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3/3/2015
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Business Continuation Planning
2 Nebraska Continuing Education Credits
Presented by:
Mike Sears
Regional Marketing Manager
United Life Insurance Company
Course Outline1. Business Valuation & Successor Planning
–Tangibles & Intangibles–Cost, Income & Market Valuation
Approaches–Successor Planning
2. Types of Business Coverage and Arrangements
–Business Planning Professionals–Key Employee Issues–Disability Insurance–Buy-Sell Agreements
Setting the Scene for Business Continuation Planning
9 of 10 business owners think exit strategies are important
47% of companies that expect to change hands in the next 5 years have no plan in place
Only 36% of family businesses survive to a second generation
Only 19% of family businesses survive to a third generation
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Chapter 1
Business Valuation
and Successor Planning
Reasons to Value a Business
Establish purchase price in a buy-sell agreement
Determine size of gross estate for death tax purposes
Plan for equitable disposition of estate among children where some are active in the business and some are not
Determine value of lifetime gifts of the business
Develop exit strategy when planning retirement
The value of a business interest is generally based on two things;
- What the company owns, which is reflected on the balance sheet, and
- What the company earns, which is reflected in the income statement
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Valuation Factors
Nature & History of the Business
Economic Outlook
Book Value of the Stock
Earning Capacity of the Company
Dividend Paying Capacity
Goodwill & Other Intangible Values
Tangibles & Intangibles
Tangibles
Buildings & Offices
Land
Machinery & Equipment
Inventory
Tangibles & Intangibles
Intangibles
Reputation, Prestige, Renown
Trade/Brand Name & Recognition
Goodwill
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Intangible- Recognition
Are there any shown that you don’trecognize?
Business Valuation Approaches
Let’s discuss each of these approaches;
Cost Approach
Income Approach
Market Approach
Cost Approach
Evaluates assets, liabilities and new worth.Three types of analyses; Book Value- fairly represents value of
assets less its liabilities Adjusted Book Value- adjusts book value
for assets that have risen/fallen in value Liquidation Value- does not consider
business as on-going, but if it ceased operating, sold assets, paid liabilities, and see what is left
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Income Approach
Value of income-earning ability. Not considering worth of company assets.
Two main methods;
Capitalization of Earnings- a formula determines ability to continue earning profits
Discounted Future Earnings-estimate of future earnings and then discounted back to present value
Market Approach
Determines value by comparing a company to a similar company that sold recently.
Adjustments can be made to account for differences in size, risk, market position, and other factors.
Successor Planning
What will happen to the business?
Continue the business
Liquidate
Sell
Other options…to be discussed further in Chapter 2
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Business Owner Planning Needs
Business Owner Planning Needs
Business Owner Retirement Planning
Owner will eventually decide to retire at some point…an exit strategy is very important!
Many owners know how to run a business…
…but they may not know how to sell a business.
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Business Owners Should…
Always Be Ready for a Sale
Can the business survive without you?
Keep good records for income, expenses, and taxes
Like an annual health checkup, a business should be looked at for hidden problems
Business Owners Should…
Diversify Retirement Planning
Consider an employer-sponsored qualified retirement plan as an employee benefit
Individual retirement plans- Traditional IRA or Roth IRA to supplement employer-sponsored qualified retirement plan
Other employee benefits- executive bonus plan, deferred compensation, stock options
Employer-Sponsored Qualified Defined Contribution Retirement Plans
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Selling the Business
Challenge: finding a buyer who is both willing and able to pay market value for the business
Necessary pre-sale planning points to ensure;
Business books/records are in order
Tax filings should be current
Collections & legal issues should be resolved
Employee benefits are current and paid
Outstanding business debt is at a minimum
Potential Buyers for the Business
Current or key employees
Family members
Competitors
Suppliers
Business broker
A “Phased-In” Transaction
Ownership can be transferred over a period of time, allowing new owner time to adjust.
A sales agreement can;
1. Provide for ‘shared ownership & control’
2. Create orderly transition between owners
3. Minimize disruptions of business operations
4. Create incentives for parties to succeed
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Funding the Sale
Cash
Borrowed funds
Sale of other assets
Private investors
A combination of these options
Death of Disability of the New Owner
If retiring owner chooses to finance the sale, continued payments are dependent on the successful operation of the new owner.
The retiring owner should protect against this risk with life and disability insurance coverage on the new owner, with benefits paid to the retiring owner.
Chapter 2
Types of Business Coverage
and Arrangements
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Business Planning Professionals
Generally requires multiple professionals.
Planning team can be two or more of the following persons…
Estate & Business Planning Attorney
Choose an attorney with emphasis in these areas in order to plan successfully
Life Insurance Agent
Life insurance is often a key element in the smooth transfer of a business to heirs or surviving business associates
Agent will assist with the best type of policy and amount of coverage needed
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Certified Public Accountant
CPA designation indicates the person has passed rigorous exams and is practiced
Some CPAs have pursued additional studies in the complex areas of business valuation methods
Financial Professional
Professionals with specialized training in financial planning helps to coordinate the efforts of the business team
Business Appraisal Expert
In the event of a disagreement with the IRS as to the value of the business interest, it is prudent to possess a detailed appraisal from a trained and qualified expert
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Key Person Issues
The loss of a key individual will have a serious effect on the earning power and maybe even the stability of a company.
This loss can have a dramatic impact in smaller businesses especially.
Key Person Issues
How long will it take for a new person to reach the efficiency of the key individual?
How much will it cost to locate and situate a replacement?
Will the new person demand more salary?
Key Person Issues
How much will it cost to train the new person?
Would the loss of the key person result in loss of clientele or other employees?
What proportion of the firm’s actual loss is it willing to self-insure, if any?
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Possible Effects from Loss of aKey Person
Weakening of company’s credit rating
Financial cost (in time and $) to find/hire/train replacement
Deteriorating morale among other employees
Loss of confidence among suppliers & customers
Business may have to be sold
3 Methods of Valuing a Key Employee
1. Cost of Replacement Method
Totals the direct, out-of-pocket costs involved in finding, hiring & training a replacement, as well as the estimated loss of opportunity costs
3 Methods of Valuing a Key Employee
2. Contribution to Profits Method
Firm calculates ‘expected profit’ on net book value of assets, then calculates ‘excess profit’ above the expected profit and assigns % attributable to each key employee.
This % is multiplied by total excess profit for each key employee. Sum is multiplied by # of years needed to find/train competent replacement.
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3 Methods of Valuing a Key Employee
3. Multiple of Compensation Method
Assumes that a key employee’s value is accurately reflected in their compensation.
A multiple is used, which depends on the type of business and difficulty of finding a replacement.
Examples; 2 x annual salary
3 x annual salary
Key Employee Coverage
Business owners use life insurance to protect their company from problems which may otherwise damage or destroy what has taken years to build.
Key Employee Coverage
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Potential Uses for Proceeds
Purchasing stock from the decedent’s estate
Honoring salary continuation arrangements to surviving spouse
Finding/recruiting/training new employee
Paying bills, strengthening credit position
Funding expansion of the business
Adding income-tax free corporate surplus
Term Life Ins for Key Employee
Pros
Typically the least expensive
Customize with riders
Cons
Term period could end prior to when the key person retires or dies
Potential renewal premiums could be overly expensive
No cash value or loans
Not flexible to changes
Whole Life Ins for Key Employee
Pros
Guaranteed
Cash value
Loans
Customize with riders
Meant to cover long-term
Cons
Most expensive cost
Not flexible to changes
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Universal Life for Key Employee
Pros
Flexible coverage
Cash value
Loans or withdrawals
Customize with riders
Meant to cover long-term
Cons
Performance fluctuations
Needs closer monitoring
Can be confusing to clients
Disability Insurance for Business Owners
Temporary or permanent disability of an owner is another threat faced by businesses
Business owners can amend existing buy-sell agreements, or create separate agreements to provide for this risk
Special disability policies can be used
Business Overhead Expense (BOE)
BOE policies are designed to reimburse certain business expenses of the owner while they are disabled.
Funds help the business survive during the owner’s absence, until they recover & return.
Only certain types of owners qualify for BOE, usually small businesses.
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Expenses Covered by BOE
Legal & accounting fees Utilities Principal payments on debt Leased equipment Business insurance premiums Office supplies Salaries Taxes Rent
Disability Ins for Business Owner
Pros
Provide a lump-sum, series of payments, or combination of the two
Help business cover expenses & operate when owner is disabled
Cons
Can be expensive
May be difficult to find certain kinds of coverage (BOE)
Buy-Sell Agreements
Contract between the business owners, enabling the surviving owners to buy out the deceased co-owner’s interest in the business.
Options to fund buy-sell agreement include;
Cash
Borrowed Funds
Life Insurance
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A Proper Buy-Sell Agreement;
1. Must be a genuine business arrangement
2. Cannot be a device for passing the business interest to family members for less than full value
3. Must be an “arm’s length” transaction, made fairly, without special discounts or considerations
Redemption Buy-Sell Agreement
The business agrees to purchase the interest of the individual owners.
Business owns a policy on each co-owner.
If one dies, the company will have funds to redeem that person’s interest in the business.
Cross-Purchase Buy-Sell Agreement
Individual owners all agree to purchase the interest of the other owners.
Each owner owns an insurance policy on each of the other owners.
Graphic to follow…
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Cross-Purchase Buy-Sell Agreement
Wait and See Buy-Sell Agreement
The stockholders and the business agree that either the individual stockholders or the business will have the first option to buy the interests of the other owners, depending on which is most advantageous.
Graphic to follow…
Wait and See Buy-Sell Agreement
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In Conclusion
Business valuation, successor planning and insurance coverage is important for
businesses of any size.
Planning tools, techniques, and professionals are available to assist with
solutions for these issues.
Let’s be sure to do our part in the insurance industry!
Course Content Source
Advisys®, Back Room Technician echowealth.com February 2015
Thank you for your time today!
