Tag: buy and sell

The Most Important Document a Sole Proprietors Needs 

by YOUR BUSINESS WORTH, posted in Business Growth and Transition, Buy and Sell Agreements, Estate Planning, Executive Benefits, Funding your Buy and Sell, Inside Sale, Life Insurance Types, Working On Your Business

 

By Thomas J. Perrone, CLU,CIC NEW ENGLAND CONSULTING GROUP OF GUILFORD, INC.

It is an overlooked planning strategy. What happens to a sole proprietor’s business when they die? The business is a financial hub for the family. At death, the hub dries up. What will happen to the owner’s financial support for the family? What can be done to protect this fiscal impact? Along with the death of the business owner, there is the business’s assets, such as, equipment, receivable, inventory, and other business property. What happens to this property? Are the heirs in a position of receiving the top dollar for what is to be sold?

Most business owners spend years building their companies. They develop relationships with customers, employees, vendors, and suppliers. They create systems, build a reputation, and work hard to make the business successful.

For many owners, the goal is either to pass the business to their family or to sell it at a future value providing financial security for themselves.

But there is a problem:

What happens to the business if the owner suddenly dies, becomes disabled, retires, or simply can no longer run it?

Without a plan, the future of the business—and the financial security of the owner’s family—can become uncertain very quickly.

That is why a sole owner should consider a One-Way Buy-Sell Agreement, sometimes called a unilateral buy-sell agreement.

A Buy-Sell Agreement Isn’t Just for Businesses with Multiple Owners

Many people associate buy-sell agreements with businesses that have two or more owners. However, a 100% owner can also use a buy-sell agreement to establish what happens to the business when a triggering event occurs.

A sole owner can enter into a One-Way Buy-Sell Agreement with:

  • Children or other family members
  • A trust
  • A competitor
  • An employee or group of employees
  • Another individual or entity interested in purchasing the business

The purpose is simple:

Create a predetermined path for transferring the business and provide liquidity to the owner’s family.

Instead of leaving the family to figure out what to do with the business after the owner’s death, the agreement establishes a framework before the crisis occurs.

What Happens If the Business Is Simply Left to the Children?

Leaving a business for one’s children may sound like an obvious solution.

But ownership does not automatically mean that the children are prepared to run the company.

Some children may have the experience and desire to operate the business. Others may not.

They may not understand the industry, have the necessary management skills, or even want the responsibility of owning the company.

And if they inherit the business and decide they want to sell it, they may be forced to sell under circumstances that are not favorable to them.

The market determines the value. Competitors may recognize that the family is inexperienced and attempt to purchase the company at a significant discount.

A properly structured buy-sell agreement can provide a much more orderly alternative.

What About Leaving the Business to a Spouse?

Similar issues can arise when the business is left to a spouse.

In many cases, the spouse’s primary concern will not be running the business. It will be replacing the income and financial security that the owner provided.

That can create tremendous pressure to sell.

A spouse who suddenly finds themselves responsible for a business they have never operated may understandably want to convert the business into cash as quickly as possible.

A One-Way Buy-Sell Agreement can establish a predetermined buyer and a method for determining the value of the business.

The agreement can be funded with life insurance or, depending on the circumstances, through the future cash flow of the business.

What If a Competitor Is the Buyer?

A competitor can be an attractive buyer because it may already understand the industry and recognize the value of the company.

More importantly, a properly structured agreement can establish the price and terms in advance.

This can help protect the owner’s family from negotiating with potential buyers at a difficult and emotional time.

What If Some Children Want the Business and Others Don’t?

This is another situation that should be addressed before it becomes a problem.

Perhaps three children inherit the business; only one wants to do it.

Or one child has spent years working in the company and understands how to run it, while the other children have little or no business experience.

The agreement and the owner’s estate plan should address these differences.

The children who want to own and operate the business may have an opportunity to purchase the interests of those who do not want to participate.

Other assets can potentially be used to equalize inheritance among children.

The critical point is to make these decisions before the family is forced to put them under pressure.

Six Questions That Should Be Answered

If children or other family members will eventually own the business, the buy-sell agreement should address some fundamental questions:

  1. Who will control the business?
  1. What happens if one owner wants to sell?
  1. Can an owner sell their interest to an outsider?
  1. Does another family member have a right to refusal?
  1. How will the business be valued?
  1. What are the terms of a future purchase or sale?

These questions may seem straightforward today.

They can become extremely complicated after the owner is gone.

What Should a One-Way Buy-Sell Agreement Address?

A well-designed agreement should go beyond simply stating who can purchase the business.

  1. Future Owners Should Be Bound by the Agreement

If ownership is transferred to another person, the agreement should provide a mechanism requiring subsequent owners to become subject to its provisions.

Otherwise, the original agreement may lose much of its effectiveness over time.

  1. Establish a Valuation Process

Business value changes over time.

Rather than waiting until a triggering event occurs and then arguing about what the business is worth, the owner can establish a valuation process in advance.

One approach is to have the business valued periodically by an independent appraiser.

For example, the agreement could provide an annual or biennial valuation.

A consistent valuation process can help establish a history of the company’s value and reduce disagreements when a transaction eventually occurs.

  1. Restrict Transfers to Outsiders

The agreement can establish restrictions on transferring ownership of interest to someone outside the designated group.

It can also provide remaining owners or family members with a right to first refusal.

This can help prevent an unwanted third party from suddenly becoming an owner.

  1. Establish the Terms of a Future Transaction

Price is only one part of a business transaction.

The agreement should also establish the terms under which a future purchase may occur.

How will the purchase be paid?

Will there be installment payments?

What happens if the business does not have enough cash?

These issues should be addressed before they become problems.

  1. Identify Triggering Events

Death is not the only event that can create the need for a buy-sell agreement.

Other triggering events may include:

  • Retirement
  • Disability
  • Termination
  • Voluntary departure
  • Other circumstances that make continued ownership or management impractical

The agreement should clearly identify the events that activate its provisions.

  1. Address Funding

Having an agreement to purchase the business is one thing.

Having the money to complete the purchase is another.

The agreement should address how the purchase will be funded when a triggering event occurs.

Depending on the circumstances, funding could involve life insurance, business cash flow, financing, or other sources.

The agreement should not simply identify the buyer. It should provide a realistic mechanism for completing the transaction.

Who Should Be Concerned About a Buy-Sell Agreement?

The Business Owner

The owner has spent years building the business.

Without a plan, the future of the company can be left to chance, potentially creating confusion and disagreements among family members and other interested parties.

The Family

For many families, the business represents a sizable portion of their financial resources.

It may also represent their future source of income.

The family should know what is supposed to happen to the business and how its value will be converted into financial security.

The Owner’s Advisers

A One-Way Buy-Sell Agreement should not be viewed as a document that exists independently from the owner’s overall planning.

The owner’s attorney, CPA, insurance professional, financial adviser, and business transition or exit-planning professional may all have important roles in designing and implementing the plan.

Each adviser brings a unique perspective, and coordination among them can improve the likelihood of achieving the owner’s objectives.

The Real Reason a Sole Owner Should Have a Buy-Sell Agreement

There is one important reason for a sole owner to have a plan.

The owner knows the business better than anyone else.

The owner has developed relationships with customers, employees, vendors, suppliers, and other stakeholders that have helped make the business successful.

The owner has also developed an instinct for making the decisions necessary to keep the company moving forward.

When that owner suddenly disappears because of death, disability, or another triggering event, the business experiences a transition.

Customers may have questions.

Employees may be uncertain.

Vendors may become concerned.

Family members may not know what to do.

Potential buyers may see an opportunity to negotiate from a position of strength.

A One-Way Buy-Sell Agreement cannot eliminate every challenge associated with the loss or departure of an owner.

But it can provide something extremely valuable:

Clarity.

It can establish who will acquire the business, how the business will be valued, what the transaction terms will be, and how the owner’s family can receive the value that has been created.

For a business owner who has spent years building a valuable company, that may be one of the most important parts of the overall business transition plan.

Building a business is difficult. Protecting the value you have created should not be left to chance.

Article related:   Single appraiser buy and sell agreement

 

The Cheapest Way to fund your Buy and Sell Agreement – article- Download your free article

Let’s discuss the topic: Toms Calendar

tperrone@necgginc.com

 

An Insurance LLC

by YOUR BUSINESS WORTH, posted in Business Growth and Transition, Buy and Sell Agreements, Company Wealth, Estate Planning, evaluations, Executive Benefits, Funding your Buy and Sell, Inside Sale, Passive Ownership, Strategies of growing business, Uncategorized

By Thomas J. Perrone, CLU, CIC

An Insurance LLC is a limited liability company (LLC) created to own and manage one or more life insurance policies to help meet the obligations under a buy-sell agreement. The Insurance LLC is a new business entity formed under local law, separate and apart from the business or businesses that are subject to the primary buy-sell obligations.  Since the Connelly ruling, Advisors are looking for ways to provide a funding arrangement for buy and sell agreements and the Insurance LLC is another way of providing for the buy and sell arrangements.  

GET YOUR FREE eBook, “Unlocking Your Business DNA”. My published book discussing 50+ years of strategies used to Protect, Create Wealth, Grow business, and Transition the business. Great strategies for advisor and business owner- yours free.

https://www.allclients.com/Form3.aspx?Key=4F3D16E276A4EC0C73BFDC182AA06C23

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

by YOUR BUSINESS WORTH, posted in Business Growth and Transition, Buy and Sell Agreements, Company Wealth, evaluations, Executive Benefits, Funding your Buy and Sell, Income from your business, Inside Sale, Life Insurance Types, Selling Your Business

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.