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!”

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! “

Building Your Leadership Team And Going Deep!

One important issue an owner can spend their time on, is getting the right people to fill the right positions in their company, while removing the wrong people from positions.

Situations are always changing and can change the dynamics of the business.  For example; the retirement of a key owner or other key employee, the unexpected loss of a key person due to death or disability can pose a significant financial hit to any company.  Planning can reduce the adverse impact.

Continuity of leadership is important.  Having a backup for the key positions would be ideal.  Sometimes you don’t have the personnel to accomplish this.  A company training program can be a valuable tool for the long-term growth of the company.  Cross training is worth the time.  Having personnel filling in for important jobs when needed is a valuable element for the business growth.

Trader Joe ‘s is a very good company and a great example of a company with interchangeable job descriptions.   Employees learn multiple jobs and task.   They rotate their jobs every few hours on the employee’s shift.  They create teams, with captains and the team helps with on the job training for the e different jobs.  Their education is ongoing.  Trader Joe’s has a bench ready to go.  This is also done with their management team.  Their candidates are always being educated to move up the line and into the position.

Board of Directors

Having an active Board of Directors can help with guidance in implementing employee growth.  This is next level management.  This is a value driver which is of importance to the growth and value of the company.  It is what a potential purchaser looks for in a company that they may be interesting in purchasing.

The board helps provide management continuity and immediate oversight in triggering events, such as divorce, death, disability, or withdrawal.  The board can be made up of key insiders and some outsiders who have insight to your business, but not necessarily in your business or industry.    Continue reading “Building Your Leadership Team And Going Deep!”

Transferring Stock does not mean you have to give up control. 

  stock option plan is an option to give the key employees more incentive to stay with your company and potentially purchase your company.   Usually the owner will sell to the employee (or employee group), 10%-25% in total.  The amount of the stock will always be less than the majority of the stock.   

 The key person has a better chance of financing future stock purchases from financial institutions by owning this amount of stock in the company.   This creates the building blocks of a future sale for the current owner.  

This percentage of ownership doesn’t give the key employee control of votes during shareholder meetings.  The majority owner can maintain control over the voting as long as the Articles of Incorporation and the Bylaws have been properly structured.   

Another options is to issue only non-voting stock to the key employee(s) in Tier 1.  By amending the corporations’s Articles of Incorporation, you can issues non-voting shares.  You can even do this with S corporation.  The one class rule of an S Corp does not apply as non voting stock is not considered a second class of stock for purposes of this rule.   

CONTROL IN SELLING YOUR COMPANY  

Usually corporate laws generally require at least two-thirds approval by the shareholders when the corporation has a major event as selling the company to a third party.    As long as you maintain at least that amount of percentage ownership, will have the ability to control the decision regarding a future sale.  Continue reading “Transferring Stock does not mean you have to give up control. “

Creating Cash Flow In Your Business

Selling your business to a key employee, or a group of employees.

Assuming that all of the purchase price is to come from the key employee (s), you can help the purchase, by (a) using a stock dividend distribution, or (b) bonus of money to the employ, such as a bonus executive program.  (See Restricted bonus agreement). 

It is important that the company have consistent cash flow, (discretionary cash flow;) to use for this purpose.  (This is the cash generated by the company which is not needed to run the operations, for debt service or capitalization of the business).

Planning for the sale of the stock to insiders, and cash flow; 

It is important to have a accurate idea of the yearly cash flow.  For example, if the discretionary cash flow is $1 million a year. You might commit 10% of the company, or $100,000 a year to help pay for stock.  Continue reading “Creating Cash Flow In Your Business”

Key group wants to buy your business, buy do they have skin in the game?

When considering the transfer of stock to a key employee, or a group of key employees, (referred to Key group), you need to determine how much they want to be involved in the company, and the risk they are willing to take in the future of the company.

In Tier One of the purchase, the key group will purchase stock.  They purchase stock from future salary, financing, or from future cash flow in the form of dividend payouts.

It wouldn’t be uncommon for the owner to want to see the purchasing employee put some skin in the game.  Seeing the employee be committed allows the employer to consider future financial programs to help the employee purchase the balance of the stock under Tier 2 (the selling of the balance of the stock). 

The owner in most cases will look at the bottom line what they want in the end and the financial capabilities of the key employee.  Smaller employees will try to make it easier for the key person to purchase the stock.  Using a bonus plan to help them buy the stock can be a very useful tool for both parties.  The employer gets a tax deduction, while the employee has additional funds to purchase equity in the company.

Using lower valuation for a better cash flow when business is sold Continue reading “Key group wants to buy your business, buy do they have skin in the game?”