exit planning name title principal financial group date, 2010

Exit Planning

NAMETITLE

Principal Financial Group

Date, 2010

t100910007c

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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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