Issues Of A Growing Company

This is a case study about   a company that did not have a buy and sell agreement in place.  The business has grown substantially.  The owners were concerned about the growth of the company, sacrificing larger salaries to invest and grow their business. 

The accountant recognized that there was a problem if there was a termination of a partner, and referred me to his clients to help educate  them on estate and business planning, and also to help them design a buy and sell agreement.   

Scenario:  

Bill and Sam started a very successful manufacturing company.  They produced the assemblies for hard drives. 

They are a C corporation and have scaled tahe business from four full time workers to about 34 employees. Their client base has grown from just a few to a few dozen over the years. 

One Page Issue(s) (With our team we identified these issues)

  1. The business has never been appraised so there is a question of the value of the company and estate.  
  2. Both partners have families and larger personal liabilities than when they started. 
  3. They have invested their earnings into the business and don’t have a retirement plan.
  4. They don’t have a binding buy and sell agreement, nor a method of funding the liability. 
  5. The owners are expecting the exemption credit to lower which will expose them to death taxes.
  6. Neither partner has done any estate planning, other than simple wills. 
  7. Retaining the key person in the firm who has the relationship with the customers, vendors and key contacts. Because he basically runs the company, the owners take a lot of time off.  They are concerned that the competition may try to recruit him.  If lost, it would have a major impact on the company.

Major issues and immediate concerns: 

  1. Potential fire sale of the firm if there is not a “planned design for buyout
  2. Uncertainty and instability for the employees, especially the key people in the firm.
  3. The possibility of the deceased partners family running the business with the surviving partner, leading to inexperienced leadership. 
  4. Lack of liquity to pay the taxes assessed on the value of the business and other administration costs. Without the valuation, it was a best guess estimate, jeopardizing accurate estate planning. 
  5. Business valuation disagreements, especially IRS litigation. 
  6. Lack of market for the business.
  7. The loss of income for the family.
  8. Lending from the banks could be cut off after the death of one of the owners. No  assurances that loans would be immediately available upon an owners termination. A concern that any new loans in the future may have convenants that credit lines would be redeemed upon a partners termination unless there was a valid buy and sell agreement. 
  9. Stress on the business’ cash flow or credit line  as a result of the surviving owner trying to purchase the deceased partner’s share. 
  10. The possibility of losing their key person to a competitor would be a significant loss to the firm.

One Page Solution

The most critical issues to solve now : 

  • Complete a Buy and Sell Agreement with funding/ both life insurance and disability insurance
  • A Certified appraisal to be done
  • Create strategies to keep the key person with the company
  • Start the process of personal estate planning for each partner

 There were other issues, but we all felt the buy and sell agreement was the most important at this point. 

One Page Solutions For Buy and Sell Agreement: 

  • Cross purchase buy and sell agreement funded with cross owned permanent life insurance
  • The insureds were about the same age
  • They were  both in great health
  • Premiums were about equal in cost, and the corporation would bonus the premium to the owners
  • Since the owners willl sell in the future, having the increased stepped up in basis would save taxes, as the partners plan on selling in the future.
  • Also wanted the insurance company to define full disability through the contract definition.

One Page Solution FOR KEY PERSON:  

A CEEP for the key person (Corporate Executive Equity Plan); For Key Person

  • Cash Equity for retirement
  • Tax free death benefit for family
  • Limited contribution by employee-basically paid in full by employer
  • Tax-free income at retirement- Will create about $200,000 tax free for 20 years at 66

There was a vesting schedule designed for the employee for 10 years. If he stayed he would have a much richer benefit than his 401k would provide

  • Non-compete, Non-recruiting  and solicitation of  employees of the firm,  and Non-disclosure agreement to be executed by key person

Estate Planning: 

Currently, working with the attorney on new wills, trusts, and an irrevocable trust for life insurance. There are some other things we are considering with real estate owned outside the state, such as LLC, AND inter vious trusts.

Triggers:  In the agreement we established the major triggers: death, disability, termination, retirement, divorce, bankruptcy.  We decided to use a disability income policy to fund that part of the plan.  We also wanted to have the definition of disability decided by the insurance company. 

As we move forward we are reviewing other issues yearly.  Also, forming the team with the attorney, CPA, and others was instrumental in accomplishing the results.  

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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?  

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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.

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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.

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[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.  

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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 

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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.  

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.