can also cause exposure of transfer of value when transferring existing life insurance policies, insuring stockholders to the trustee of a trusteed cross purchase agreement, which does not fall within one of the exceptions to the transfer of value rules.  To avoid this initial ownership problem, the trustee should be the original applicant, owner and beneficiary of the polices.   

Insight 18 Key Groups Have a Voice In Your Company!

Your Key Group Holds The Key To Your Success! But! You Need To Listen To Them!

This was an interesting case we worked on. There were a few educational moments that I would like to share with you. 

Scenario:  Three brothers owned a successful manufacturing company. The company had several government contracts over the years and built an exceptionally good reputation with the government agency. These contracts were very profitable and kept the company busy. The company took pride in its work, delivery of the projects, and having the staff to accommodate the project, which lead to ongoing contracts. Over time, it became clear that doing work for the government and a few other companies was all the manufacturing company needed to be profitable and grow. 

So, what is the problem? On the outside, nothing, but inside there were some disturbing situations brewing. 

This scenario set up the problem we had to deal with. The key person in the firm developed a strong relationship with the agency head who awarded the contracts. He did an excellent job enhancing the relationship over the years. Through his efforts, the owners were able to be very profitable and to take sizable salaries each year. 

Because the key person ran the business like he was the owner, the three owners were able to take a lot of time off. They usually spend about two days in the business a week and took long vacations. 

The problem started when the owners decided to give the key person a large bonus the past year for doing a fantastic job. However, the key person assumed this would be the norm each year. A good salary and a fabulous bonus, which the key person was looking for each year. So, when a new year rolled around, there was anticipation by the key person to receive the bonus. When he approached the owners about the bonus, there was a clear disconnect between their vision and the employees. 

The owners felt that the bonus was based on performance of a particular year and did not think the key person would be looking for this substantial bonus each year. In a way, the owners felt they were being held hostage by the key person. “Once a luxury, it became the necessity”

However, when we broke it down for them, they realized the key person had the relationship with the government agency, not the owners (they did not even know the contact). The government contract represented about 40-50% of their sales. The keyman also had a great relationship with the private companies. We suggested to the owners that key person was more than a key person, he was their middle management! 

PROBLEM: The key person wants to receive a bonus as if it was part of his salary each year. Owners did   not want to pay it! Also, the company had 40% or more of its revenue in one basket (the government agency). 

Our part:  We communicated to the owners that based on the relationship the key person has with the vendors and customers, there would be a potential disaster if the key person were to leave. A few things which would happen: 

  1. He would take the business to a new employer.
  2. He could take employees with him. 
  3. He could stay but put less of an effort in building the business. 

After looking at all the facts, the owners realized they had a great deal and what they were receiving from the efforts of the key person was certainly more than what the keyperson wanted. 

 Educational moment:  We suggested the following.

  1. Owners communicate to the key person that he is a part of the growth of the company, and not only give him a bonus, but include an incentive of a % of business growth, or some metric that was measurable.
  2. Create a “graded-vested benefit,” which would be hard for the key person to walk away from. 
  3. Execute a non-compete clause and a non-disclosure agreement concurrently with the implementation of a selected benefit for the key person. “This is what we would like to give you, but for this we want you to agree to this.
  4. We discussed the disproportionate revenue from the government and discussed ways to increase their customer base. We suggested that no more than 10-15% of revenue should be coming from one source. 

These were only a few of the steps we suggested. 

It is common for owners to reevaluate their middle management; however, compensation is only part of the equation. Creating a middle management culture takes time, loyalty, along with compensation and benefits. Your key person(s), may be one of the most valuable assets of your company. Certainly, it is one of the value drivers which increase the value of your company. 

Without A Conclusive Direction, We Know This Case Will Go Bad for The Family!

Re:  Limited Information Case!

Current fact-pattern (albeit scarce)

This was a case which a professional advisor brought to us. We did not engage this client because there was a lack of facts collected. However, we did want to demonstrate to the advisor, that there were options his client could consider if there were more accurate facts.[1]  As a professional advisor you must obtain many accurate facts of the current situations.  This was a case which had great potential; however, the client was not willing to put the work needed to find solutions.  

Dad is planning on leaving family business to son A, with son B to inherit other assets.  Dad is hell-bent on leaving business at death to get the stepped-up basis. Which is fine if you know all the facts, but he didn’t know all the facts, nor did his advisor council him on them.  

There is no certified appraisal of the business, worth $10,000,000(owner suggested). Spouse would inherit other property (rental real estate and residence along with stock portfolio about $5,000,000). There are no mortgages on the commercial real estate or the residence. 

  1. There is no certified appraisal of the business. 
  2. No estimate of real estate value. 
  3. Dad’s health is questionable. 
  4. No life insurance or corporate benefits other than health insurance.
  5. Estate documents are very old- 25 years old. 
  6. Accountant was not proactive in the planning.
  7. Advisor did some investing for the estate owner.

MODELING:  Until we had more facts about the client’s situation we are limited in our models. However, there are some hypotheticals as options.  As mentioned, the options available need more facts before for these can be considerations. 

  1. Do a current certified appraisal. The cost to litigate in Federal Tax Court compared to a certified appraisal is dramatic. 
  2. Recapitalization of company, creating non-voting stock to create a minority discount, and to use the gift tax exemption to gift this stock to his son maximized before 2026 the gift tax exemption and estate exemption ends.  
  3. Family trust for income purposes for the spouse with son B as beneficiary.  (stepped up basis, and unified credit available)
  4. If exemption credit were less at dad’s death after 2026, use marital deduction and continue gifting program.  
  5. There is also the possibility that Dad could gift limited shares to Son A and then also sell the other shares to Son A with a SCIN[2]. Self-Cancelling Installment note based on his health this could be a consideration.
  6. If company was a pass-through company, spouse could enjoy income from the company after dad’s death without employment.   
  7. Suggested using the company to create tax-effective benefits for the family members, such as a Cash Balance AccountExecutive Compensation such as Deferred Compensation.  
  8. Family could set up an irrevocable trust funding it with a second to die life insurance policy and gift the premiums to the trust.   The tax-free life insurance death benefits could clear up any liabilities, taxes, or level more of the estate value to the sons. 

Keep in mind, this is a hypothetical model, and there are many more directions which we could go.  It is extremely important that the professional advisor get as much information they can from the clients, and their other advisors, so there is a correct representation of the current situation.   In this way, you can build the models needed to satisfy the clients financial wishes.  


[1] DISCLAIMER:  we did not engage this client. Lack of facts.

[2] This is a method of transferring property when the mortality of the owner is questionable because of health issures. There is a premium that must be paid on the sale.  If the owner lives longer than mortality, the family will end up paying more.  However, if death occurred less than mortality, the note would be cancelled.  (owner must not be terminal ill when they enter this transaction.) 

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

 

 

page1image7794464

 

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

10 Questions Every Business Owner Should Know Know!

  1. What strategies are you using to make sure you will grow your business to the maximum value it can grow to.  
  1. What are you doing to make sure you have a key group, culture, and a method to keep them with you for the future?  
  1. What makes you think you are taking advantage of all the benefits available to use in your company that would help, you, your company, and your family on a tax-effective basis.  
  1. How will you extract the greatest potential value of your business upon your death, disability, or retirement (the three major reasons you will have to leave your business)?  
  1. What ideas and strategies have your accountants and attorneys given you in the last three years that has made a significant difference in your growth of the business? 
  1. If you died tonight, who would own your business? And are you sure that is true? 
  1. Make makes you sure that your key people will not leave you? And if they do, what makes you think that they will not go to your competitor, start their own business, and/or reveal your business secrets the competition. 
  1. What makes you believe your key people would not steal your employees, and clients, if they decided to set up shop across the street from you? 
  1. When was the last time “all your advisors” sat in the same room for the morning and talked about your goals, and what is the best advice they could give you to create more growth and better business? 
  1. How would your spouse know what all the passwords needed to open your computer accounts, would she know where the key to the front door of your office is, if you died last night?  

For A Free Business Kit click the link below:

https://www.allclients.com/Form2.aspx?Key=49D7A9612BCD8971E08D1B3293625EBA

Common techniques and situations where life insurance is required!

When you apply for life insurance with a trust, how is it set up? What are some of the ramifications? 

Basically, a life insurance policy is purchased by the trust and is owned by the trust.  The Grantor pays the premium in the form of gifts to the trust.  By doing so, the life insurance is not part of the estate, the benefits are tax-free, and if done correctly, premiums are considered present interest gifts in most cases.  The combination of the trust (Irrevocable Insurance Trust), and the Life Insurance maximizes and leverages the amount of property which can pass to the estate!   

  • The Trust needs a Tax ID (EIN) from the IRS since this is a tax paying entity 
  • A non-interest-bearing checking account in the name of the trust is needed to deposit cash into to cover the premium payment.  
  • The Grantor makes gifts to beneficiaries of the trusts. Gifts are deposited into the checking account. Gifts are normally within the annual exemption limit. 

Life Insurance and Business Succession Planning 

  • Equalization when leaving a business to family members when some of the members will receive the business while others will not.  Life Insurance can be the equalizer for the other children not receiving business interests.  
  • For businesses that are heavy in real estate, the life insurance can guarantee liquidity to cover maintenance expenses and lost cash flow. 
  • Life Insurance is a component of most buy and sell agreements to ensure the surviving partner has liquidity to buy out the interest of the deceased family member. 

To receive our FREE Estate Planning Guide for Business owners, BUSINESS OWNERS ESSENTIAL R-6:  CLICK HERE FOR THE DOWNLOADON the drop-down menu pick R-6 Business Owners Essentials. 

Types of Insurance:  Whole life, 2nd to die. What are the benefits of each?  

  • Second-to-die/survivorship life insurance can be in the form of a whole life or Universal life insurance policy.   It covers two lives and is paid at the survivor’s death.  It is normally when the capital requirements are needed at the death of the survivor.  Based on the mortality of two lives, it provides a discount for the insurance.  However, after the 1st insured dies, the premiums are normally needed, so a consideration would be the cash flow after a death of either one of the insureds.  However, if the capital requirement will be at the 2nd death, this type of policy is less expensive than buying two policies.   
  • Whole Life Insurance and Universal life are designed to stay in force for the insured’s lifetime. Whole life has guarantees, while Univeral life is albeit more flexible. It has the potential to cost more to keep in force for the whole of life.  However, universal life does offer guaranteed death benefit plans. Whole life and Universal Life can be used when the capital is needed for the lifetime of the insured.  
  • Term insurance is designed to last for a specific period before it expires.  Although term insurance is the least expensive initially, with outlay, it can become the most expensive over time.   However, it is a great plan to own when you have defined the capital exposure needed for a specific period and no longer. An example would be a bank loan for a brief period, a potential exposure or need not lasting for more than 20 years.   

Is life insurance death benefit tax free  Most of the time if arranged correctly.  However, there are a few exceptions when life insurance is not taxfree.   

  • Paid directly to the designated beneficiary (trust or individual) it will be paid tax free.   
  • The unholy triangle:  owner –dad; Dad gifts the policy ownership to daughter.  Daughter names her daughter as beneficiary.  At dad’s death there is a gift from Daughter (owner) to her daughter as the named beneficiary.  
  • Transfer for value:  This is when a policy is sold to another person as owner and paid to a non-exempt class, the policy will be taxable on the proceeds in excess of what the policy was sold for.  
  • Owner A, sells, his policy to his brother-in-law. At A’s death, the proceeds will be taxable in excess of what the brother-in-law paid towards the policy.  
  • However, if the brother-in-law was a Corportation (office of), a partner, a partnership, there would be no income taxes.  
  • Or anyone whose basis is determined by reference to the original transferor’s basis.  
  • The insured (or insured’s spouse or ex-spouse if incident to a divorce under Sec 1041) 

Avoiding the three-year look-back period when existing insurance is transferred to a trust.  

  • If the policy is already owned the insured can gift the policy to the trust, making a lifetime gift to the trust, the trust can then buy the policy for the interpolated reserve value of the policy  
  • Set up the trust before the purchase of the life insurance. Have the trust buy the policy, the trust would be the original owner and beneficiary.  

Download Our  FREE Business and Estate Planning Guide for Business OwnersBUSINESS OWNERS ESSENTIAL R-6:   

CLICK HERE FOR THE DOWNLOADON the drop-down menu pick R-6 Business Owners Essentials. 

What changes can be made to an irrevocable trust when the estate planning has changed?  

  • Decanting the trust varies from state to state. Decanting techniques can pass the assets into a new trust and take advantage of enhancements that may have appeared in the trust code since the original trust was created.  
  • Establishing a new trust for the life insurance:  The funding must be valued at the value of the old trust (namely the interpolated reserve value). It requires an exchange of assets. The trustees would also sign a contract of sale when the life insurance is transferred.  Certain procedures need to be in order.  

These are a few of the areas professional planners should be aware of when working on the estate of their clients.  These are some of the more complicated planning techniques, which come up often and are critical to making sure advisors are aware of the potential tax traps.   

I have found it best to work with the “team” of the client’s advisors so there is less of a chance to make mistakes when planning the estate of the business owner.   

To receive our FREE Estate Planning Guide for Business owners, BUSINESS OWNERS ESSENTIAL R-6:  CLICK HERE FOR THE DOWNLOADON the drop-down menu pick R-6 Business Owners Essentials. 

You Saw It Coming And I Saw It Coming, We Both Saw It Coming…But we still bought it!…

After fifty years of running a tremendously successful planning firm, WORKING ONLY eighty days a year, I can make this statement with full confidence!  

Every business owner deserves success and financial independence when they give all they must to build a business.  NO issue here.  If done correctly they will enjoy financial independence and an abundance of leisure time which I call “your beach”.   

What gets in the way of preventing a business owner from becoming financially independent and finding their “own beach”, are two things:   

First Reason: The business owner has their hands in everything. Nothing gets by them.    They work eighty hours a week and wonder why they have no time for themself or families.   They believe you must work “hard” (to them that means anything that keeps them busy).   While they are doing insubstantial work, they are neglecting the important work (The Business and Financial Key Elements to Their Business).   

Second Reason Archaic and falsehood beliefs that business owners “bought into”, such as.  

  • Your inventory and your receivables are like money in the bank,  
  • You must work hard in the early years so you can slow down in the later years 
  • Take every dime you have and invest it in your business 
  •  You need to invest in your business in order to grow 
  •  Every business needs time to grow 
  •  You can’t grow fast 
  •  Borrow as much as you can 
  •  It’s a lot of money, but it’s a write off 
  •  When you go into business you initially spend more money than you want to 
  •  You need to invest in your business   
  • Plow all your profits back into the business   
  • You don’t need to give your key people additional benefits 
  • “It’s easier for me to do it, I’ll do it the right way” attitude 
  • If I train someone to do it, they may leave me and start their own business 
  • You don’t need a business valuation just use a simple formula 
  • I have all the systems in my head, we don’t need a document 
  • I’m not worried about leaving the business, they will figure it out 

Falsehoods, and archaic business principals   do more to destroy businesses than a bad economy.   If you don’t fix this situation, no matter how hard you work; YOU WILL NEVER GET TO YOUR FINANCIAL INDEPENDENCE AND “YOUR BEACH”.   It’s that simple!  

But the good news is that you can correct these problems by using a technique that has worked for me and my business clients for over fifty years.    It’s called the “ONE PAGE BLUEPRINT SOLUTION”, and it only takes TWO HOURS MONTH (two lunch breaks) to implement and correct the two major reasons why business owners can’t become financially independent and find their “own beach.”    

To help you learn more on how you can eradicate the two reasons, I am offering a free copy of my eBook called, “Unlocking Your Business DNA”, (Cracking the code to a better business, bigger profits and more time on the beach).   THIS BOOK WILL help you understand the principals discussed.  Limited supply.  To receive your FREE EBOOK, CLICK.

* Book can be purchased on Amazon; Kindle and Paperback. All profits go to Wounded Warrier Project.

**Full Steam Ahead (title; You Saw It Coming)

Life Insurance USES For Business Owners! The Uses of Permanent and Term Life Insurance!

In my very long career as a professional advisor and insurance agent, there were many occasions when I worked with CPA’s, and attorneys that were misinformed about the type of life insurance that would be appropriate in certain situations in a business arrangement.  

Many times, I found that the advisors were basing their opinions more on their personal feelings rather than the actual case fact pattern.  In most cases, when I explained to them the long-term nature of the need, or even the short-term nature, they had a better understanding of the situation, excepting my suggestion of the type of coverage to be used.    

I do believe in term insurance and that it has a place. I have used it over the years in situations where we felt the insurance benefit was only needed for an ascertainable period.   An example would be to fund a liability in a company where the company is new and does not have the cash flow to pay the larger permanent coverage.   

Another area would be when the need is temporary, such as a short-term bank loan, or an outstanding company loan.     

I have experienced clients purchasing term insurance because the premiums were very low, at least for that time frame.  I have had clients tell me they would buy term and invest the difference.  They don’t invest the difference.  They wake up one morning only to realize the term insurance started to increase in premium at an unsustainable rate to pay, and the client still needs the coverage.  Oh, yea, they didn’t invest the difference. Trust me on this, they never do.   

As a side: Term insurance was designed not to be in force when the insured dies. Insurance companies make a lot of money on term insurance because they know the policy will not be in force when the insured dies (based on their mortality data).   

Term insurance was designed to do one thing. Cover the capital liability for the period which the liability will exist.  

Now that that is out of the way, let me review some areas where permanent insurance works, and in many cases works better than any other financial vehicle.   

Business Succession:   

Many times, when I review the Business Succession Document, I find that the life insurance does not correspond to what the agreement says. Either the life insurance is underfunded, lapsed, or will be terminating soon, as it was term insurance.   

In this case permanent life insurance would have been the best solution as it has double duty dollars.  It would fund the death of an owner, help fund the retirement of an owner, or help should the owner become ill, help with income when needed.   Until the business owner transitions his position; the insurance would be needed.  This could be for many years. 

Example:  Sole Proprietor 

Many sole proprietors will tell you they don’t have a market for their business.  In essence they have a job, not a business.  However, through insurance planning, they could create a market.  For the cost of 1-3% of what the business owner feels their business is worth, there is a ready market.  At the owner’s death, the life insurance company (for 1-3% of capital), will step in and pay the family the value of the business, with tax-free dollars.   

The family also can sell the business assets without a fire sale.  Even if they sell it for pennies on the dollar, they made out better than without having the life insurance.  In this way, the business owner can keep the family in the lifestyle they have become accustomed too.  

If set up correctly, the sole proprietor could have paid the premiums through the business check book. Depending on the business structure, the premiums would be taxable to the owner, however, the cash flow comes from the business.  If the sole owner was a C Corp, they could have used split dollar and paid the taxes on the economic benefit, or the taxes on the loan regime. Either way it would have been a less expensive way of providing the market value for the company, while making sure the family received the business value, tax-free.   

This is an example of where permanent coverage is the best.  The owner of the business can also have a plan that will pay them a retirement income from the policy, while they are trying to sell the business.  An example of double duty dollars.    

The life insurance also has triple duty dollars as it can be used to help fund the costs of estate taxes, probate and settlement costs at the business owner’s death.  

PROFIT  PROTECTION 

 Most profitable organizations have key persons and key groups.  They are the people who if they didn’t come to work tomorrow, would have a negative effect on the earnings of the company.   

Once you define them, insuring them will protect your profit center.  Not only will you protect you earning and profits, but the insurance would also create new tax-free dollars at a key person’s death.  

The benefit will help the owner:  

  •  Find a replacement for your key person 
  • Fund the “usually the first one doesn’t work cost”, search for the key position and person 
  • Absorb the period where no profits are being generated by the new key person(s), for the period of the learning and adjustment period 
  • Create benefit where you can lower or eliminate turnover with your key person group 

There are “double duty dollars” using permanent life insurance.  Not only are you protecting your profits from a loss, and the cost of capital to replace, but you can also use the life insurance as an executive benefit to keep the key person from leaving the company.  The cash values of the policy can create a very rich tax-effective retirement benefit on top of the normal retirement plan.   

You can create a benefit with vesting schedules and restrictions which give the owner control over the cash values and create a benefit where you are rewarding the key person(s) with a very high retirement benefit if they stay.  This type of benefit is very effective in lowering turnover of your key people.  A salary, bonus is forgotten and expected, however, a special key person benefit is substantial and hard to walk away from.   

This again is another area where permanent life insurance works, and where term does not. 

Golden Handcuffs 

In many small companies there are key groups that are the major reason for the profits.   They know the company, know how things work, and in many cases act like an owner of the company.  They are the group that create the profits, allow the owner to live a nice lifestyle and allow the owner to come and go as they wish.   

These are the people you want to keep for life!  However, they are well known. The competition knows them very well.  Not surprisingly, the competition makes it a point to meet them when they can, such as at trade shows, industry meeting, and gatherings, hoping to test the waters to see if they can sway them away with some type of financial offer.   

They are that good, and if your competition could sweep them away from you, the owners world would change overnight.   

 THE GOLDEND HANDCUFFS  

To keep this key person or group, you need to create something they can’t afford to walk away from. A benefit so good, that even your competition would find it hard to offer to them. This is all possible by using the proper permanent life insurance policy, and the combination of well-established tax law.   

Over the years I have done many comparisons using mutual funds, annuities, stock, and company earnings, but nothing compares to the combination of a permanent life insurance policy and the tax law which allow this type of benefit.   

Using “Golden Handcuff” programs allow you to write the rules, have a vesting schedule, recover your costs, take tax deductions, and other design flexibilities.    

 By using the leverage of the tax code, and life insurance tax code, you can create a non-walkaway benefit for your profit center.   

Example:  We just finished a plan, where the key person will walk away with a substantial income at retirement.  The employee’s cost was less than $266 a year.  The employee received a large deduction and had complete control of the funds until the employee retired.  The employee would have to make over 40% ROI on his contribution to the plan in order to receive the benefits he will be receiving.   

Not only will the employee have a great retirement benefit, if he died prior to retirement, his family would have received $74,500 tax free for the next 10 years.   

As you can see, there are some very good uses of permanent life insurance, and in many cases the best and most economical solution.   

A Tax-deductible Life Insurance Plan 

One area that many small business owners are not aware of is section 412(I), where owners can design having a life insurance policy with 100% tax deductible premiums.  Normally, this is a plan that works very well with small companies and a few employees.  Again, another area where permanent life insurance works the best.