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Business Succession Planning With Key Person Coverage And Buy-Sell Agreements

OLA 1069E 0709

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This material was not intended or written to be used, and cannot be used, to avoid penalties imposed under the Internal Revenue Code. This material was written to support the promotion or marketing of the products, services, and/or concepts addressed in this material. Clients and other interested parties to whom this material is promoted, marketed, or recommended should consult with and rely solely on their own independent advisors regarding their particular situation and the concepts presented here.

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Planning Your Company’s Future

What would happen to your business if something should suddenly happen to an owner or a key employee right now?

Who would run the business?

Would revenues decrease?

Would clients take their business elsewhere?

Do you think your business could survive?

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Planning Your Company’s Future (Cont.)

Without adequate planning, your business may be negatively impacted or forced to close in a relatively short period of time

Why? Not because you did something wrong, but because you did nothing

“Most people don’t plan to fail; they fail to plan.”

~ John L. Beckley

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The Need For A Business Succession Plan

Crucial step to help ensure successful transfer of your company or business interests

Assures funds will be available to provide maximum financial flexibility in event of retirement, death, disability, or other separation from business

Reduces chances of conflict among remaining principals, employees, and heirs, lessening chance of costly and time-consuming litigation

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Business Succession Planning Tools

Key Person Coverage

Buy-SellArrangements

BusinessValuation

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Key Person Coverage

1. How long would it take to replace your key person(s)?

2. How much business does your company stand to lose during transition?

- Insurance policy on key person’s life, where business is owner and beneficiary, may help cover cost of transition.

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Benefits Of Key Person Coverage

Key Person Coverage provides protection from economic loss caused by a key employee's death:

Funds are now available to recruit, hire and train the new replacement.

Access to the life insurance cash value for a variety of business needs, such as collateral for a loan or funding of salary continuation plans.

The life insurance death benefits are generally federal income tax–free.

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What Is A Buy-Sell Agreement?

Legally binding contract that can be used with all types of businesses

Agreement must be drafted by attorney

Stipulates that, at death, retirement, disability, or other withdrawal of principal, his/her share of business must be sold to remaining principals, key employees, and/or business itself

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What Is A Buy-Sell Agreement? (Cont.)

Remaining principals, key employees, and/or business itself must purchase portion of business owned by deceased, retired, disabled, or withdrawing principal

Life insurance may be purchased to help fund agreement at death or retirement

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Benefits Of Buy-Sell Planning Agreements

Can help mitigate conflict and speed up transition

Helps to make certain business continues, without loss/reduction of revenue, assets or client base

Pre-approves who will run the business

Prevents inadvertent termination of business status

Helps to secure value of business interest or stream of income to the surviving principals and heirs.

Pre-funds sale of decedent's business interest from estate, often with life insurance

Provides liquidity for taxes to the estate

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There are three primary ways to fund a buy-sell agreement:

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Funding A Buy-Sell Agreement

Pay Cash

Requires large sums of liquid assets that may not be

readily available, particularly at the time of an unforeseen

event. May have to liquidate valuable personal or business

assets below market value in order to raise cash quickly.

Borrowthe Money

The loss of an owner or key person may impair the credit

rating of the business and its ability to borrow. Principal

plus interest must be paid. This could be a tremendous

strain on the business budget.

Purchase a Life Insurance Policy

Money is available from the policy cash values or death

benefit for the purchase of the business interest.1

Policy cash values grow tax deferred and death proceeds

are federal income tax-free.2

1 Loans and withdrawals will affect the cash value of the policy and could affect the death benefit. Amounts received on withdrawals and surrenders may be subject to federal income taxes and/or company-imposed surrender penalties.2 For a C corporation, the annual increase in cash value and the life insurance death benefits may be subject to the corporate alternative minimum tax.

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Buy-Sell Agreement specifies:

Owner will not dispose of his/her ownership interest during owner’s lifetime without first offering it for sale to other owners

Who will be selling and who will be buying

It is mandatory for seller to sell and for buyer to buy

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Key Provisions Of A Buy-Sell Agreement

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Buy-Sell Agreement specifies:

Purchase price based upon pre-established formula or valuation to be used at time of death in order to determine definitive price for ownership interests

Which state laws apply

Changes/termination of agreement

Process to update coverage should be established and valid reasons to terminate agreement should be stated

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Key Provisions Of ABuy-Sell Agreement (Cont.)

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The remaining principals will purchase the business interest of the deceased or departed owner

Each principal purchases life insurance policy on each of the other business principals

For two owners: A purchases a policy insuring B's life, and B purchases a policy insuring A's life.

Determination of number of policies:

n = number of owners

Policies needed = n(n-1)

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Types Of Buy-Sell Agreements: Cross Purchase

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Cross Purchase

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Business (instead of individual) agrees to purchase stock from deceased or departing principal(s)

Business owns and is the beneficiary of life insurance policies on principals

One policy purchased for each principal

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Types Of Buy-Sell Agreements: Stock Redemption

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Stock Redemption

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Possible solution to changing tax laws, business needs, as well as personal issues

Actual purchaser of deceased principal’s ownership interest and respective amounts not determined until death of business principal

Initially set up as a cross purchase with principals purchasing policies on each of the other co-owners

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Types Of Buy-Sell Agreements: Wait-And-See

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Wait-And-See

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Wait-And-See: Protecting The Business

At death, policy benefits are paid to remaining principals. They either loan money to business or use to make the purchase themselves.

Business has first option to purchase interest

If business does not exercise option, owners have option to purchase interest

If owners do not exercise option to purchase interest, business must purchase interest

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Often, owner has no idea what business is actually worth

Most business owners over or undervalue their businesses by at least 50%

Without proper valuation, owner’s financial plan may not meet owner’s needs at time of major event, such as sale of business, divorce, or death of owner

Regular appraisals can determine current market value of business

Valuation is crucial factor in determining individual’s net worth and life insurance needs

Reduces chance that IRS will challenge the stated value of the business

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The Need For A Business Valuation

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Help protect yourself and your business from economic loss and increase likelihood of success

Reduce risk of loss at death of key person or at time of business transfer

Plan to retain control of business and assure funds will be available to provide financial flexibility

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Business Succession Planning Minimizes Risk

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Transamerica Life Insurance Company, Transamerica Financial Life Insurance Company (collectively “Transamerica”), and their representatives do not give tax or legal advice. This material is provided for informational purposes only and should not be construed as tax or legal advice. You should rely solely upon your own independent advisors regarding your particular situation and the concepts presented here.

Discussions of the various planning strategies and issues are based on our understanding of the applicable federal tax laws in effect at the time of presentation. However, tax laws are subject to interpretation and change, and there is no guarantee that the relevant tax authorities will accept Transamerica’s interpretations. Additionally, this material does not consider the impact of applicable state laws upon clients and prospects.

Although care is taken in preparing this material and presenting it accurately, Transamerica disclaims any express or implied warranty as to the accuracy of any material contained herein and any liability with respect to it. This information is current as of July 2009.

Transamerica Financial Life Insurance Company is authorized to conduct business in the state of New York. Transamerica Life Insurance Company is authorized to conduct business in all other states.

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OLA 1069E 0709

Business Succession Planning With Key Person Coverage And Buy-Sell Agreements