Succession Planning

10/5/2015
Succession Planning
Succession Planning
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
For Reference of NECA 2015 San Francisco
Attendees Only
1
10/5/2015
Program Overview
•
•
•
•
•
•
•
•
Planning
Succession 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.
For Reference of NECA 2015 San Francisco
Attendees Only
2
10/5/2015
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?
For Reference of NECA 2015 San Francisco
Attendees Only
3
10/5/2015
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
For Reference of NECA 2015 San Francisco
Attendees Only
4
10/5/2015
Planning
• Auto
– 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…
For Reference of NECA 2015 San Francisco
Attendees Only
5
10/5/2015
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.
For Reference of NECA 2015 San Francisco
Attendees Only
6
10/5/2015
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?
For Reference of NECA 2015 San Francisco
Attendees Only
7
10/5/2015
Succession Planning
**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)…
Succession Planning
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).
For Reference of NECA 2015 San Francisco
Attendees Only
8
10/5/2015
Succession Planning
• Taxes
–
–
–
–
–
–
Capital gains
Dual tax in a C corporation
Built in gains
Ordinary income vs. capital gains
Purchase price allocation
Non-compete agreements
Succession Planning
• Taxes
–
–
–
–
–
Consulting fees
Cash basis taxpayer
Gifts
Estate tax
Don’t let taxes drive a transaction
For Reference of NECA 2015 San Francisco
Attendees Only
9
10/5/2015
Succession Planning
• 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.
Succession Planning
The following professionals should be part
of the succession team:
•
•
•
•
•
Attorney
Accountant
Financial Planner
Investment Advisor
Insurance Agent
For Reference of NECA 2015 San Francisco
Attendees Only
•
•
•
•
•
Banker
Bonding Company
Business Broker
Psychologist
Transition advisor
10
10/5/2015
Succession Planning
• 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?
Succession Planning
•
•
•
•
•
•
•
•
•
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.
For Reference of NECA 2015 San Francisco
Attendees Only
11
10/5/2015
Succession Planning
• 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)
Succession Planning
• Family transition
– Family harmony
– Personal well – being
– Confront emotional issues
– Are they capable?
– In-laws
For Reference of NECA 2015 San Francisco
Attendees Only
12
10/5/2015
Succession Planning
• Business transition
– Embrace change
– Strong management team
– Exiting owner (family) must abide by rules
implemented by new management team.
Succession Planning
• Management transition
– Family member
– Non – family member
– The organization must know who the new
management team is.
For Reference of NECA 2015 San Francisco
Attendees Only
13
10/5/2015
Succession Planning
• 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.
Succession Planning
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.
For Reference of NECA 2015 San Francisco
Attendees Only
14
10/5/2015
Succession Planning
• 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
Succession Planning
• Methods
– Merger – Similar to a third party sale in the
end
– Other
§ ESOP - Sale to employees
For Reference of NECA 2015 San Francisco
Attendees Only
15
10/5/2015
Succession Planning
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).
Succession Planning
• Benefits of this method:
– Provides liquidity to estate and business in
death.
– Smooth transition between business and
family.
For Reference of NECA 2015 San Francisco
Attendees Only
16
10/5/2015
Succession Planning
•
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?
Succession Planning
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
For Reference of NECA 2015 San Francisco
Attendees Only
17
10/5/2015
Succession Planning
• Disadvantages
– Control issues if employees acquire enough
stock and change corporate policy.
– High administrative costs.
– Must use specialist.
Succession Planning
• 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,
2015 - $5,430,000
For Reference of NECA 2015 San Francisco
Attendees Only
18
10/5/2015
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
Succession Planning
• 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
For Reference of NECA 2015 San Francisco
Attendees Only
19
10/5/2015
Succession Planning
• 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?
Succession Planning
• 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.
For Reference of NECA 2015 San Francisco
Attendees Only
20
10/5/2015
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?
Succession Planning
• 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
For Reference of NECA 2015 San Francisco
Attendees Only
21
10/5/2015
Exit Strategies
• Sell to Competitor
– Effect in marketplace
– Effect on employee morale
– Blending of company cultures
Succession Planning
• 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.
For Reference of NECA 2015 San Francisco
Attendees Only
22
10/5/2015
Succession Planning
• 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
Succession Planning
• 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?
For Reference of NECA 2015 San Francisco
Attendees Only
23
10/5/2015
Succession Planning
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.
Succession Planning
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?
For Reference of NECA 2015 San Francisco
Attendees Only
24
10/5/2015
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 Planning
• Estate exemptions
– 2009
– 2010
– 2011
– 2012
– 2013
– 2014
– 2015
For Reference of NECA 2015 San Francisco
Attendees Only
$3,500,000
Estate tax repealed
$5,000,000
$5,120,000
$1,000,000?
$5,340,000
$5,430,000
25
10/5/2015
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 65-67
§ 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.
For Reference of NECA 2015 San Francisco
Attendees Only
26
10/5/2015
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
For Reference of NECA 2015 San Francisco
Attendees Only
27
10/5/2015
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
For Reference of NECA 2015 San Francisco
Attendees Only
28
10/5/2015
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
For Reference of NECA 2015 San Francisco
Attendees Only
29
10/5/2015
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}
For Reference of NECA 2015 San Francisco
Attendees Only
30
10/5/2015
Questions?
James F. Weber, CPA
Managing Member
jweber@weberobrien.com
(419) 885-8338 ext. 224
Don’t forget…
• 10:15am-11:30am Special Session: Life on the Rock
• 11:30am-4:00pm NECA Show Hours
For Reference of NECA 2015 San Francisco
Attendees Only
31