Presented by: William E. Roberts, CLU, ChFC AUCTORIS May 14, 2014 Preparing to Become the Next...

Presented by:

William E. Roberts, CLU, ChFCAUCTORISMay 14, 2014

Preparing to Become the Next Generation

Farm and Ranch StatisticsUSDA 1999 Agricultural Economics and Land Ownership Survey revealed:

• Close to 50% of farm and ranch owners were 65 or older

USDA 2010 economic survey revealed: • Most farm and ranches are family

owned• 88 percent of all farm assets were

illiquid• 70% of the nation’s farms and ranches

will change hands in the next two decades

• 89% of farmers and ranchers do not have a transition plan  

2

Recent Family Business Study

Of 500 Family Businesses surveyed:

•50% plan ownership transition by 2016

•70% have no written transition plan

3

Six Issues in Ag Family Transition Planning

1. Relationship issuesa. Intransigent senior generationb. Siblings conflictc. Siblings spousesd. Multiple marriages resulting in non-blood

line next generation heirse. Mixing business and personal expenses

2. The Numbersa. Three siblings beget eight children

….how to divide 8 ways

4

Six Issues in Ag Family Transition Planning

3. Operating siblings in conflict with non-operators

4. The potential of an estate taxa. Creates a liquidity crisisb. Forced sale of illiquid farm or ranch

assets

5. Planning documentsa. Don’t existb. Out of datec. Values out of date

6. Heirs not prepared for what they will inherit

5

FAMILY BUSINESS

6

Research on Wealth Transition

70%

30%

SuccessfulWealth

Transition

WealthTransition

Failure(Regardless of

Assets)60%

Trust andCommunication

25% UnpreparedHeirs

12% Family WealthMission

3%Poor Tax Planning,

Legal Errors Based on two studies of The Williams Group.

Study #1 – Interviews by The Williams Group of 2,500 families who had transferred wealth, were in the process or had done nothing. Research confirmed 70% failure rate and identified causes of the failures, even among families who only owned investable assets.

Study #2 – Research on 750 families conducted by The Williams Group and Michael Morris at the Family Business Institute at the University of Oklahoma. Research supported the 70% failure and the causes of the failures.

Conclusion – Whether a family owns a operating business or is in the business of managing its assets, the failure rate is the same.

7

How is Most Transition Planning Created?

• It is often ignored

• Focused on Estate Planning

• Estate taxes are a primary driver of planning

8

Critical Ingredient for Transition Success

99

Competent Successors

10

Without Competent Successors, there is no

Succession Plan• What does the next generation want

to do?–They need to do it well–May need lots of mentoring

• Need to create or develop competent leadership

• Non-family ranch manager11

Ag Family Business Case Study

12

Case FactsA. Neuberger Family-Owned RanchB. Location in Eagleford Shale area of

south central TexasC. 1200-1500 head of cattle (amount

varies with drought and feed availability)

D. >50,000 acresE. The ranch owned by the family for

several generations13

Business Operations

A. All assets – land, cattle, and mineral rights – owned in The Neuberger Family Ranch Corporation, a C-Corporation

B. Neuberger Ranch Corporation is owned equally by the three siblings (G-3) currently living on the ranch

14

Family SituationA. Parents are deceased, but left the ranch with

considerable debtB. Bob Neuberger (oldest operating sibling) age 53,

married to Evelyn1. Cal – age 242. Evan – age 223. Ellen – age 20

C. Billy – second oldest – age 51 and married to Lauren

1. Darren – age 202. Sarah – age 18

D. Kevin – youngest brother – age 45, married to Jean

1. Debbie – age 152. Robert – age 12 15

Family AssetsMineral rights:• Oil and gas fracking results in

between $120-150K cash flow per month

• Being used to pay down debt • Debt reduced from over $5M to less

than $1M today• Cash flow could last 15-20 years

16

Family Assets

• Total value of the ranch, land, cattle, equipment and mineral rights cash flow exceeds $35M.

• There is a last man standing mandatory buy-sell agreement in affect for the interests of the 3 siblings but it is perceived to be out of date and buy out is for $5M per sibling.

17

What are the challenges?

18

Family Conflict Issues

“Relationship issues are the biggest liability a family business faces”.

-Joe Paul, Partner, Aspen Family Business Group

• Family has volatile interpersonal issues• Jealousy over money spent on one

sibling’s house versus another’s• Compensation issues….equal is not

equitable• One sibling is “the boss”• In-laws feelings hurt

19

Family Ownership Issues

• Major family value is to retain the land within the family to honor their parents’ and grandparents’ wishes

• Two of the seven next generation (G-4), Cal & Ellen are interested in operating the ranch into the next generation

20

1. The simmering conflict between the families has been keeping them from addressing their ranch succession planning

2. Buy-Sell Agreement is out of date, underfunded, and does not match current objectives

3. All the assets are owned by the operating C-Corporation

21

Summary of Challenges

4. Two of the seven G-4’s interested in operating the ranch … likely minority ownership

5. Potential estate tax issues could force a sale

6. Estate plans are out of date and are not taking advantage of opportunities to reduce estate tax at G-3 demise

22

Summary of Challenges

23

“Happiness is having a large, loving, caring, close-knit family …in another State”. – George Burns

Succession Strategies Application

24

Conflict and confrontation between siblings and their family:

•Family agrees this is a major impediment holding them back

•Family business consultant providing outside input

• Intervention regarding an addiction issue•Real breakthroughs in communication•Had to be addressed simultaneously with the estate and buy-sell planning

•Some of the issues may not be “solved”25

Current Buy-Sell Agreement

26

Buy-Sell Agreement

27

C-Corp

Stock BasisOwner's B & C keep

their same basis sinceC-Corp buys Owner A's

Shares

Owner A'sEstate

Sale of SharesC-Corp buysshares from

Owner A's Estate

Owner B

Owner C

InsuranceCompany

$5.0M

Death BenefitPaid to C-Corp

as policy owner

$5.0M

Stock

Stock Redemption Issues1. Death Benefit paid to C-Corp may trigger AMT

2. No Increase in Basis to surviving owners

Challenges

28

Added Tax Cost (20% rate)

Added ObamaCare Tax Cost (3.8%)

29

Current Corporate Ownership Issues

30

Neuberger RanchC-Corp

Current Corporate StructureAll Business Units Under One C-

Corporation

RanchLand & Cattle

Mineral Rights

EquipmentHuntingRights

Operation

31

Ownership Structure Concerns

– Liability and creditor protection issues

– If the ranch is ever sold, very unfavorable tax treatment accorded a sale of assets owned by the C-Corp

– Makes planning for the passage to the next generation very cumbersome

Challenges

32

Next Generation Objectives not in alignment

2 will stay on ranch while the other 5 are likely to leave

– Challenges to family harmony and business success if operating and non-operating children have equal say and vote.

– Differing objectives of operating and non-operating children

– Very difficult to divide the assets of the ranch without huge tax impact

– Could result in family conflict and disharmony in the next generation

Challenges

Solutions?

33

5 Alternative Strategies• Do nothing & stay together• Divide ranch, mineral rights, and debt into

1/3 interests• One sibling buys out the other two and

continues operation• Sell out and divide assets• Stay together

– Attempt to work on differences– Change C-Corp to an S-Corp; Recap from voting to non-

voting stock– Develop a fair compensation plan– Allocate home improvement budget– View mineral cash flow as an “ownership asset”– Work on transition plan to G-4’s interested in operation 34

35

Neuberger RanchC-Corporation

C-Corp to S-Corp

Neuberger Ranch S-Corporation

10% 90%Voting Stock Non-Voting Stock

Buy-Sell Design

36

Buy-Sell Agreements

1. Purpose of a buy-sell agreement– Create a plan that defines

control, value and dispensation of the stock under defined triggering events

37

Buy-Sell Agreements2. Major components of a buy-sell agreement

– Triggering Events• Death • Disability• Termination of participation• Divorce• Sale of the entity

– Valuation for different triggering events– Funding for triggering events

38

Estate Tax Issues

39

Growth / Tax 7% 2% 45%Neuberger Taxable Lifetime Estate Net to % Wealth

Yr Year Ranch1 Debt1 Estate Exemption Tax Heirs Lost1 2 3 4 5 6 7

$35M / 3 kids 1-2 (3 - 4) * Tax% 3 - 5 5 / 3

1 2013 11,666,667 1,000,000 10,666,667 10,500,000 75,000 10,591,667 0.7%2 2014 12,150,000 666,667 11,483,333 10,710,000 348,000 11,135,333 3.0%3 2015 12,667,167 333,333 12,333,833 10,924,200 634,335 11,699,498 5.1%4 2016 13,220,535 13,220,535 11,142,684 935,033 12,285,502 7.1%5 2017 14,145,972 14,145,972 11,365,538 1,251,196 12,894,777 8.8%6 2018 15,136,191 15,136,191 11,592,848 1,594,504 13,541,687 10.5%7 2019 16,195,724 16,195,724 11,824,705 1,966,958 14,228,766 12.1%8 2020 17,329,425 17,329,425 12,061,200 2,370,701 14,958,723 13.7%9 2021 18,542,484 18,542,484 12,302,424 2,808,027 15,734,457 15.1%

10 2022 19,840,458 19,840,458 12,548,472 3,281,394 16,559,064 16.5%15 2027 27,827,269 27,827,269 13,854,527 6,287,734 21,539,535 22.6%20 2032 39,029,184 39,029,184 15,296,517 10,679,700 28,349,484 27.4%25 2037 54,740,450 54,740,450 16,888,591 17,033,336 37,707,113 31.1%30 2042 76,776,313 76,776,313 18,646,369 26,158,475 50,617,838 34.1%34 2046 100,638,084 100,638,084 20,183,430 36,204,595 64,433,490 36.0%35 2047 107,682,750 107,682,750 20,587,098 39,193,043 68,489,707 36.4%

Wealth Transfer Projection - Bob & Evelyn Neuberger

Bob & EvelynTaxable Estate Wealth Transfer

At Bob & Evelyn's Death

40

Transition Issues

How is the estate tax funded??

41Taxes Family

Issues to be considered

•Should some of the growth be

transferred to the next generation

now?

• How will any interest transferred be

held?

• Buy-sell agreements to control where

those interests go in event of a

triggering event42

Estate Issues

Gifting Considerations

1. If stock is gifted or sold to NexGen, who or what should be the owner?

– Outright ownership• Concern: Spousal rights

– A trust for the benefit of G4

43

Gifting Considerations

2. Estate planning considerations for NexGen’s?

– Possible estate taxation– Will stock stay in the

bloodline, be sold back to other NexGen’s or passed to spouse?

44

A Plan to Pay the Estate Tax

– Section 6166– Life Insurance– A combination

45

Estate Issues

Irrevocable life insurance trust

– Keeps insurance out of the estate

– Provides liquidity when needed

– Can be funded with income producing gifts

– Premium financing46

Estate Issues

“The definition of crazy and impossible is doing the same thing over and over again and expecting different results!”

- Albert Einstein47

Lessons Learned from Neuberger Case

1. Important to seek outside specialist to deal with relationship issues

a. “Relationship issues are the biggest liability a family business faces”

2. Transition planning requires a team of advisors

3. Next generation succession planning is more complicated due to the number of successors

4. Outdated documents can be contentious

5. The estate tax liability can complicate the best of plans

6. The next generation is often frustrated by their parents issues and lack of a plan

48

Shirtsleeves to Shirtsleeves?

49

Risk PerceptionWhy do 90% Fail? • 60% of failure is due to a lack of

communication and trust within the family around group decision making and governance

• 25% of failure is due to unprepared heirs

• Only 3% of failure is due to failures in financial planning, taxes and investments

50

What is Success?

51

Healthy

United

Family

High Self EsteemBuilding Trust,

Communication & Team Through “Meaningful Experiences”

Manage & Use

WealthWisely

All Leading to – Healthy Family Group Governance; Able to Manage Entities and Trust

Structures

What is Failure?

52

Unhealthy

DividedFamily

Low Self EsteemEntitled

Individuals

Wealth Used

Inefficiently &

Wasted

All Leading to – Unhealthy Divided Governance

Rating your Family’s Preparation

Wealth Transition Checklist53

54

William E. Roberts, CLU, ChFC

Co-Founder/Principal5350 S. Roslyn Street, Suite 310Greenwood Village, CO 80111

Office: 303.740.8001Fax: 303.220.9545

William.Roberts@auctoris.comwww.AUCTORIS.com55