Succession Planning. Succession Planning. James F. Weber, CPA, CGMA Managing Member

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1 James F. Weber, CPA, CGMA Managing Member This session is eligible for 1 Continuing Education Hour and 1 Contact Hour. To earn these hours you must: Have your badge scanned at the door Attend 90% of this presentation Fill out the online evaluation for this session Attendees Only 1

2 Program Overview Planning Exit Strategies Estate Planning Tax Matters Appendix A - Summary of terms Appendix B - Legal matters to consider Appendix C Notice and consent of insurance Planning A good succession plan must be planned properly. The most important decision of our life is often the last decision we make. Good planning requires financial balance between your personal and business assets. The largest single asset of a business owner is often the business. Attendees Only 2

3 Planning Save! Contribute to a retirement plan as aggressively as you can. 401(k), profit sharing, safe harbor, cash balance, union plan Prepare a budget. Pay off all business and personal debt. A large number of business owners have not formally done their: Estate plan Succession plan Planning Most people do not meet with their advisors on a regular basis to review and update their plan. How much time do you spend on your personal plan? Have you built a strong personal net worth outside of the company or is your company your retirement? Attendees Only 3

4 Planning In order to begin to plan for retirement you must answer the following questions as corporate benefits are important. Do you plan to work in the Company when you retire? If you don t plan to work in the Company when you retire, what benefits do you currently receive from the Company that you will have to pay personally for in retirement? Planning Put a dollar value on the following benefits: Insurance Medical (Medicare) Work qualification - 32 hours Life Insurance Disability Insurance Long Term Care Insurance Related Party Matters Real Estate Family at work Wife & Children Attendees Only 4

5 Auto Planning Lease/Purchase Maintenance and repairs Fuel Insurance Planning Club dues Travel Entertainment Legal Accounting Retirement contribution Other - You know what they are? You know what you currently receive. Determine the annual value Attendees Only 5

6 Planning Calculate your family monthly/annual budget What are your monthly and annual expenses? How much passive or active income will you receive? (Consulting fees, rents, investment income) How much income will you receive from the sale of the Company? (gross amount tax debt at 4%) Planning Calculate your family monthly/annual budget (cont d.) How much Social Security, 401K, and all other income will you receive? Will all of your debts and mortgages be paid off? Remember your current benefits that are no longer paid by the company! Do not include inheritance in your plan. Be conservative with your estimates of income and expense. Attendees Only 6

7 Planning You will need approximately $2,337,900 cash to receive $10,000 a month, net of tax at 20% for 25 years 65 to 90 at an 4% return with 3% annual inflation. If this is all that you need and you have sufficient assets invested to create passive income at this level, you may not need to do any significant planning today. Planning One thing that should NOT be a part of your planning is: Basing the value of your business on what you need for retirement. Only a family member will pay that value if it is more than fair market value. When you go back home, meet with your attorney, investment advisor, insurance agent and CPA together and ask a simple question: Will I be able to comfortably retire at age 65 and if not, what should I be doing to correct the problem? Attendees Only 7

8 **On average only ONE IN THREE closely held businesses pass SUCCESSFULLY to the next generation!** Lack of proper transition planning is often why businesses fail after the original owner retires, becomes disabled, dies or just get s plain old and loses the best people (tired of waiting) Need a sound plan to accomplish the following: Transfer control according to your wishes. Carry out the succession of your business in an orderly fashion. Create a legacy (if that is important to you). Access the imbedded value of your Company. Reduce risk (bank, bonding, seller financing). Attendees Only 8

9 Taxes Capital gains Dual tax in a C corporation Built in gains Ordinary income vs. capital gains Purchase price allocation Non-compete agreements Taxes Consulting fees Cash basis taxpayer Gifts Estate tax Don t let taxes drive a transaction Attendees Only 9

10 Succession planning cannot be done without considering estate planning. They are often interrelated. Once succession planning is complete, the estate plan needs to be revisited and often revised. The following professionals should be part of the succession team: Attorney Accountant Financial Planner Investment Advisor Insurance Agent Banker Bonding Company Business Broker Psychologist Transition advisor Attendees Only 10

11 Have these advisors meet with you to discuss the process? Have they done this before? (references) Are they right advisors to take you through this process? Do they tell you what you want to hear or do they tell you what you need to hear? The process: Create a strong, well run and organized company. Run it like a business. Hire key people (family/non-family), make them responsible/accountable, pay them for success. Create, follow and exceed your business plans. Prepare projections, benchmark your company to others. Develop strong reporting and management positions. Determine fair market value. Hire a representative to market the company or be a transaction adviser. Attendees Only 11

12 When a buyer is found: Non-disclosure agreement (NDA) Release data (tax return, financial statements, work in process, equipment list, projection) Buyer to create letter of intent (LOI) Complete buyer due diligence Draft agreement Evaluate trailing liability effect (pension) and risk, if any (owner financing) Family transition Family harmony Personal well being Confront emotional issues Are they capable? In-laws Attendees Only 12

13 Business transition Embrace change Strong management team Exiting owner (family) must abide by rules implemented by new management team. Management transition Family member Non family member The organization must know who the new management team is. Attendees Only 13

14 Estate transition Equalize estate for family members who have no business ownership. Ensure fairness in business. Develop exit strategy for family members who do not participate in ownership of business. Family and in-laws will have issues with family members who control business interest. Is there more than one (1) owner? Buy/Sell Agreement: Allows corporation or remaining stockholders to purchase stock. Value for stock (valuation, formula value, stated value). Funded on death with life insurance. Attendees Only 14

15 Methods Stock redemption Remaining stockholders purchase stock on death, disability or retirement. Corporation purchases stock or if S Corp stockholders purchase the stock (inside vs. outside). Sale to outsiders (third party buys the company) Asset sale Stock sale Methods Merger Similar to a third party sale in the end Other ESOP - Sale to employees Attendees Only 15

16 Funding Life insurance Corporation pays premiums on life insurance: If stockholders are beneficiary, premiums deductible by corporation and reported as income to stockholder beneficiary (cross purchase). If corporation is beneficiary, stockholders pick up no income and corporation gets no deduction for premiums paid. Remember registration for key man Life Insurance under section 101(J)-2 (Appendix C). Benefits of this method: Provides liquidity to estate and business in death. Smooth transition between business and family. Attendees Only 16

17 Drawbacks Funded with life insurance Insurance may be difficult to acquire and expensive with age and medical issues. Business is transferred upon death, what happens if you live? Do you have a current buy-sell agreement? Is the value reasonable? Have you looked at this agreement with your legal counsel and your CPA in the past 12 months? ESOP Employer stock ownership plan: ESOP can accumulate cash to acquire or redeem stock of retiring business owner. Qualified plan that enables employees to invest primarily in their employer s stock. Corporation can deduct cash contributions and dividend payments to ESOP Proceeds to seller may be tax deferred Attendees Only 17

18 Disadvantages Control issues if employees acquire enough stock and change corporate policy. High administrative costs. Must use specialist. Gift stock to family members Gift $14,000 per year to family members without incurring gift tax. Married taxpayers can split gift and double exclusion to $28,000. Even if gift comes from one spouse Lifetime gift exclusion through December 31, $5,430,000 Attendees Only 18

19 Exit Strategies Sell stock to family member Fair market value must be determined by third party. You can still make annual gifts. Is the family member qualified? Effect on key employees? Will they pay fair market value? Are they bondable, are they bankable? Will they respect non family management team? Estate planning issues Other children Allows business owner to transfer business to next generation tax free during his/her life. Reduces owner s taxable estate May create an income tax advantage. Shifting income to lower bracket taxpayers Attendees Only 19

20 Disadvantages Owner giving up income Dividends Pass through basis Owner may not be ready to give up control. Children can go bad - divorce Can all children really run the Company? Will there goals be aligned? Do you have a board? Do you have a family succession consultant? Sale to key employee Do they have capital? Will the owner fund a portion of the selling price? Can the key employee get financing? What do they have at risk? Will the Company have positive cash flow with the financing in place? Use of a deferred compensation plan for down payment. Attendees Only 20

21 Exit Strategies Sell to key employee Is key employee qualified? Effect on family members in the business? Effect on customers? Effect on other employees? Are they bondable, are they bankable? Sale to competitor May be simplest succession plan If no family member or key employee can acquire business, may be best option May provide highest value for owner May provide quickest liquidity for owner Merger - Interesting option Liquidation (Really!) Taxes Capital gains Ordinary income Attendees Only 21

22 Sell to Competitor Exit Strategies Effect in marketplace Effect on employee morale Blending of company cultures What is the company s fair market value? Has a business valuation been done? Cost of a valuation? Common valuation concepts in buy-sell documents: Appraisal Formula Stated amount In practice net book value seems to prevail amongst contractors. Attendees Only 22

23 Have you had an appraiser? Independent appraiser? CVA or ABV value the company? What is the cost? What are the economic variables that define value? Define the relevant value concept used: Net book value Capitalized net earnings EBITDA Do you have related companies? Rental, real estate, equipment companies, other Do you have restatements or adjustments to income to reflect extraordinary, unusual or unnecessary expenses? i.e. excess compensation, benefits, rents other? Attendees Only 23

24 How does your industry model value businesses like yours? Complete a stress test on your value. Remember no value is relevant if the company s historical average or current earnings can t cover the debt service necessary to amortize the debt over a amortization period of 5 to 7 years after tax and achieve a fixed coverage ratio of at least 1.2. Buy-Sell Agreement Does a buy-sell agreement exist? Are the buy-sell agreements fully signed and executed by all parties? Is this reviewed annually? Is there a formula (appraisal, formula, stated amount) in the buy-sell that explains how the sale price is calculated? Are the buy-sell agreements to be funded by life insurance? Is the value reasonable? Are payment terms reasonable? Attendees Only 24

25 Estate planning Estate Planning General reasons for estate planning Preserve assets Minimize estate taxes Distribute assets according to your wishes Do you have Medical power of attorney, durable power of attorney, wills, trusts? Estate exemptions Estate Planning 2009 $3,500, Estate tax repealed 2011 $5,000, $5,120, $1,000,000? 2014 $5,340, $5,430,000 Attendees Only 25

26 Estate Planning Business and business real estate get sold for cash. How does this affect estate plan? How does this affect insurance needs? Life Insurance (income replacement and estate tax payment) Disability Insurance unavailable after age Long Term Care Insurance Estate Planning If business is sold, you need to meet with advisors to make appropriate changes to your estate plan. Set up a meeting with your advisors to implement the following: Financial plan Estate plan Review at a minimum annually. Attendees Only 26

27 Tax Matters S Corporation vs C Corporation Capital Gains vs Ordinary Income 338 (H) (10) Election Recapture Allocation of Purchase Price Form Consulting Fees Statutory Rates Other Basis Asset vs. Stock Purchase Appendix - A Summary of Terms Entrepreneur Children Key Employee Competitor Fair Market Value Net Book Value Capitalized Earnings Restatements to Net Income Attendees Only 27

28 Appendix - A Present value of discounted cash flows Sale Merger Liquidate Recapitalize Cash Flow Equity Capital Gains Ordinary Income Appendix - A Installment Sale ESOP Financing Bank Debt Family Debt Investor Capital Subordinated Debt Personal Financial Statement Attendees Only 28

29 Appendix - B Legal matters to consider Non-compete, Non-disclosure, Nonsolicitation Creation of a general term sheet Letter of intent (LOI) Due diligence Seller financing Stock in buying Company Interest rate, AFR rate Subordination of seller debt to bank debt Appendix - B Buyers personal guarantee Buyers corporate guarantee Stock held in escrow Acceleration clauses Change in control provisions Tag along provisions Take back provisions Default provisions Attendees Only 29

30 Appendix - B Purchase agreement Unfunded pension liability provisions Venue Cash held in escrow Appendix - C NOTICE AND CONSENT OF INSURANCE Notice is hereby given that, in accordance with the terms and conditions of a certain Shareholders Agreement entered into as of even date herewith by and among, an Ohio corporation (the Company ), {shareholder #1} and {shareholder #2} (hereinafter referred to as the Agreement ) and pursuant to the requirements set forth in Internal Revenue Code Section 101(j)(2), as it may be amended from time to time, the [the Company/ name of insurance policy holder] use: the following only if it s an individual policyholder, not the Company: (hereinafter referred to as the Policyholder ) intends to insure the life of { name of employee/ insured} for a maximum face value amount of $ to satisfy the insurance requirement set forth in the Agreement (hereinafter referred to as the Policy ). The Company/ Policyholder shall be the named beneficiary of the Policy., CONSENT I, { name of employee/ insured} in accordance with the terms and conditions set forth in Agreement and the requirements set forth in Internal Revenue Code Section 101(j)(2), as it may be amended from time to time, hereby acknowledge, accept and consent to the intended purchase and issuance of the Policy on my life by the Company/Policyholder for the face value amount stated above. I further consent to the designation of the Company/ Policyholder as beneficiary under the Policy and acknowledge that the Policy shall remain in full force and effect during my employment with the Company and, keep in bolded in an individual is the policyholder, otherwise delete: upon the determination of Policyholder, after the termination of my employment with the Company. {employee/insured} Attendees Only 30

31 Questions? James F. Weber, CPA Managing Member (419) ext. 224 Don t forget 10:15am-11:30am Special Session: Life on the Rock 11:30am-4:00pm NECA Show Hours Attendees Only 31

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