Tag: business succession

Why 75% of Businesses Fail in 10 Years (And How to Fix It)

by YOUR BUSINESS WORTH, posted in Business Growth and Transition, Buy and Sell Agreements, Company Wealth, Estate Costs, Uncategorized

By Thomas J. Perrone, CLU, CIC

Your Business May Have a Plan. But Does It Have a Plan for the Details?

After more than 53 years working with business owners, I have noticed a recurring problem:

Business owners are often unaware of the things they don’t know.

And that lack of awareness can be expensive.

Most business owners are very good at running their businesses. They know their customers, their products, their employees, and their markets. They know how to generate revenue and solve the problems that show up every day.

But there is another side of business ownership that often gets overlooked—the planning that takes place behind the scenes.

I call this the Plan for Details.

It is the planning that addresses how you will grow the business, protect what you have built, create wealth from the business, and eventually transition out of the business.

It is different from the action plan that gets you into business and keeps the cash flow moving.

And that difference can have a tremendous impact on the ultimate value of your business.

Three Levels of Awareness

I believe there are three different levels of awareness among business owners.

1. You know there is a problem—but you tolerate it.

You recognize that something isn’t working perfectly, but because the business is still operating, you don’t address it.

“It’s working well enough” becomes the answer.

2. You discover a problem and fix it.

You weren’t aware of the issue, but once someone points it out, you understand it and take action.

This type of awareness can prevent financial leakage and help improve the business.

3. You don’t know what you don’t know.

This is the most dangerous situation.

You don’t know that an opportunity exists. You don’t know that a risk exists. You don’t know that something is costing you money.

And because you don’t know about it, nothing changes.

This is one of the biggest challenges facing business owners today.

There are opportunities to increase business value, protect the company, improve cash flow, retain key employees, create wealth outside the business, and prepare for a future transition—but many owners simply aren’t aware that these opportunities exist.

The Business Owner’s Action Plan vs. the Plan for Details

When most people start a business, their attention naturally goes toward the Action Plan.

They want to get their product or service to market.

They want customers.

They want revenue.

They want cash flow.

They want the business to grow.

And that’s exactly where an entrepreneur should be focused in the beginning.

The Action Plan is exciting. It’s where the energy is.

But the part that often gets avoided is the Plan for Details.

The Plan for Details addresses four critical areas:

  • Growth

  • Protection

  • Equity creation and distribution

  • Exit and transition

These are the areas that can determine whether a business simply produces an income—or ultimately creates substantial wealth for its owner.

What Happens Without a Plan for Details?

Without this type of planning, business owners can find themselves facing problems they never anticipated.

They may:

  • Lose key employees.

  • Lose customers or valuable relationships.

  • Face lawsuits or other unexpected risks.

  • Have no plan if the owner dies or becomes disabled.

  • Experience significant financial consequences when an owner dies.

  • Lose money unnecessarily through inefficient tax planning.

  • Fail to build wealth outside the business.

  • Struggle to create a strong company culture.

  • Have difficulty attracting and retaining talented employees.

  • Miss opportunities for innovation.

  • Discover too late that their business isn’t attractive to a buyer.

None of these problems necessarily mean the owner did a poor job running the business.

They may simply mean that the owner never had a comprehensive Plan for Details.

Building Business Value Is More Than Increasing Revenue

One of the most important concepts in business planning is understanding value drivers.

Value drivers are the characteristics of a business that make it attractive to a prospective buyer.

A buyer doesn’t simply look at what the business makes today.

The buyer wants to know:

Will this business continue to produce cash flow after I buy it?

That leads to questions about:

  • Growth potential

  • Cash flow

  • Key employees

  • Management depth

  • Systems and processes

  • Customer relationships

  • Company culture

  • Dependence on the owner

  • Opportunities for future growth

A business with strong systems, capable employees, good cash flow, and growth potential is generally much more attractive to a buyer than a business that depends almost entirely on its owner.

That’s why planning for a transition shouldn’t begin when you’re ready to sell.

It should begin years—even decades—before you leave.

What If You Died Tonight?

Here’s a question every business owner should ask:

What would happen to your business if you died tonight?

Or what happens if you become disabled?

What happens to your employees?

What happens to your customers?

What happens to your bank financing?

What happens to your family?

What happens to the value you’ve spent years building?

For example, the loss of an owner or key person can have an immediate impact on a company’s financial stability and operations.

And a key employee who leaves may take valuable relationships, knowledge, employees, and even trade secrets with them.

The solution isn’t simply to hope they stay.

The business needs a strategy for retaining the people who are critical to its success.

Key Employees Are Part of Your Business Value

A strong company doesn’t depend entirely on the owner.

The goal should be to develop people who can think and act like owners.

When you accomplish that, several things happen.

You create stronger management.

You create greater freedom for the owner.

You create more time for family and other priorities.

You improve cash flow.

You create a business that can operate without the owner being involved in every decision.

And you make the business more attractive to a future buyer.

A buyer wants to purchase a business—not purchase a job.

If the owner walks out the door and the business falls apart, the business becomes much harder to sell.

Culture Is a Business Asset

Another often-overlooked component of business value is company culture.

A strong culture can make recruiting easier because people want to work for companies where they feel valued and where they can see a future.

Culture can also improve retention.

And when good people stay, they accumulate knowledge, build relationships, develop systems, and become increasingly valuable to the organization.

The result is a stronger business.

Creating Wealth Outside the Business

Many business owners spend decades building wealth inside their company.

The problem is that their business may represent the overwhelming majority of their net worth.

That creates concentration risk.

It also creates a problem when the owner eventually wants to retire.

The question becomes:

How do you convert business success into personal wealth?

This is where careful planning can be particularly important.

The business may be capable of generating cash flow that can be used strategically to create wealth outside the company while continuing to grow and operate the business.

The objective isn’t simply to accumulate money.

The objective is to create a business that produces cash flow, builds equity, and ultimately allows the owner to convert business value into financial independence.

Why Traditional Planning Often Doesn’t Work for Business Owners

One reason business owners don’t have a Plan for Details is that traditional planning can become unnecessarily complicated.

Business owners are busy.

They don’t want a planning process that takes months and requires endless meetings.

They want to understand the issues, make decisions, and move forward.

Another problem is that different advisors often work independently.

The business owner may have a CPA, attorney, financial advisor, insurance professional, and business consultant—but nobody is bringing the pieces together.

In my experience, the best planning occurs when the appropriate advisors work together.

Your CPA understands the tax issues.

Your attorney understands the legal issues.

Your financial advisor understands investments and financial strategies.

Your business consultant understands the business.

Put the right people around the same table and you can begin solving the actual problems of the business rather than simply selling products.

The Four Areas of the GWT Business Planning System

The GWT Business Planning System focuses on four fundamental areas.

1. Growth

How can you increase the value of the business?

What systems, people, processes, and strategies can help the company grow?

2. Protection

What happens if something goes wrong?

What if the owner dies?

What if the owner becomes disabled?

What if a key employee leaves?

What if the company is sued?

What if cash flow suddenly becomes a problem?

Protection planning is about preparing for the “what ifs.”

3. Equity Creation and Distribution

How can the business create wealth for its owner?

And just as importantly, how can some of that wealth eventually be distributed outside the business?

The goal is to use the business strategically—not simply as a source of income, but as a vehicle for creating wealth.

4. Exit and Transition

Eventually, every business owner has to answer one question:

What happens to the business when you’re no longer running it?

That doesn’t necessarily mean selling tomorrow.

Transition could be 10, 20, or even 30 years away.

But the decisions you make today can have a tremendous impact on the options available to you later.

The GWT 30-Day Business Planning Pathway

The GWT Business Planning System was designed around a simple idea:

Business planning doesn’t have to consume your life.

The process uses a series of approximately 15–16 planning blueprints that help identify the areas that deserve attention.

You don’t necessarily need all of them.

You identify the areas that are most relevant to your business, prioritize them, and then work on them one at a time.

The process is designed to take approximately 2–4 hours of the business owner’s time over a 30-day period.

It includes short educational videos, forms, discussions, and planning sessions.

The goal isn’t to overwhelm you with information.

The goal is to help you become aware of what you don’t know, identify the areas that need attention, and establish a practical path forward.

The Real Goal Isn’t a Bigger Binder

Business planning shouldn’t be about creating a complicated document that sits on a shelf.

It should create action.

A good Plan for Details should help you:

  • Build business value.

  • Protect the value you’ve created.

  • Improve cash flow.

  • Develop key employees.

  • Build management depth.

  • Create a stronger company culture.

  • Reduce dependence on the owner.

  • Create wealth outside the business.

  • Prepare for unexpected events.

  • Increase the likelihood of a successful transition.

Ultimately, it should give the owner something that is often just as valuable as money:

freedom.

Freedom to spend more time with family.

Freedom to take time away from the business.

Freedom to make decisions based on opportunity rather than necessity.

And eventually, freedom to leave the business on your terms.

Your Business Needs More Than an Action Plan

The Action Plan gets the business moving.

The Plan for Details determines what happens after it starts moving.

If you are a business owner, ask yourself:

Do I know exactly what would happen to my business if I died, became disabled, or lost a key employee?

Do I have a plan for building value?

Do I know how I will eventually get my wealth out of the business?

Could my business operate successfully without me?

Would someone want to buy my business today?

If you don’t know the answers, that’s not necessarily a problem.

It may simply mean you’ve discovered something you weren’t aware of.

And that’s where good planning begins.

The Bottom Line

Most business owners don’t have a business planning problem because they don’t care.

They have one because they’re busy running the business.

The Plan for Details is designed to help close that gap.

It gives you a way to step back from the day-to-day operation of the company and look at the bigger picture—growth, protection, equity creation, and transition.

The earlier you begin, the more options you have.

And the objective isn’t simply to build a bigger business.

It’s to build a business that creates wealth, protects that wealth, and ultimately gives you the freedom to decide what happens next.

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If you would like to learn more about the GWT Business Planning System and the 30-Day Business Planning Pathway, contact Thomas J. Perrone, CLU, CIC at 203-530-6615.

10 Mistakes Business Owners Make That Can Cause a Failed Transition or Exit

by YOUR BUSINESS WORTH, posted in Business Growth and Transition, Buy and Sell Agreements, Company Wealth, Estate Planning, Executive Benefits, retirement, Tax Free Income, Valuation, Value drivers, Working On Your Business

By Thomas J. Perrone, CLU,CIC

1. Waiting Until They Are Ready to Sell to Start Planning

One of the biggest mistakes is treating transition planning as something that begins when the owner decides to retire or sell.

A successful transition may require years of preparation. The decisions made today can determine the options available years from now.

Mistake: “I’ll deal with the transition when I’m ready to leave.”

Better approach: Build the business with the eventual transition in mind from the beginning.

2. Making the Business Too Dependent on the Owner

If the owner has to approve every decision, maintain every major relationship, and solve every important problem, the business may be difficult to transfer.

A buyer wants to purchase a business—not a job.

Mistake: Building a company where the owner is indispensable.

Better approach: Develop capable managers and employees who can operate the business without the owner’s constant involvement.

3. Focusing Only on Revenue Instead of Business Value

Revenue doesn’t automatically translate into a valuable business.

A prospective buyer will want to know whether the company can continue producing cash flow after the owner leaves.

Growth potential, cash flow, management depth, systems, customer relationships, culture, and owner dependence all affect the attractiveness of a business to a buyer.

Mistake: Assuming “more revenue” automatically means “more value.”

Better approach: Identify and strengthen the company’s actual value drivers.

4. Failing to Develop Key Employees and Management

A business that relies heavily on one owner—or a small number of key people—can become vulnerable when those people leave.

A strong management team gives the business continuity and can make it significantly more attractive to a future buyer.

Mistake: Keeping the business dependent on a few individuals.

Better approach: Develop people who can think and act like owners.

5. Ignoring Company Culture

Culture is often treated as something soft or secondary. But a strong culture can improve recruiting, retention, knowledge transfer, and employee loyalty.

When good employees stay, they accumulate knowledge, develop relationships, and strengthen the organization.

Mistake: Assuming culture has nothing to do with business value.

Better approach: Treat culture as an asset that contributes to the strength and continuity of the business.

6. Failing to Prepare for the Owner’s Death or Disability

One of the most important questions an owner should ask is:

“What would happen to my business if I died tonight?”

The consequences can affect employees, customers, financing, family members, and the value of the business.

Mistake: Assuming there will always be time to deal with an unexpected event.

Better approach: Have a strategy for protecting the business against the unexpected.

7. Keeping Most of Their Wealth Trapped Inside the Business

Many owners spend decades accumulating wealth inside their company.

That can create concentration risk and make retirement more difficult because the owner eventually has to figure out how to convert business equity into personal financial security.

Mistake: Building a valuable business without developing a strategy for converting that value into personal wealth.

Better approach: Create wealth outside the business while continuing to build the company.

8. Failing to Build Systems and Processes

A buyer is not simply buying today’s income. The buyer wants confidence that the company can continue operating successfully after the transaction.

If the business’s knowledge, customer relationships, and operating procedures exist primarily in the owner’s head, the business becomes harder to transfer.

Mistake: Running the business through personal knowledge instead of documented and repeatable systems.

Better approach: Build systems and processes that allow the company to operate consistently without depending on the owner.

9. Having Advisors Who Work Independently Instead of Together

A business owner may have a CPA, attorney, financial advisor, insurance professional, and business consultant—but if each advisor works independently, important pieces of the transition plan can be missed.

The material emphasizes that effective planning occurs when the appropriate advisors work together to address the actual problems of the business.

Mistake: Assuming several individual plans automatically create one comprehensive plan.

Better approach: Coordinate the legal, tax, financial, insurance, and business planning.

10. Having No Written Plan for What Happens When the Owner Leaves

Ultimately, every business owner has to answer:

“What happens to the business when I’m no longer running it?”

That could mean selling to a third party, transferring to family, transitioning to employees, or another strategy. The specific method isn’t the only issue—the important point is to begin preparing before the owner needs to make the decision.

Mistake: Building a successful company without deciding how that success will eventually be transferred.

Better approach: Develop a transition strategy years before the anticipated exit.

The Bottom Line

A failed transition is often not caused by a bad business.

It can be caused by a good business that was never prepared to survive the owner’s departure.

The business owner should be able to answer five basic questions:

  1. Could my business operate successfully without me?

  2. What makes my business valuable to a buyer?

  3. What happens if I die or become disabled tomorrow?

  4. How will I turn my business equity into personal wealth?

  5. What happens to the business when I leave?

The earlier these questions are addressed, the more options the owner has—and the greater the opportunity to build a business that creates wealth, protects that wealth, and ultimately gives the owner the freedom to leave on their own terms.

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Consequences Of Not Creating A Buy and sell agreement!

Featured by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Company Wealth, Estate Planning, evaluations, Funding your Buy and Sell, Income from your business, Inside Sale, Life Insurance Types, Selling Your Business, Working On Your Business

Part 2 

BY Thomas J. Perrone, CLU, CIC 

S Corporations enjoy the advantages of limited liability, transferability of ownership and professional business operation and management. The S Corporation is taxed similarly to a partnership, as it is a pass through to the shareholders.  

The C Corporation is taxed at the Corporation level first. When the C Corporation is profitable and generates taxable profits. When profits are distributed to the individual shareholder it is taxed again when dividends are received by the shareholder.  

You will find S Corporations normally when the individual rates are lower than the Corporation rates. Also, losses in the S Corporation shareholders may benefit, by deduction, the losses on their individual tax returns.  

S Corporation requirement 

  • No more than 100 shareholders- members of family are considered one shareholder 
  • Must be a domestic corporation 
  • Only individuals, a decedent’s estate, estate of individuals in bankruptcy, and certain trusts are eligible shareholders of s Corporation 
  • No shareholder can be a nonresident alien 
  • One class of stock (different voting rights are allowed) 

Basis and S Corporation 

There is only one level of taxation in the S Corporation. That is at the shareholder’s level.  

If the shareholders basis exceeds the distribution, the shareholder usually will not be taxed when they receive the distribution.  

If the S Corporation has never filed as a C Corporation and has no retained earnings or profits, distributions received by an s Corporation shareholder are not subject to income tax if the distribution does not exceed the shareholder’s basis. Consequently, the larger the basis the greater amount of distribution can be taken tax-free.  

Quick overview of Basis 

  • nontaxable distributions of previously taxed income 
  • income distributed in the same year in which it was earned 
  • losses 
  • nondeductible expenditures such as life insurance expenses 

Keep in mind that the adjustments to shareholder basis is an ongoing procedure and will vary from their initial contribution to, or investment in, the Corporation. Usually, a service corporation will have a low basis because of the low initial investment made in these types of businesses.  

Life insurance to fund the Buy and Sell Agreement 

Life Insurance can have several advantages for S Corporations in a buy-sell agreement.  

A nondeductible expenditure such as life insurance premiums decreases a shareholders’ basis in an S Corporation. The cash value policy can help offset, eliminate, this adverse situation.  

Life insurance cash value helps offset the premium charged to the capital account. The cash value offsets the premium paid so that the decrease to the capital account is offset by the cash value of the policy.  

 As an example, if the premiums are $15,000 and the cash value increases by $12,000, then only $3,000 is charged to the capital account reducing the basis of the stockholder by $3,000. As opposed to having a term insurance policy with a premium of $4,000. The permanent coverage will have less effect on the basis reduction of the stockholder than the lower term insurance premium.  

Over a longer period, there will be in increase over the premium, consequently eliminating the basis reduction. In the term insurance scenario, the reduction of cost basis will continue. In some cases where the term must be renewed, or the term has an increasing premium, the lowering of the basis can be substantial.  

Death benefit and basis 

If the life insurance is set up as a redemption basis, it is possible to plan for an increase in basis for the remaining stockholders, by using a promissory note for the deceased stockholder before settling the life insurance claim. Since the death benefit is tax free income, it will increase the basis. Example:  there are three stockholders, A dies. Instead of making the claim on the life insurance, A is bought out using a short-term promissory note. Once completed, the death claim is filed, and proceeds will come in tax free for the remaining stockholders which will increase their basis. If the death benefit were used for the decedent, there would have been a wasting of the basis since the decedent’s estate would normally receive a stepped-up cost basis.  

Stock Redemption in S Corporation 

The buy and sell agreement are between the stockholders and the Corporation. The S Corporation owns the policy on the stockholders and is the beneficiary of the policy. Death proceeds to the Corporation are tax free and increase the basis of the stockholders. A big advantage to arranging the buy and sell agreement under an S Corporation is avoiding the alternative minimum taxes and the loss of basis found in a C Corporation.  

Cross Purchase buy and sell in s Corporation  

The arrangement all owners of a business agree upon in advance to purchase proportionate shares of the decedent shareholder’s interest. Each stockholder would own life insurance on the other stockholder(s) and be the beneficiary.  

  • Life insurance premium is a nondeductible personal expense 
  • Shareholders receive the death benefit federal income tax-free 
  • The surviving stockholder uses the funds to purchase the stock, which will increase the basis of their holdings, by the amount purchased.  

Some key issues:  

Section 318 Attribution Rules  

In a C Corporation, attributions can be avoided for tax purposes by arranging the buy and sell agreement under a Cross Purchase. Since the Corporation is not redeeming the stock, and it is the stockholder, attribution and the treatment of the redemption being treated like a dividend distribution is avoided.  

In an S Corporation, if the S Corporation does not have retained earnings or profits , it will have the same tax result as if the shares were sold or exchanged, allowing the shareholder to recover their basis tax-free, with any amounts exceeding. Basis being treated as capital gains.  

 A poorly structured buy-sell agreement could result in the loss of S Corporation status, as well as the possibility of increasing the surviving shareholder’s tax burden on future distributions from, or on, the sale of the S Corporation. However, there are some great advantages of setting up a proper buy-sell agreement which can be even greater advantages than those available to C Corporations.  

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Conclusion: 

The S corporation can be a great tool for many business owners as a corporate structure. A Buy and Sell Agreement must be carefully considered and drafted with consideration of avoiding the loss of an S Corporation Election.