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Financial Insights: MONY’s Smart Assets Course
Buy-Sell Agreements
MONY Life Insurance Company and MONY Securities Corporation are members of The MONY Group
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Buy-Sell Planning: SMART Business Succession/Transition Strategies Buy-Sell Planning involves an orderly business sale...
…To family, partners or co-shareholders, or outsiders …Considering the tax, financial, and emotional needs …Of the buyer …And of the seller and /or his or her family
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Buy-Sell vs. Business SuccessionThe Difference
Succession Planning: May be accomplished by a sale, gift, or bequest at death Main Objective: To continue the business
Buy-Sell Planning: Always involves a sale of a business interest Main Objective: To convert an owner’s business interest
into cash
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The Buy-Sell Agreement A contract between identified buyer(s) and seller(s),
obligating the buyer to buy and the seller to sell.
“Trigger events” are specified in the contract.
The contract fixes the price (by dollar amount or formula) and terms of the sale
Having a “funding plan” in place is critical!
Proper buy-sell planning helps eliminate uncertainty
for owners, buyers, and sellers!
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Possible Triggering Events
Retirement
Disability
Death
Termination of Employment
Divorce
Bankruptcy
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Business Survival Rates:Not Encouraging!
Only 30% of businesses survive a transition to the next generation*
Death or disability of an owner are two of the most destabilizing events to a business’s future
*Kennesaw State University Study, 1998
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The Chances of One Owner Dying Before Age 65 Are High
Shareholder
A B C
Probability
Sex Age Of Survival
M 45 .7958 F 50 .8823
M 55 .8512
1 - (.7958 X .8823 X .8512) = 40% Source: 1985 Society of Actuaries Disability Termination Study
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The Chances of a 90+ Day Disability are Also High
1 - (.8281 X .8189 X .8731) = 41%Source: 1985 Society of Actuaries Disability Termination Study
Shareholder
ABC
Sex
MFM
Age
455055
Probability Of No Disability
.8281
.8189
.8731
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There would be a 40% chance this company would have to pay-out at least $1,000,000 in surplus for a buy-out at death before any shareholder reaches age 65
Corporate Value
Number of Shareholders
Value Per Shareholder
Chances of 1 Death
$3,000,00$3,000,00
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$1,000,000$1,000,000
40%40%
This May Result in a Large Financial Loss
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When a Business Owner Dies...The owner’s family may...
Stay in business with surviving owners, Sell to surviving owners, Buy-out surviving owners, Sell to a third party (alone or together), Liquidate the business (with consent of other owners)
Which option would you choose if you were:
1 a surviving owner 2 the decedent’s family?
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The Owner’s Family Wants
Top Dollar At Sale
Prompt Settlement In Cash
Fixed Value For Estate Tax Purposes
Relief From Business Worries
As Little Conflict As Possible
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The Surviving Owners Want
Full Control At Sale
Business Continuation
Minimum Payments
Smooth And Prompt Transition
No Interference from Heirs
Uninterrupted Access to Credit
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Everyone Can Lose!!!
Without an Agreement
Possible: Liquidation Litigation Loss of Value Conflict and Delay Bad Feelings and Unhappiness
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With an Agreement Everyone Can Benefit!!!
Smooth and orderly transition
Binding value for estate tax purposes
Agreeable price and terms
Avoidance of conflicts
No forced liquidation
A known plan reduces trepidation & turmoil
Certainty vs. uncertainty can make all the difference!
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Professional Corporations--Special Considerations
Sale must be made to other qualified professionals-- CPAs Attorneys Engineers Physicians
Often, “goodwill value” is not accounted for, and there are few hard assets in the corporation
PCs are typically valued differently from other business structures--perhaps only 1x-3x annual income!
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Professional Corporations--Implications
…Buy-sell proceeds may not be sufficient to support retirement, disability income needs, or surviving family in the event of a buy-out at death.
Integrating buy-sell planning with overall retirement, disability, and survivor-income needs is especially important!
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Family-Owned Businesses--Special Considerations
Not all children may be active in the business
Children may not be ready to run business when it suddenly becomes necessary
A surviving spouse may still depend on income derived from the business
Estate “equalization” may be an issue
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Family-Owned Businesses--Special Solutions
Intra-family buy-sell agreements can be part of a solution
Equalization of the estate among children can be addressed using non business assets
Non-family key employees may be given incentives to stay, such as “golden handcuffs” benefit programs
Integrating buy-sell planning with overall retirement, disability, and survivor-income & estate planning is especially important!
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Basic Types of Buy-Sell Arrangements
1. Entity Buy Out
2. Cross Purchase
3. Wait-&-See (a.k.a. combination or hybrid)
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Entity Buy-Out
The business purchases the business interest from the withdrawing owner or his/her estate upon triggering the agreement.
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Entity Buy-Out
Sells Shares
To Business
Receives Cash
Owner A or A’s Estate
Business
Business Owner B
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The remaining owners purchase the business interest from the withdrawing owner or his/her estate upon triggering the agreement.
Cross Purchase Buy-Out
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Cross Purchase Buy-Out
Sells Shares To Remaining Owners
Receives Cash
Remaining Owner B
Business
A or A’s Estate
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Case Study: Cost Basis ComparisonEntity Buy-Out vs. Cross-Purchase
Bob and Abby started ABC, Corp. many years agowith $100,000 each.
Current Value of business: $3,000,000.
Bob retires in 2001; buy-sell agreement is triggered.
Bob’s share is purchased for $1,500,000
Abby runs the business and sells it in 2009 (8 years later) for $6,000,000.
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Cross-Purchase Planning: Reduces Gains Taxes At Subsequent Sale
Entity X-P
Sale at B’s retirement: $1,500,000 $1,500,000
Initial basis (each): (100,000) (100,000)
Increased basis to A: 0 (1,500,000)
A’s basis After Sale: (100,000) ( 1,600,000)
Sale price $ 6,000,000 $ 6,000,000
Taxable capital gain: $5,900,000 $ 4,400,000
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Wait-&-See Buy-Sell: A Combination Agreement
Buy-Sell contains option for either corporate OR personal purchase of withdrawing/deceased’s shares
Funding is cross-owned outside the corporation. (ie; A owns assets which will pay for B’s interest)
Provides flexibility to help meet needs when triggering event occurs.
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Which Type is Right? Entity:
Less complex to arrange Funded with corporate assets May be best choice if business will NOT be sold after an owner’s death
Cross-Purchase: Increased cost basis to survivors Can fine-tune ownership % No Corp. AMT or excess surplus worries Often the best choice for family businesses
Wait-&-See Maximum flexibility at execution + captures advantages of each No effective difference to owner/estate doing the selling
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Buy and Sell Essentials
Written Agreement
Accurate Valuation
Adequate Funding
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What the IRS thinks at estate tax time?
What owner might accept for it?
What a buyer would offer for it?
What the book/adjusted book value is?
What the liquidation value is?
What is the “True Value” of a Business?
Maximum
Value
Minimum
Value
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Court Cases on Valuation
Estate Case Value per Share of Businesses Delay inValue By Estate By IRS By Court Settling
Helmers, G.J.9 TCM 524 $ 500.00 $ 1,000.00 $ 900.00 5yr. 4mo.
Pendelton, A.S.20 BTA 618 $ 150.00 $ 400.00 $ 400.00 5yr. 4mo.
Goodall, R.A.24 TCM 807 $ 7.44 $ 10.30 $ 10.30 11yr. 7mo.
Maxcy, G.27 TCM 783 $ 10,593.00 $ 12,463.00 $ 10,593.00 8yr. 11mo.
Sundquist, V.US 74-2 USTC $ 270.00 $ 500.00 $ 270.00 7yr. 9mo.
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An Accurate Business Valuation can Help...
Lock in a sale price
Reduce estate taxes
Reduce legal costs
Improve lines of credit
Reduce delays and disputes
Provide fair treatment of heirs
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Buy and Sell Essentials
Written Agreement
Accurate Valuation
Adequate Funding
Review periodically; update as needed
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Adequate Funding
1. Existing Capital
2. Borrowing
3. Installments
4. Sinking Fund
5. Sale of assets to raise cash
6. Life/Disability Buy-Out Insurance
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Existing Capital
Will it be there when the need is?
Who’s got that kind of money?
Lost business opportunities?
C-Corp. accumulated earnings problem?
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Borrowing
Will buyer qualify?
Can borrower repay?
High interest charges?
EXPENSIVE!
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High Cost of Borrowing
Cost of Repaying A $500,000 Personal Loan - Over 10 Years
Percentage of Original
Loan
163%
Interest Rate
10%
Annual Payment
$81,373
Total Interest
Paid
$313,730
Total Payments
$813,730
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High Cost of Borrowing
Pre-Tax Income Required to Make Cumulative Payments Over 10 Years
Interest Rate
10%
CumulativePayments
$813,730
@ 28% Bracket
$1,134,900
@ 39.6% Bracket
$1,352,860
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High Cost of Borrowing
Corporate Sales Required To Generate Pre-Tax Income Needed To Pay Off $500,000 Personal Loan
Pre-Tax Pre-Tax IncomeIncome
$1,134,900$1,134,900
@ 20%@ 20% Profit Margin Profit Margin
$5,674,500$5,674,500
Pre-Tax Pre-Tax IncomeIncome
$1,352,860$1,352,860
@ 20%@ 20% Profit Margin Profit Margin
$6,764,300$6,764,300
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Installment Payments
Can buyer afford it?
Will buyer default?
Installments may outlast business?
False sense of security?
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Sinking Fund
Lost Business opportunities?
Will money be on time?
Corporate income tax due on accumulations?
C-Corp. accumulated earnings problem?
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Sale of Assets
Forced sale is NOT conducive to best price!
Will it cover the need?
Was it desirable from a business perspective?
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Life & DBO Insurance
1. Easy to use
2. Cost-effective AND those costs are known in advance
3. Helps eliminate risk
4. Provides an income tax free death/disability benefit
5. Premium can be waived during disability w/purchase of appropriate rider (life ins.)
6. Can provide tax-deferred accumulation to help fund RETIREMENT buyout at the same time (life ins.)
7. Premiums must be paid and owners must be insurable
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Funding Using Insurance:Paying the Premium
Business can pay…one way or another Directly, in entity arrangement Split dollar Executive bonus or double bonus
Make premiums deductible
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Owners Receive Proceeds
Owners Pay Premium
Shareholder or Estate Sells Shares
Business Pays Cash
<--Agreement-->
Capital
Contributio
n
Combination Agreement--Funded with Life / Disability Buy-Out Insurance
Insurance company
Business
Remaining Owners
Insured/ Owner’s Estate
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Business Succession Arrangement
Insurance helps stabilize a business by providing funds that can help---
Pay income and estate taxes Provide working capital Meet payroll Pay suppliers and creditors Expand, diversifying, reorganizing Replace key employees Buy unmarketable shares
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Buy-Sell Life Insurance
What If It Were Tax Deductible?
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Insurance owned by your profit sharing plan lowers your costs…
Deducting a Business Succession Arrangement
Insurance Face AmountInsurance Face Amount
Annual PremiumAnnual Premium
Income Tax BracketIncome Tax Bracket
After Tax CostAfter Tax Cost
IRS ShareIRS Share
$1,000,000$1,000,000
$30,000$30,000
40%40%
$18,000$18,000
$12,000$12,000
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Deducting a Business Succession Arrangement
What if the insurance were on the life of your business partner?
Purpose:
To help fund a buy and sell arrangement at death.
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Pure Death
Benefit
Annual Premium
Cash Value
Deducting a Business Succession Arrangement
Insurance Company
Profit Sharing Plan Account of Shareholder #1 (Insures Shareholder #2)
Shareholder #1Pays Tax on PS58Receives Death Benefitincome tax free
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CashStock
Pays TaxesProvides Income
Deducting a Business Succession Arrangement
Shareholder #1Buys Stock From Estate Of Shareholder #2
Estate OfShareholder #2Receives Cash for Stock
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Deducting a Business Succession Arrangement
Living Buy Out At Retirement
Each shareholder’s profit sharing account can also tap the cash value of the insurance it owns to buy the shares of a withdrawing or retiring shareholder.
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Deducting a Business Succession Arrangement
Special Taxation Of Shares Distributed From Buyer’s Profit Sharing Plan
Cost basis is ordinary income
Built-in gain is capital gain if sold after 12 months, or it’s IRD at death
After distribution, additional gain is capital gain if sold after 12 months, or is stepped-up at death
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Buy-Sell Planning & the 2001 Tax Law
The Estate Transfer Tax is eliminated in 2010 only...
...But, it’s replaced with a modified carryover basis plan in that year...
...And the Estate Transfer Tax returns in 2011, at 2001 levels.
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First Death Planning: What if Bob were Single and Dies in 2010 or 2011?
2010 2011
Sale Price at B’s Death: $ 3,000,000 $ 3,000,000
Bob’s Initial Basis: (100,000) (100,000)
Basis Step-Up To Children (1,300,000) (2,900,000)
Taxable Gain $ 1,600,000 $ - 0 - -- versus --
Taxable Estate Repealed $ 3,000,000
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First Death Planning: Transfer Costs On Buy-Sell At Bob’s Death
Year 2010 “Sunrise”
Gains Tax on $1,600,000
Federal Gains Tax $320,000
State Gains Tax 80,000
Federal Estate Tax - 0 -
State Death Tax 182,000
Total Taxes $582,000
Year 2011 “Sunset”
Estate Tax on $3,000,000
Federal Gains Tax $ - 0 -
State Gains Tax - 0 -
Federal Estate Tax 763,000
State Death Tax 182,000
Total Taxes $ 945,000
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First Death Planning Options
Replace cash used to pay expected transfer costs with personal insurance owned out of the estate.
Reduce the value of the buy-sell to reduce the gains and estate taxes due. Replace lost value to family with life insurance owned out of estate.
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Buy-Sell Agreements: Thinking outside the Box
What if an owner has no co-owners? Agreement with key employees? Agreement with competitor? Sale using business broker or M & A firm?
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Sale to An Outside Buyer --Prepare 2-5 Years in Advance!
Consider a professional valuation
Consider co-owners’ exit strategies
Focus on profitability
Keep running the business!
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A Buy-Sell Agreement is a Good Idea When...
There is a high degree of financial risk for the family of the retired / disabled / deceased owner
It’s important to guarantee a market at retirement, death or disability for the sale of an otherwise unmarketable business interest
It’s important to fix the value of the business for federal estate tax purposes
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A Buy-Sell Agreement is a Good Idea When...
A surviving owner is unable or unwilling to remain in business with the deceased/withdrawing owner’s heirs
It’s important to prevent outsiders from taking over the business
The owner / owner’s estate needs cash and the business is unable to provide it
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Buy-Sell Planning:Critical Components
A written agreement Address ALL appropriate contingencies Provide for valuation Address funding
Type of agreement is a secondary issue… but, when appropriate, consider opportunities!
Business Succession:Buy-Sell Planning
MONY Life Insurance Company and MONY Securities Corporation are members of The MONY Group
