Rushing Through the Most Important Document in Your Business!

Featured by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Company Wealth, Estate Planning, evaluations, Funding your Buy and Sell, Life Insurance Types, Selling Your Business, Uncategorized, Valuation

In my career I have experienced several business owners rushing through the implementation stages of designing their buy and sell agreement (BSA), probably one of the most important documents they will ever need, treating the process with little thought. As Rodney Dangerfield would say, “No respect”. When it was completed, it was very basic, doing more harm than good.

In some cases, maybe more than I think, the document being used by the drafting attorney was a “hand me down” from another attorney. While the “hand me down form” may have been useful in drafting another person’s situation and making it easier for the drafting attorney to do, it was not going to maximize my client’s planning situation.

In Paul Hood’s great book, “Buy And Sell Agreements, Last Will And Testament For Your Business”, he covers the consequences of not designing the right buy and sell agreement, and how important it is to spend the time and money preparing and designing this important document, with an experienced lawyer. ^[i]

Paul specifically speaks about attorneys using a “hand me down agreement”, and how it may be more harmful by having it than not.

The “Paul Hood Fire Drill”

He uses the idea of the “fire drill”. What happens when a “trigger happens? What will be the outcome and the consequences based on how your BSA is set up (or not set up), when you play it out. Like you were the leaving owner, and then again as the remaining owner. On a personal note, the “fire drill” advocated by Paul is something I use all the time and has been instrumental helping my clients and their attorneys in drafting the proper strategies for their situations. I have found that this has been a great way of helping my clients design the best BSA for themselves. It has allowed them to make it real and start developing questions and ideas that they can implement in their design. It keeps them involved with the process.

The “Fire Drill” strategy has put my clients in the “power seat” of knowledge, so when they discuss their BSA with their attorney, the elements and strategies that are being used are not foreign to them. This consequently helps them design a better BSA, reducing the time needed to spend with their attorney ($$$$$).

Keep in mind, many business owners start the process of designing the BSA when there has been no experience of consequences with an owner or co-owner leaving the company.

Everyone is Equal at the Start!

When owners design their BSA, they are all equal in status. People that enter into agreements want the agreement to favor them when a triggering event happens, even if the agreement has not been updated in years or there is no reference to the triggering event.

When are clients initially design their BSA, it probably will be one of the few times that all the partners will be negotiating with each other, because when there is a triggering event, chances are they will be negotiating with someone other than their co-owner.

The representative of the departing co-owner will have a different perspective as to what they want out of the BSA! Whether it is the spouse, their child, their law firm, whomever, they will be negotiating from a different point of interest.

Business relationships, and friendships are put aside. It is at this point you would hope your BSA covers all the areas of concern that need to be covered. The bottom line is the agreement must be exact as to what will specifically happen based on the triggering event. There is no room for errors if the document is specific. The best time to do this is when everyone is on equal ground.

For this reason, owners designing their BSA with their attorney should take it very seriously because they are really pre-negotiating for the people, they love the most without any certainty of which trigger will occur and which side of the trigger they will be on, leaving or a remaining co-owner.

It is extremely important that the triggering events be identified and that you will understand what will occur with each trigger event.

Paul Hood’s “fire drill” has made it easier for my clients to understand the importance of designing a solid BSA. By posing questions to the scenario, the BSA becomes very real to them.

Examples of how they would play out the “fire drill”

· What if you’re the first co-owner to leave?

· What if you’re the last remaining original owner?

· What if you end up with a co-owner you don’t want to be owners with?

· What happens if one of your co-owners, dies, divorces, or goes bankrupt?

By implementing your “fire drill”, you will start to formulate different scenarios for your own situation creating your own buy and sell design.

This is a critical document in keeping your business going should a trigger happen to any of the co-owners. Unfortunately, you must deal with it in advance and before there is a triggering event.

Risks when implementing your BSA:

· Using an attorney who is using a fill in the blank form.

· Not planning the scenarios before designing the plan.

· Not having a BSA.

· Not signing it.

· No dealing with how to fund such triggers.

There are so many elements to the buy and sell agreement that need to be covered, the planning of this document can’t be taken lightly. However, that is not to say you can’t have a great BSA. Having experienced professionals to help guide you through the process will pay off great benefits in designing and implementing your BSA.

We suggest you find competent counsel who has experience in designing the buy and sell agreements and discuss your goals and objectives with them.

Again, my best advice is pick up Paul Hoods book (“Buy and Sell Agreements, last will and testament for your businesss”.) Read and study it.

If you would like our free Business Succession and Transition Planning Guide, click the link and we will send you a FREE WHITE PAPER to get you started. in your planning. YOUR FREE GUIDE

^[i] E. Paul Hood is a prolific technical author. He has published a number of books on planning and is one of the leaders in estate planning and business succession planning.

The Education of the Quintessential Employee!

June 18, 2022 by YOUR BUSINESS WORTH, posted in Business Growth and Transition, Executive Benefits, Selling Your Business

My friend of fifty-four years, George, is a very remarkable person. In a recent conversation I had with him, I realized that George defines the “quintessential employee.” Why? He makes the “quintessential employee” easy to spot. Just follow him around when he works.

As George was telling me about his history with his company, he related how the company owner came to visit him unexpectedly to thank him for his service of 29 years. When I asked him why he thought the owner appreciated him, he described for me all the things he did over that period.

Consequently, what George told me was the definition of the “model key person.” A person that every business owner wants, and needs, in their organization.

You can spot a model employee in a heartbeat because:

They are the first ones to come to work. They almost never take time off. They volunteer time when needed to cover for others. They learn more than they must and are eager to learn. They are so good at their job (s) you would think that they were the owner.

Key employees like George are valuable for the owners because, they always make life easier for the owners. Key people bring so much to the table, and are the most valuable asset in a company.

Intrinsic rewards examples in the workplace

Below are some intrinsic rewards that may affect your workforce. Fostering these activities and feelings in the work environment could help your team grow and thrive. A key person exemplifies these values.

Completing meaningful tasks
- Letting employees be selective
- Gaining a sense of competence
- Making noticeable progress
- Feeling inspired to be more responsible
- Being an important part of an organization or team
- Feeling accomplished
- § Proficiency in knowledge or a skill
- Feeling pride

I have frequently suggested to many business owners that they groom talented people in their firms who have the take charge values and attitudes which parallel the owner’s. They normally get it, want it, and can do it.

A key thing an owner can do is to surround themselves with like-minded and value driven employees and build from there. The key person has the values of the owner, and the key person influences other workers over time. They set the example of the company’s culture and the value of the owner and the company .

Two Questions:

How do you find such a person?
1. How do you keep them?

Finding is the hard part, keeping is the easy part.

Finding the right person really comes down to the culture which the company portrays to the public. Like Costco or Trader Joe’s, who have the reputation of a wonderful place to work. They continually enhance their reputation of wonderful places to work. By having a well-known culture, companies attract like-minded individuals. Also, having the sense of value, the company can immediately filter applicants who apply for a position. Knowing the company values, is a built-in filter and a screening tool for the company when hiring. Question: “Can this person develop into a key person”? And “Does this person have the values that represent this company?”

Small family businesses can build that type of culture by hiring based on value, creating good compensation, benefits, giving respect to workers, positioning them in the right seat, (also taking them out of the seat if it does not fit, and putting them in another seat the is more appropriate), respect for the workers, along with other factors.

Retaining employees can be accomplished through benefits, time off, respect, vested benefits, ownership interests, and several other ways.

The importance of developing and keeping key people cannot be overlooked.

Creates more business value
- Purchasers of a business want to have middle management in place
- Builds reputation and culture
- Key people tend to impress other employees as a good example
- Key people, as described, are also likely purchasers of the business, or
- Likely to run the business while the owner enjoys life, but still has the control and wealth

My suggestion to many small business owners over the years has been to find ways to build a key group as quickly as they can and to build the group around the values which the owners have.

If you have an interest in learning other ways of keeping your key people, this video will be of value.

Case Study #3. Corporate Executive Equity Plan (CEEP )

For A Free White Paper called, “Wealth Without Taxes”. Click

If you didn’t think you had to plan- Get ready to in 2022!

September 4, 2021 by YOUR BUSINESS WORTH, posted in Uncategorized

Over the years I have observed the inability of many business owners to plan their business and personal estate effectively, for one reason or another. Any excuse doesn’t matter, the bottom line is many (great majority of business owners) don’t have adequate estate and business financial plans. I have often referred to them as “plan by default”, as opposed to a “designed plan”. Guy Baker is were I first heard the terms this way. Very adequate considering the subject.

As you can see in the illustration below, when you consider the exposure of $5 million estate after exemption credits are use, you have the additional loss of the stepped up cost basis. There is a tax ratio of 74% vs. 12% in 2022 if some of the proposals go forth.

Image the business owner who has a high value property which has deferred gain locked in, and the results of that property when at death it is passed to the children?

Here is one of the reasons why business owners should pay attention.

zoom in.

Critical Step Needed To Create An Exit Strategy! Part 1

May 10, 2020May 10, 2020 by YOUR BUSINESS WORTH, posted in Business Growth and Transition, Company Wealth, evaluations, Income from your business, Uncategorized, Valuation, Value drivers, Working On Your Business

Some business owners think that selling their business is a matter of getting an appraisal and putting the business on the market hoping for a good offer.

Many business owners that I have worked with initially assumed they knew the value of their business and what they could sell it for.

Through our education process they realized there is much more to selling their business, then just the establishing a value and then going to market. One of those factors or variables is whether the business owner needs the business value for their future retirement, most do!

Helping the owner figure out what they need for retirement is critical in establishing what they need to sell their business for, and what action is needed to increase the future value of the business (Value Drivers). In this article I will cover two of the seven steps that are the most critical when planning a future exit from the business.

Whether the sale is one year or ten years from now, these are the steps needed to sell a business.

Must identify the Exit Objectives (why, when, and in some cases who)
Identify Personal and business financial resources; (this is part of the future financial security of the business owner and their family).
Maximize and Protect Business Value
Ownership Transfer to Third Parties
Ownership Transfers to Insiders
Business Continuity
Personal Wealth and Estate planning

In this post I will cover steps 1-3, and cover steps 4-7 in the June issue.

In comprehensive Exit planning, (when you break the process down it looks like this):

Your Exit Objectives

Building and preserving business value
Selling your company to a third party
Transferring your ownership to insiders

Your Business and Personal Financial Resources

Business Continuity
Personal wealth and estate planning

Owner’s goals and aspirations are

Financial Need
Overall Goals
Value based goals
Defining the owner’s goals and aspirations shows the client’s wants and needs and identifies what is important to the business owner. By spending time collecting this information from the business owner we establish a strong relationship, while differentiating you, and allowing you to be the quarterback of the plan.

Accurate information from the owner is critical to planning. Calculating what the GAP of resources the owner needs to have in order to supply their future retirement income is critical. It is here where the measurement of their resources helps to decide what they need to sell their business for, to help fund the gap. Continue reading “Critical Step Needed To Create An Exit Strategy! Part 1 “ →

Single Appraiser vs. Multiple Appraiser Choices

April 21, 2020 by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Company Wealth, evaluations, Funding your Buy and Sell, Selling Your Business, Uncategorized, Valuation, Working On Your Business

This month I wrote about multiple and single Appraiser choice. My friend Ed Pratesi was nice enough to give me some of his thoughts, which I definitely respect due to his experience and training. Ed, thank you for this contribution.

Ed Pratesi wrote:

I read with interest your comments on Single Appraiser vs. Multiple Appraiser choices that owners have for a BSA. I agree in part with your assessment that the single appraiser choice is preferred but I do have a number of caveats and suggest that before the number of appraisers needed is secondary to choices made before this decision. Let me explain my thoughts:

Firstly, the choice of number of appraisers almost always works, whether one, two or the three step approach – except when it doesn’t!

Prior to the determination of the number of appraisers needed is preceded by what I refer to as the education process that a business appraiser must take the owners through in order to develop an agreement and a process that will likely be triggered when an unanticipated or unfortunate event has occurred.

In never ceases to amaze me that owners will spend money on creating a business plan, invest in physical assets and talent and not spend enough time on one of the most important events that will occur in their lives – either their exit or a partners exit. My complaint is not pointed at the owners but at the appraiser called in to initially called in to assist in the valuation.

My point simply is the an appraiser needs to explain the valuation process, the valuation methods used to value a business, the applicability or not of the methods to the company, a discussion of the definition of value – (for example fair market value or fair value, more on this in a later discussion), a complete discussion of adjustments that appraiser consider in the valuation process, and what discounts could apply and the reasons for application of discounts.

This part of the valuation process is more consultative and sets the framework for the conduct of an initial appraisal and of the work product. Finally, once the appraisal is complete a meeting to discuss the results and the process is essential and should be prefeaced with scenario planning should a provision of the BSA be triggered.

The goal is to get buy-in on the process not just the number!

I hope I have addressed part of the discussion of the number of appraisers – more to follow if desired…

Ed Pratesi

Edward E. Pratesi, ASA, CM&AA, ABV, CVA

Managing Director | UHY Advisors N.E., LLC
6 Executive Drive, Farmington, CT 06032
D: 860 519 5648 | C: 860 558 0453 | F: 860 519 1982

epratesi@uhy-us.com | www.uhyvaluation.com

www.linkedin.com/in/ed-pratesi-140b762

Life Insurance Proceeds In Business Valuations

March 23, 2020March 23, 2020 by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Company Wealth, Funding your Buy and Sell, Uncategorized, Valuation

If life insurance proceeds are considered as the funding vehicle, then the proceeds of the policy received following the death of a shareholder would not be considered a corporate asset for valuation purposes.(1)

It would be recognized that it was purchased for a specific purpose of funding the buy-sell agreement (BSA). IF it were considered a corporate asset, it would offset the company’s liability to fund the purchase of shares, added back as a non- recurring expense.

Treatment 1: (used as a funding vehicle, not a company asset)

Example: A company with a $10m value, has two shareholders, owning 50% of the company. The company holds a $6m life insurance policy on each owner (assuming no alternative minimum tax issues).

RESULTS: At Shareholder #1’s death, the company collects $6m of life insurance benefits. The surviving partner will receive $10m company value, and $1m of net tax-free proceeds, a total of $11m value. The deceased stockholder receives the $5m for the business.

Treatment 2: (A corporate asset)

Treating the life insurance as corporate assets for valuation purposes.

The proceeds are treated as a non-operating asset of the company. This asset along with other net assets, would be available to fund the purchase the of shares the of a deceased shareholder. Keep in mind that the expense of the deceased stockholder might be added back into income as a nonrecurring expense. (2)

The treatment type can have a significant effect on the net position of a company or selling shareholder. There is also an affect in the ability of the company to purchase the shares of the deceased stockholder, and impact of the position of the remaining shareholders.

Company $10m, before $6m of life insurance. When you add the $6m into the value, the company value is $16m. The deceased shareholder entitled to $8m, the company pays $6m in life insurance proceeds and takes out $2m in promissory note.

RESULTS: The surviving owner, owns a company with 8 million and a note of $2 million.

Which treatment is fair? One owner ends us with $11m while the deceased owner, ends up with $5m. In treatment 2, the surviving owner has to carry a $2m debt to purchase the business. Two dramatic differences. A good reason, why the discussion should take place with your advisors.

More importantly, all parties should understand the ramifications of adding the life insurance proceeds in the valuation or using the life insurance as a specific vehicle to fund the BSA.

——————————

1. Mercer: buy and sell agreements for boomers

2. Non-reoccurring expenses: Non-reoccurring expenses can be somewhat more complex. These are expenses which is specifically designated on the company’s financial statements as an extra ordinary or one time expense. The company does not expect to continue the expense overtime, at least not on a regular basis. Non-reoccurring expenses can be somewhat more complex.

The Interplay Between the Funding Mechanism And the Valuation?

Featured by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Company Wealth, Funding your Buy and Sell, Selling Your Business, Uncategorized, Valuation

What happens when life insurance proceeds are part of the funding vehicle of a buy and sell agreement (BSA).

Example

When a stockholder owner dies and life insurance payments are made, is the valuation of the stock being redeemed as part of the value of the company?

The way life insurance benefits are treated in the buy and sell agreement (BSA), could lead to different estate treatment and income tax. In both areas, the results can be dramatic.

Does the agreement tell the appraisers how to treat the life insurance benefits in their valuation? Does the agreement provide for the company to issue a promissory note to a deceased shareholder, and what are the terms?

Keep in mind, the agreement is no better than the ability of the parties and/or the company to fund any required purchases at the agreed upon price. An agreement that is silent on this issue is like not having an agreement.

Life insurance

Generally, life insurance premiums are not deductible, and the pass through of non-deductibility can create pass-through income for the shareholders of S corporations, and the owners of partnerships and limited liability companies. Knowing how to treat the life insurance premium for tax purposes would be important information for you. We suggest you discuss this with your CPA.

Although the life insurance premium is not deductible, the death benefits generally are tax- free, notwithstanding the alternate minimum tax treatment for C corps.

Keep in mind the funding mechanism is not actually necessary to define the engagement for valuation purposes and has nothing to do with appraisal standards or qualifications. It provides the funding for the company to afford the value, and to make sure the selling stockholder receives the value. In essence, it’s the mechanism to fund the liability of the contract, or at least part of it.

Wants and Needs of the Buyer and the Seller- The normal push and pull!

The seller wants the highest price and the buyer wants the lowest price. Without a doubt the best time to set the price would be prior to a triggering event, when both parties are in parity and neither is the subject of the trigger. It is the best time when both parties will be the most reasonable in setting the rules of the agreements as they are both fair minded in the negotiations.

Funding Methods

Life Insurance: In most cases life insurance will be the most inexpensive method for funding the death benefit part of the agreement, when comparing, self funding, and loans (including corporate promissory notes) to fund the liability, notwithstanding the ability to get a funding loan from a loaning institution. In most of the comparisons I have done over the years, life insurance is the least expensive, most guaranteed, and the easiest method of funding for death benefit purposes.

Corporate Assets: They would have to be accumulated for this purpose, and would likely be included in the valuation, and also would be subjected to taxes during the accumulation stage. What if the death of the stockholder occurred early after the agreement? Would there be funds available to fund the liability of the agreement, as there would be a lack of time to accumulate the necessary net profits for the funding?

External borrowing: Depending on the company’s financial position, it may be possible to fund the purchase price by borrowing. However, this should be negotiated in advance and before its needed. Remember, the time to requests funds from an institution is when you don’t need them. Also, on the other side of this funding element, is the possibility the loan covenant requesting the outstanding note balanced to be called in when there is a dramatic change in ownership and management. The lending institution may be questioning the ability of the company’s future financial position and the ability to stay profitable.

Promissory Notes: If this is going to be used, the terms of the notes should be in the agreement. Although cash payments are preferable to the seller.

Combination of cash and promissory notes: Important to note: Anytime capital is being used by the corporation, it is important not to unreasonably impair the capital of the business. Many state laws prohibit transactions that could impair capital and raise the question of insolvency.

Without the mention of what funding mechanism is being used in the agreement to repurchase shares, lessens the value of the agreement. Also, with stated funding, the economic or present value of the redemption price set by the agreement can significantly be reduced, because of inadequate interest or excessive risk leveled on the selling shareholder.

Weak terms in the agreement of the funding mechanism diminishes the value of the agreement from the sellers prospective. However, terms that are too strong can taint the future transactions. What is clear is that it is essential for the parties to discuss the funding mechanism for the triggers of a BSA, keeping in mind both the sellers value position and the purchaser’s ability to fund the costs.

A Road Map For A Succession Planning Essentials For Planning Creating Your Team Of Advisors

January 24, 2020January 24, 2020 by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Company Wealth, Income from your business, Tax Efficient, Team, Uncategorized, Valuation, Value drivers, Working On Your Business

Who Are They	Their Role
Accountant	Develops financial statements Provides tax advice Assists in Estate planning Assists in Business value
Attorney	Negotiates agreements Tax Advice Prepares estate documents Advises on business structure along with implementation
Management Team	Manages the ongoing operation Operational advice and expertise for new owner Enables business continuity
Business Appraiser	Estimates fair market value of Business Provides the credibility of asking price Advice on how to maximize business value
Business Broker	Finds buyer and market insight for value
Financial Advisor	Facilitates and council’s family goals and value Plans for the future of the estate and distribution May have the capacity to help fund Buy and Sell Agreements and Deferred Compensation situations Offers financial advice to all the members Helps project future financial needs
Banker-Commercial	Financing options for acquisition Access to other experts that may be needed Supports the business transition before and after the acquisition

Exit Options: 1

Transfer the business to a family member; This represents about 42%

Sell to partners or your employees (directly or through ESOP); This represents about 17%

Sell to a third party; 19%

Partner: 10%

Wind down business -3%
Don’t know -8%

Questions To Consider

Are there one or more family members who want to take over the business?
Does the family successor have the skills to operate the business and guarantee the return on your investment?
What are the qualifications and skills someone would need to purchase your business to guarantee the successful transition?
If you transitioned to your family member, how will your employees, suppliers and customers react?
What is the most tax-efficient way to pass ownership to family members?
Will you continue to have a role in the business?
How will this succession option impact the rest of the family?

Selling to partners or your employees

Which employees or partners are best suited to purchase your business?

Do they have funds or access to funds?

Will you have to finance part of the sale?

Do they have the management capability to run the business successfully?

Can the business take on debt for this transaction long term?

Where will the purchase price come from?

Do the purchasers have assets as collateral?

Third party

Who are likely candidates in your industry that would be interested in your business?

Do you want to sell the whole business or only part of it?

Will the potential buyer have the entire financial resources to purchase the business, or would you be prepared to partially fund their acquisition?

What is the most tax-effective way to sell your business?

Why Use Non-Compete Agreements!

November 5, 2019November 5, 2019 by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Funding your Buy and Sell, Income from your business, Inside Sale, Key People_Or Group, Selling Your Business, Uncategorized, Valuation, Value drivers, Working On Your Business

Non-compete agreements (NCA) represent a separate agreement. They could be in an employment contract, or as a separate article in a buy and sell agreement. Sometimes they are referred to as “Covenants not to complete. “

This is based on the possibility that an employee can do harm to a company upon termination. They could know sensitive information about the company’s operation, owners and employee’s personal information, special operations, and proprietary information to a competing advantage, along with so much more.

Picture a very long-term employee working side by side with the owners, for many years, and then leaving to work for the owner’s competitor. Certainly, there can be issues.

No compete agreements (NCA), can be used to retain employees also. It would be very difficult to change jobs within an industry or profession when the leaving employee is limited to compete in a geographic and specific industry for a period of time. However, non-compete agreements are hard to enforce, because in many instances the agreement has overreached and is very broad in the definition of industry and geographic coverage.

Continue reading “Why Use Non-Compete Agreements!” →

What Status Is The Stock After A Triggering Event?

November 5, 2019November 5, 2019 by YOUR BUSINESS WORTH, posted in Buy and Sell Agreements, Key People_Or Group, Passive Ownership, Strategies of growing business, Value drivers, Working On Your Business

Chris Mercer author of “Buy-Sell Agreements for Baby Boomers Business Owners” addresses a very good question. Who owns the stock after the trigger event? After a trigger event, does the affected shareholders retain the rights, risks and privileges of the ownership, things like, voting, distribution, access to financial information, etc., or are their shares converted to another status, such as (example), the “pending sales of stock” status?

If the shares are converted into the new class or status, do they have the right to receive dividends, or interest while in that pending status, if so, who should be receiving it?

The agreement can also have a clause where the stock that is waiting to be purchased would convert to a “non-voting “status prior to being purchased.

There are many times a stockholder has signed personally for a corporate debt. The stockholder may desire to have the remaining stockholders make an effort to get the departing stockholder off the note, as they have ceased to be a stockholder.

The questions that Chris puts forth are legitimate issues and should be dealt with when business owners and their council set out to design a buy and sell agreement for the company.

Thank you, Chris Mercer, for bringing these topics to the forefront.

Over the years, many of the buy and sell agreements which I have reviewed over the years, do not address or mention these particular situations, and could create a void should the situation arise.

Check Chris Mercers publications. He puts out very good information that is useful to practitioners.