2015 MDRT Annual Meeting e Handout Material. Key Concepts of Business Ownership Agreements

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1 2015 MDRT Annual Meeting e Handout Material Title: Speaker: Key Concepts of Business Ownership Agreements David T. Lyons, J.D., CPA Presentation Date: Tuesday, June 16, :00 11:30 a.m. The Million Dollar Round Table (MDRT) does not guarantee the accuracy of tax and legal matters and is not liable for errors and omissions. You are urged to check with tax and legal professionals in your state, province or country. MDRT also suggests you consult local insurance and security regulations and your company s compliance department pertaining to the use of any new sales materials with your clients. The information contained in this handout is unedited and errors, omissions and misspellings may exist. Content may be altered during the delivery of this presentation Million Dollar Round Table Million Dollar Round Table 325 West Touhy Ave. Park Ridge, IL USA

The Million Dollar Round Table (MDRT) does not guarantee the accuracy of tax and legal matters and is not liable for errors and omissions.

2 David T. Lyons, JD, CPA Key Concepts of Business Ownership Agreements Sales Opportunity On January 1, ,000 Baby Boomers born b/w turned 65. Projections simulate that this rate will continue for the next 18 YEARS! Referenced in There s a Perfect Storm Approaching for Exiting Business Owners. By: Gary Ampulski, Midwest Genesis, April 8, Sales Opportunity The US Census Bureau states: 53 year old business owners make up 70% of all businesses or 4.2 million businesses! If all those businesses decided to sell now, it s predicted the amount of money needed is approximately 10 trillion dollars. Referenced in There s a Perfect Storm Approaching for Exiting Business Owners. By: Gary Ampulski, Midwest Genesis, April 8,

By: Gary Ampulski, Midwest Genesis, April 8, 2015. Sales Opportunity The US Census Bureau states: 53 year old business owners make up 70% of all businesses or 4.2 million businesses!

3 Sales Opportunity 90% of businesses do not survive after the death / retirement of owner. Surviving businesses have business ownership agreements. Does your client want to continue his business legacy? Client Profile Owner who has built a legacy and wants to protect it Owner who wants to retire in the next 10 years Owner who has a key employee Owner who has no plan / incomplete plan No Agreement No requirement to purchase shares No protection for employment Majority owner has bargaining leverage Minority owner subject to Trade Secrets Act 2 2

4 Signed Agreement Creates market for shares Protects employment Eliminates disputes Bargaining parity? Case Study - Enviro Alex, age 55, is the sole owner of Enviro Engineering LLC. She has been working at Enviro for 20 years, and has found a successor, Peter, who she would like to offer ownership in the firm. The plan is for Alex to retire in 10 years and sell the Enviro to Peter. Alex has asked you to recommend a plan to make Peter an owner, and to properly insure the transaction. Case Study - Enviro What would you recommend to Enviro and why? 3

She has been working at Enviro for 20 years, and has found a successor, Peter, who she would like to offer ownership in the firm.

5 Enviro s Recommendation Income partner Income partner receives a percentage of operating cash flow Income partner does not share in equity Enviro s Recommendation Non Qualified deferred compensation / phantom shares Provides life, disability, and retirement benefits Not deductible to corporation Fund is owned by corporation Vesting is limited to defined trigger events Enviro s Recommendation Equity owner Peter shares in income and equity Requires purchase by Peter 4

disability, and retirement benefits Not deductible to corporation Fund is owned by corporation Vesting is limited to

6 Peter s Recommendation Equity owner Peter shares in income and equity Requires purchase by Peter Case Study - Enviro Enviro and Peter agree that Peter will be a ten percent equity owner. What are the next steps? Case Study - Enviro Should the company be appraised? Alternatives to appraisals? Insurance company appraisals No appraisal willing buyer, willing seller Deal size 5

owner. What are the next steps? Case Study - Enviro Should the company be appraised?

7 Case Study - Enviro Alex, the majority owner, wants Peter to be obligated to buyout Alex in the event she terminates employment, or reaches retirement age. Alex and Peter agree to have a written agreement. Case Study - Enviro How many attorneys are necessary to negotiate and draft the agreement for Alex, Peter and Enviro? How does an attorney be independent and represent a person diligently if the attorney s representing multiple parties? Documents Business Ownership Agreement Employment Agreement Alex/ Peter Non-Solicitation / Trade Secrets Agreement Sample Promissory Note Sample Pledge Agreement 6

Case Study - Enviro How many attorneys are necessary to negotiate and draft the agreement for Alex, Peter and Enviro?

8 Business Ownership Agreement Defines controlling vote Restriction ownership Defines trigger events Provides valuation Provides discounts Business Ownership Agreement Provides terms of sale Provides funding Controlling Vote Majority versus Super Majority Majority for company operations Super majority for any significant and non-operational transactions 7

Provides terms of sale Provides funding Controlling Vote Majority versus Super Majority

9 Controlling Vote Peter will want super majority to be more than 90% in order to terminate Peter without cause Restrictions on Ownership Alex will demand shares restricted to employees but exempting Alex Alex will want a right to veto any transfer First right of refusal vs. right of approval Agreement should have both rights Restrictions on Ownership Peter will want preemptive rights. Preemptive rights allow Peter to protect his ownership percentage if new shares are issued or sold 8

veto any transfer First right of refusal vs.

10 Trigger Events Loss of employment due to: Death Disability Retirement Termination of Employment Divorce Expulsion Expulsion Competing Business Insubordination Lack of Best Efforts Trade Secrets Violation Share Transfer Violation Planning for Trigger Events Death Life Insurance Disability Disability Insurance Retirement Sinking Fund Termination of Employment Terms Divorce Cannot Plan 9

Secrets Violation Share Transfer Violation Planning for Trigger Events Death Life Insurance

11 Trigger Events Purchase Rights Optional or mandatory purchase Alex & Peter wants the purchase rights to be optional except for the events of death, disability, or retirement Peter wants the purchase rights to be mandatory if he is terminated without cause Valuation Agreed price Appraisal Net Asset Value Liquidation value of the company Set price with sunset Valuation Alex and Peter agree on appraisal and that the seller and buyer pay for the appraisal based upon ownership. Alex and Peter will mutually agree on the appraiser. 10

Valuation Agreed price Appraisal Net Asset Value Liquidation value of the company Set price with sunset Valuation Alex and Peter

12 Discounts Fair Market Value Minority Discount Marketability Discount Other Discounts Time of Ownership Length of Service Expulsion Discount Exemptions from Discounts Death, Disability, Retirement Discounts Alex wants a 35% discount if Peter terminates employment for any reason except for death or disability Peter will be subject to a minority and marketability discount Alex is exempt from all discounts 11

Retirement Discounts Alex wants a 35% discount if Peter terminates employment for any reason except

13 Discounts Example: Peter s Discounts Age: 35% Minority 25% Marketability 15% Gross Value: 100,000 Dollars Discounted Value: 100,000 x.65 x.75 x.85 = 41, 437 = 41% of initial value Terms of Sale Cash Promissory Note Pledge Agreement Collateral Terms of Sale Alex will want a cash flow protector for the note. Cash flow protector is a clause that limits payment to a percentage of cash flow to the company. 12

85 = 41, 437 = 41% of initial value Terms of Sale Cash Promissory Note Pledge Agreement Collateral

14 Cash Flow Protector All cash funds derived from operations minus cash funds used to pay current operating expenses, and establish reasonable reserves for future expenses, debt payments, capital improvements, and replacements, as determined by a majority Cash Flow Protector Limit payments to the lessor of the payment or 25% cash flow No default if cash flow is less than payment Note can be extended indefinitely Rogue Employee Protector No payment if employee violates Non- Compete No payment if employee violates Trade Secrets No payment if employee violates any representation or warranty in company agreements 13

the payment or 25% cash flow No default if cash flow is less than payment Note can be extended indefinitely Rogue Employee Protector No payment if

15 Company Protection Non-Solicitation Agreement Trade Secrets Agreement Employment Contract No Preemptive Rights Employee Protection Solicitation allowed if terminated without cause Termination pay, if terminated without cause Allowed to purchase shares to protect your position preemptive rights Trade secrets protected by statutes: no written contract required Funding Life policy for purchase Life policy for loss of key person Disability buyout policy for purchase Policies should be listed in Business Ownership Agreement 14

your position preemptive rights Trade secrets protected by statutes: no written contract required Funding Life policy for purchase

16 Funding Life policy for employee s family for income protection Disability protection for employee for income protection Funding Alex is insured for 100% of the value of Enviro Peter is insured for 100% of Enviro Alex and Peter are owners of each others policies Funding Alex receives a personally owned disability policy for 60% of her salary Peter receives a personally owned disability policy for 60% of his salary Peter purchases a life policy to protect his income Alex purchases a life policy to protect her income 15

policies Funding Alex receives a personally owned disability policy for 60% of her salary Peter receives a personally owned

17 Disability Funding If Alex is disabled Alex receives the disability income tax free from her personally owned policy Alex receives payment from Peter/ Enviro subject to the cash flow protector. Death Funding If Alex dies prior to retirement the family receives the full value of the business from Peter. Peter receives the fund to buy the business from his policy on Alex Alex s family receives the full value of Alex s loss of income from her personal life insurance policy Retirement Funding During Alex s retirement, Alex receives payment from Peter or Enviro subject to cash flow/ rogue employee protectors If Alex dies during retirement Peter will have the funds to pay off the note 16

Peter receives the fund to buy the business from his policy on Alex Alex s family receives the full value of Alex s loss of income from her personal life insurance policy

18 Sinking Fund Alex and Peter may decide that it will be advantageous to have a sinking fund for Alex s retirement. A cash value life insurance is an excellent sinking fund vehicle due to its non-taxable status A target of 20 25% is prudent Other Opportunities Owner who is starting a legacy Owner who has a partner or wants to bring on a partner Employee who is buying a business from a retiring owner Someone who wants to insure the earning capacity of another Questions? 17

prudent Other Opportunities Owner who is starting a legacy Owner who has a partner or wants to bring on a partner

2013 MDRT Annual Meeting e Handout Material

2013 MDRT Annual Meeting e Handout Material Title: The Top 22 Overlooked Uses of Life Insurance in 2013 Speaker: Philip Kavesh, J.D., LL.M. Presentation Date: Monday, June 10, 2013 3:30 5:00 p.m. The Million