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Exit Planning
NAMETITLE
Principal Financial Group
Date, 2010
t100910007c
While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that The Principal is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
Insurance products from the Principal Financial Group® are issued by Principal National Life Insurance Company (except in New York) and Principal Life Insurance Company, Des Moines, IA 50392.
Exit Planning
What Is Exit Planning
A Process
Resulting In YOUR SuccessfulTransition Out Of The Business
Exit Planning – The Process
4 Simple Steps
Step 1 – Set Priorities
Step 2 – Determine Value
Step 3 – Sale to Outsider/Insider
Step 4 – Estate/Wealth Transfer Planning
Exit Planning – Set Priorities
How much longer do you want to work in the business before retiring or moving on? __________ years
What annual after-tax income do you want/need during retirement (in today’s dollars)? $________________
Who do you want to transfer the business to? Family? Co-owner? Key employee? Outside Party?
Needs for Owners and Executives
• Specific business owner issues:– When can I exit my business?– Will my kids be able to – or want to - take over?– Will it sell for what it’s worth?– How can I avoid huge taxes?– Can it survive without me?– How do I reward key employees/management
team to stay?
Considerations for Owners and Executives
• Retirement funds – Will I have enough?• Healthcare – How will I pay for it when I retire?• Survivor needs –What if I die too soon? • Financial security – What if I outlive my finances?
Family Businesses:
Competing Values
Conflicting Values
Determine Value
Who Performs Valuations
• Business appraisal firm
• Business Broker or Investment Banker
• CPA
• Financial and Insurance Professionals
Valuation
“Beauty is in the eye of the Buyer.”
Value is based on reasonable expectations
What are some industry standards?
Rules of Thumb• Dental Practice: A multiplier of annual net earnings
plus fixtures, equipment, inventory• Law Practice: 0-100% annual fee revenue, dependant
on client retention• Accounting Practice: A multiplier of gross annual
revenues• Medical Practice: A multiplier of annual net
earnings, plus fixtures, equip. &inventory• Real Estate Agency: A percentage of gross annual
commissions
Informal Business Valuation
Business Value Drivers
• Focus on increasing cash flow• Develop operating systems that improve sustainability of
cash flows• Document sustainability of earnings• Improve facility’s appearance• Pay down debt• Solidify and diversify customer base• Implement a strategy to grow the company• Build a solid management team, and groom a successor
“Sale Too Little” – Issues and Opportunities:
• Increase Cash Flow
• Increase Value
• Increase Return
“More Than Enough” – Issues and Opportunities to consider:
• Taxes
• Wealth Preservation
• Charitable Giving
The Sale Price to Income Challenge
Sale Price
Sale price needed to support income goal
$4MM $6MM $8MM
Sale Price
$2MM
Motivating Employees
• Equity Based
• Stock Bonus• Stock Option• Stock Purchase
• Cash Based
• Cash Bonus• Nonqualified Deferred
Comp.• Phantom Stock Plan
Sale to Insiders OR Outsiders
Common Techniques• Buy Sell
– Stock or Assets– Cross Purchase or Redemption
• Capital Transfers– Compensation and Benefits – ESOP– Recapitalization
• Gift– Charitable– Family
Buy – Sell Techniques
• Cross Purchase• Redemption/
Entity Purchase
• ADVANCED: Wait-and-See, Partnership
• Stock or Assets?
A B
Bus
A
Non “Buy-Sell” Example: Stay Bonus
• Problem – – Family business with non-family key employees
– How to keep them in the business?
• Solution– Stay Bonus for non-family employees– Life Insurance funds the bonus
Capital Transfers
Compensation and Benefits:
Consulting contract
Non-Qualified Deferred Compensation
Executive Bonus with Restrictive Endorsement
Select Reward Plan
Qualified Plan
Capital Transfers
A Qualified Plan: Employee Stock Ownership Plan or “ESOP”
Invests primarily in company stock
Permits borrowing to finance the cost
Qualified plan testing and administration
Annual stock valuation
S or C Corporation status
Capital Transfers
ESOP: A Qualified Plan
– Creates a market for sale of stock at Fair Market Value (FMV)
– Cash now; Exit Later– Source of liquidity for personal planning– C Corp owners: deferral of gain – S Corp owner: avoidance of tax
Leveraged C Corp ESOP
ESOPESOP
Bank
Tax Deferred Reinvestment
Company
Buy
Stock
Loan 1
Loan 2Selling Shareholders
S Corporation – Tax Elimination
Company
ESOPESOP
$510,000 taxed toShareholders
S dividenddistributions
Non-ESOP Shareholders
$490,000 Tax Free!
$1,000,000 Taxable Earnings
51%49%
Family Business Issues
• One third of Fortune 500 companies are owned or controlled by families*
• 67% of NYSE companies are owned or controlled by families*
• Family-owned businesses represent 62% of the U.S. workforce*
• 19% of family business participants have not completed any planning other than writing a will, and only 37% have written a strategic plan.*
*All statistics and original sources can be found on the
Family Firm Institute Web site: www.ffi.org.
Sources of Funding for the Exit Plan
• Business Equity
• Financing
• Tax Benefits
• Insurance
Exiting Your Business
Three Key Steps
• Assure the Financial Survival of your Business … and you and your Family
• Establish an Exit Plan, including– Valuation– Buy-Sell Review
• Fund your Plan
Estate/Wealth Transfer Planning:
Taxes Can be the Culprit
• Capital Gains Tax
• Alternative Minimum Tax Rate
• Ordinary Income Top Tax Rate
• Federal Estate Tax Rate
Can we all agree federal estate taxes are not likely to STAY repealed?
Mixed feelings …but within a range
“I think Congress won’t do anything … and the exemption will be $1 million
“I’m betting Congress will retroactive the $3.5 million exemption at 45%”
“The Treasury needs money”
“I think there’s a chance the exemption will be $5 million”
Source: “Rebuilding 401(k) Retirement Savings: Three
Stages of Rebuilding,” October 2009
Tax Sources
IncomeAsset
CapitalAsset
Estate
= Subject to taxation
Estate of Blount v. Commissioner,428 F.3d 1338, 1342 (11th Cir. 2005).
• Buy sell agreement to redeem shares at pegged value at death
• IRS ignores estate’s business valuation
• Tax Court affirms IRS
• Circuit Court affirms on issue of valuation• Estate value is $6.50 MM
• Must redeem at $4.00MM
Ten Estate Planning Mistakes
• Too much jointly held property
• Leaving everything to your surviving spouse
• Your will is not your will
• Improperly owned life insurance
• Success in wealth accumulation ≠success wealth transfer
• Leaving retirement plans to your children
• Lack of liquidity
• Equally inequitable
• Everyone must pay estate taxes
• No integrated estate plan
Example 1: Estate Equalization
Challenge
• Some children are in the business; some are not
• Want to treat all the children equally
• Want to pass on majority of the wealth after the second of the two parents die
Solution
• Treat the children equitably
• Set up irrevocable trust with 2nd to Die Life Insurance policy
• Use proceeds to provide wealth to children not involved in the family business
Estate Equalization-Solution
Example 2: Interest Only Note
Challenge
• Parents want business to pass to children (or key employees)
• Business value is appreciating
• Cost of a direct buyout is prohibitive
Solution
• Sell interest in business to children for interest only note
• Buyer buys life insurance on seller. At death, proceeds pay off principal on note
• Only principal (not appreciation) is taxed in estate
Interest Only Note – How It Works
The Marketplace
Market Challenges
• Credit Markets• Capital Markets • Globalization –
the dark side
Market Opportunities
• Technology potential • Post-recession
growth• Globalization –
the Force
Exit Planning – The Process
Summary• 4 Steps of Exit Planning• Family Considerations• What’s the business worth?• Exit Planning many times effects your estate• Maximize value• Minimize taxes• Maximize flexibility• Put a plan in place; pre-fund, if possible
“Do it for me” “Do it yourself”
Q & A ?
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Copyright ©2010 Principal Financial Services, Inc.