Improve Your Practice by Adding Business Succession Planning Services

1. Improve Your Practice by Adding Business Succession Planning Services Presented By: James J. Flick Central Florida Forum of Estate Planning Attorneys Orlando, Florida February 22, 2013

2. I.) INTRODUCTION. • Beginning in 1970, estate tax planning grew rapidly. However, in recent years the growth has slowed considerably and may even be shrinking. A variety of developments contributed to the slowdown, including: • Many states have simplified the probate administration process • The dramatic increase in the federal estate tax exemption since 2001 • Popularity of LegalZoom.com and other low cost providers of legal documents

3. I.) INTRODUCTION. • In response to these developments, estate tax planning attorneys must consider expanding into complementary areas of practice. • The purpose of this outline is to provide information for estate planning attorneys who wish to diversify their practice by expanding into business succession planning.

4. II.) BENEFITS OF OFFERING BUSINESS PLANNING SERVICES. • More than 80% of the business enterprises in the United States are family dominated. • Family-owned and family-managed businesses account for 50% of the nation’s employment and 64% of its GDP. • Business owners are lucrative clients. • Big cases involving complicated planning. • More ongoing activity than virtually any other type of client.

5. II.) BENEFITS OF OFFERING BUSINESS PLANNING SERVICES. • According to Kiplinger’s, in 2001 roughly 50,000 small business owners retired, but by 2009 the number of retirees was expected to be approximately 750,000 - a fifteen-fold increase. Exit planning for closely held business owners (Jeff Scroggin & the Future of Estate Planning, Steve Leimberg’s Estate Planning Newsletter #1657)

6. III.) RECENT FAMILY BUSINESS SURVEYS. • A 2007 family business survey conducted by Laird Norton Tyee, Oregon State University and Seattle University revealed some intriguing facts: • Almost 60% of majority owners in family businesses are 55 or older (30% are 65 or older). • Over two-thirds believe the current CEO will not leave during the next 5 years. • Less than 30% have formal succession plans and less than 40% have a successor identified and preparing for the transition.

7. III.) RECENT FAMILY BUSINESS SURVEYS. • Two-thirds of family businesses don’t require family members to have the qualifications or experience necessary to be successful. • 25% believe the next generation is not competent to run the business. • Shockingly, 93% depend almost exclusively on the business for income.

8. III.) RECENT FAMILY BUSINESS SURVEYS. • The 2007 MassMutual - Kennesaw State University American Family Business Survey confirm the findings of the Laid Norton Tyee survey. • In addition, discovered that planning by business owners has dropped since its prior survey conducted in 2002. • Unfortunately, the majority of family businesses fail to survive the transition from one generation to the next. • According to a report by the Small Business Survival Committee, only 30% of these businesses survive into the second generation of family ownership, and just 13% survive into the third generation.

9. IV.) TRAINING AND SKILLS REQUIRED TO PROVIDE BUSINESS SUCCESSION PLANNING SERVICES. • Estate planning attorneys who wish to offer business succession planning services need to get additional training and education in business succession planning • Planning with buy-sell agreements • Incentive compensation planning and estate planning for closely-held businesses • Income taxation of individuals, corporations and partnerships.

10. IV.) TRAINING AND SKILLS REQUIRED TO PROVIDE BUSINESS SUCCESSION PLANNING SERVICES. B. Business planning reference materials include: • Corporate Buy-Sell Handbook by Stephen J. Leimberg. Leimberg Associates, Inc. www.leimberg.com. • Structuring Buy-Sell Agreements: Analysis With Forms by Howard M. Zaritsky. Warren, Gorham & Lamont Estate Planning Treatise. • An Estate Planner’s Guide to Buy-Sell Agreements for the Closely-Held Business by Louis A. Mezzullo. ABA Publishing www.ababooks.org. • Estate Planning for the Family Business an ALI-ABA course conducted annually (last course was 7/7/10 to 7/9/10), excellent course materials and audiotapes, www.ali-aba.org. • Tax Planning for Family Wealth Transfers: Analysis With Forms by Howard M. Zaritsky. Warren, Gorham & Lamont Estate Planning Treatise.

11. IV.) TRAINING AND SKILLS REQUIRED TO PROVIDE BUSINESS SUCCESSION PLANNING SERVICES. • Estate Planning for Farms and Other Family-Owned Businesses by Robert M. Bellatti. Warren, Gorham & Lamont Estate Planning Treatise. • Business Enterprise Institute a membership organization that provides education, newsletters, marketing materials, comprehensive exit planning software (EPIC) and BEI Certified Exit Planning credential. www.exitplanning.com. • Exit Planning Institute a membership organization that provides education, newsletters, marketing materials, and Certified Exit Planner credential. www.exit-planning-institute.com. • Family Business Experts web site with free articles, checklists, questionnaires and good links. www.family-business-experts.com.

12. IV.) TRAINING AND SKILLS REQUIRED TO PROVIDE BUSINESS SUCCESSION PLANNING SERVICES. • Income taxation reference materials include: • WealthCounsel’s annual two day Tax Camp. The first day is devoted to income taxation. • Estate Planning for the Family Business this ALI-ABA course includes a discussion of income tax issues related to business succession planning (see details above). • Tax and Financial Planning for the Closely Held Family Business by Gary Zwick and James Jurinski. www.ali-aba.org. • Corporate and Partnership/LLC Taxation For EP Attorneys by Peter J. Parenti. Peter’s outline from a 2004 WealthCounsel presentation. Attached as an exhibit.

13. V.) PRACTICE TOOLS IN WEALTHDOCS AND THE KNOWLEDGE BASE. • WealthDocs Business Succession Planning System is a module that appears in the WealthDocs – Advanced Edition. It includes the following documents: • Buy-Sell Agreement – a comprehensive document that offers the primary different types of agreements and a large selection of optional provisions including all commonly used provisions and various sophisticated provisions • Employee Purchase/Bonus Agreement – a stock purchase agreement for use in incentive planning for key employees

14. V.) PRACTICE TOOLS IN WEALTHDOCS AND THE KNOWLEDGE BASE. • Section 83(b) Election – sample tax election to recognize income from receipt of restricted property • Deferred Compensation Agreement – creates non-qualified deferred compensation agreement, phantom equity (stock) plan and equity (stock) appreciation rights plan for use in incentive planning for key employees • Top Hat IRS Letter – sample notice to the Department of Labor regarding the establishment of a key employee deferred compensation plan • Stay Bonus Plan – innovative plan designed to retain key employees after the death or disability of the sole owner of a business

15. V.) PRACTICE TOOLS IN WEALTHDOCS AND THE KNOWLEDGE BASE. • Practice tools found in the Knowledge Base on WealthCounsel’s website include: • Asset Purchase Agreement (2007) – sample agreement for a business asset sale • Buy-Sell Agreements: Outline and Sample Agreements by Louis Mezzullo (2004) • EP 207 – Drafting Business Succession Documents: WealthCounsel outline from a December, 2006 two day course (472 pages). Contains an introduction to the Business Succession Planning System and sample forms; including several forms not available in the Business Succession Planning System. • One Way Buy-Sell Agreement (2007) – a buy-sell agreement designed for use by a sole business owner and key employees

16. VI.) MARKETING BUSINESS SUCCESSION PLANNING SERVICES. • New Clients • Determine if They Own an Interest in a Business: Data Collection. • Estate planning questionnaires should request information about any interest owned in a business. • Get a copy of existing buy- sell agreements, retirement plans, organizational documents, and a listing of existing owners of the business. • Integrate Estate and Business Plan. • A proper estate plan must integrate the business planning into the estate plan. • The estate planning should include a review and analysis of the existing business succession plan.

17. VI.) MARKETING BUSINESS SUCCESSION PLANNING SERVICES. • Contact Existing Clients • Inform Existing Clients That You Provide Business Succession Planning. • Tell your existing clients. Otherwise, they will assume that all you do is estate planning and that you do not provide business-planning services. • Methods to Contact Existing Clients. • Contact existing clients are by telephone, mail and email. • For high net worth clients, personal call are best. • Send a letter informing existing clients that you now are offering business-planning services.

18. VI.) MARKETING BUSINESS SUCCESSION PLANNING SERVICES. • Insurance Professionals • Insurance Professionals a Top Source. • The nature of business succession planning tends to generate significant insurance sales. • Insurance professionals initiate more business succession planning than attorneys, financial planners and CPAs. • Often, insurance professional have more expertise and experience in business succession planning than do other professionals. • Contact Existing Insurance Professionals. • Inform all life insurance professionals that you work with that you are doing business succession planning. A personal phone call or visit to the insurance professional would be best. • Offer to attend meetings with the insurance professional and prospective business succession planning clients at no charge.

19. VI.) MARKETING BUSINESS SUCCESSION PLANNING SERVICES. • Establish Relationships with New Insurance Professionals. • In your meetings with insurance professionals, point out that your practice offers special services to help business owners with their estate and business succession planning. Let them know that you recognize the important role that insurance plays in business succession planning.

20. VI.) MARKETING BUSINESS SUCCESSION PLANNING SERVICES. • Certified Public Accountants. • CPAs work with many closely held businesses and are an excellent source of clients for business succession work. • Difficulty is convincing them to refer business succession clients to your practice. • Other Attorneys. • Attorneys who do not do business succession planning can be good referral sources. • Corporate/business law attorneys and in-house counsel. • When working with other lawyers, you have to be very careful not to disturb the existing relationship the lawyer has with their client. • Reinforce that you are brought in to only do the succession planning and that the company attorney is a crucial participant in the planning team.

21. VI.) MARKETING BUSINESS SUCCESSION PLANNING SERVICES. • Seminars to the Public. • Give seminars to business owners. • Invitations to business owners and rain brokers are a good way to reinforce that you provide business succession planning. • Seminars to Professionals. • Provide seminars to Insurance professionals, financial planners and CPAs.

22. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Traditionally, business succession planning focused on the preparation of a buy-sell agreement designed to establish an orderly transfer of ownership interests upon the death, disability or retirement of a business owner. • This planning focused more on estate planning than on assuring the successful continuation of the business after the loss of an owner or key employee. • Typically initiated at the prompting of an insurance advisor or estate planning attorney who warns that unless owners take prudent measures, they will leave their families unprotected in the event of death of permanent disability.

23. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • The business owner and insurance advisor or estate planning attorney determine the terms and provisions of the buy-sell agreement. The estate planning attorney, or an attorney recommended by the insurance advisor, prepares the agreement. • The insurance advisor assists the business owner in selecting insurance products to fund all, or some, of the purchase obligations under the buy-sell agreement. • If the planning is initiated by the estate planning attorney, the attorney updates the business owner’s estate plan to integrate the business planning.

24. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Basic Primer on Buy-Sell Agreements. The three basic forms of buy-sell agreements are (1) the redemption agreement; (2) the cross-purchase agreement; and (3) the hybrid agreement.

25. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Redemption Agreement (entity purchase). Under a redemption arrangement, the corporation redeems the shares of a deceased shareholder at his death. • Advantages: • The simplicity of only one life insurance policy per shareholder • Premium costs are allocated to the shareholders according to their percentage ownership in the corporation • Assures compliance with the terms of the buy-sell

26. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Disadvantages: • No step-up basis in purchased shares • The insurance policies are subject to attachment by the corporation’s creditors • If the corporation is a C corp., the death proceeds may also be subject to the alternative minimum tax • If corporate-owned buy-sell policies are over-funded to provide non-qualified retirement benefits to the owners, the benefits are generally taxable. • For an S-corp owner, the results are slightly better because the shareholder has some basis in the policy

27. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Cross Purchase Agreement. Under a cross purchase arrangement, each surviving owner buys the deceased shareholder’s stock directly from his estate. • Advantages: • Because individuals own the policies and receive the income tax-free death benefit, they can obtain a full basis step-up by buying the stock directly from the decedent’s estate. • Policies are protected from the corporation’s creditors

28. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Disadvantages: • The most obvious disadvantage is the number of policies required to accomplish the funding. • Policies are subject to attachment by shareholder’s creditors. • A shareholder may fail to pay premiums or refuse to pay death benefits pursuant to the buy-sell agreement. • The premium burden is allocated based on the cost of insurance of each other shareholder.

29. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Hybrid Agreement (“Wait and See”). In a hybrid agreement, each owner agrees to offer to sell his or her ownership interest to the entity and to the other business owners. • In most hybrid agreements, the business owner (or his or her estate) first offers to sell the interest to the entity, and offers it to the other owners only if the entity declines to buy it. • Advantages: The common “wait and see” approach allows surviving shareholders to keep the insurance proceeds for themselves and use any retained corporate earnings to effectuate a redemption.

30. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Tax Considerations for Buy-Sell Agreements. • Tax Considerations for a Corporation. A corporation must address the following income tax issues: • Deductibility of premiums on insurance policies used to finance the purchases under the agreement. • Taxation of life insurance proceeds received with respect to policies used to provide money to redeem the stock of a deceased stockholder. • Recognition of gain or loss on the purchase of the corporation's own shares with cash or with appreciated assets.

31. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • The corporation's basis in stock it purchases from a stockholder. • The effect of a purchase of its shares on a corporation's earnings and profits. • The effect of a purchase on corporate net operating loss carryovers.

32. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Income Tax Considerations for Stockholders.Stockholders must be concerned about both income tax and transfer tax issues with respect to their buy-sell agreements. The tax considerations vary depending upon the type of agreement used. • Redemption Agreement (sale to the business entity) • Treatment of the distribution as a sale or exchange, rather than a distribution, under IRC Sections 302 and 303. • Constructive dividend treatment when the corporation assumes the obligation of the stockholder to buy shares. • Compensation treatment under IRC Section 83. • Installment sales or annuity treatment on deferred payment sales of stock to a corporation.

33. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Cross-Purchase Agreement (sale to other owners) • Capital gains on the sale of stock. • Installment sales or annuity treatment on a deferred payment. • Compensation treatment under IRC Section 83. • Effect of the sale on S corporation status. • Hybrid Agreement.The tax considerations under a hybrid agreement will depend on the identity of the actual purchaser of ownership interests when a transfer occurs.

34. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Income Tax Considerations for Sales of Partnership Interests.The income tax treatment of the sale of a partnership or membership interest of an LLC taxed as a partnership differs from the treatment of the sale of corporate stock in several material respects. • Compliance with the family partnership or LLC rules of IRC Section 704. • Effect of the sale of the interest on the entity's taxable year with respect to the selling partner or member and with respect to the remaining partners or members, under IRC Section 706.

35. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Recognition of gain or loss by the selling partner or member. • Character of any gain recognized on a sale of a partnership or membership interest to other partners or members as ordinary income under IRC Section 751, including allocation of the purchase price among various component assets by the agreement of the parties. • Character of payments from the entity as ordinary income (or as a distributive share of profits) or payments for a share of goodwill under IRC Section 736.

36. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Estate and Gift Tax Considerations. • Fixing estate tax values with a buy-sell agreement, whether between related or unrelated persons pursuant to the requirements under IRC Section 2703. • Integrating a buy-sell agreement into a marital deduction estate plan so that valuation set in the agreement is also used for deduction purposes.

37. VII.) THE TRADITIONAL APPROACH TO BUSINESS SUCCESSION PLANNNG. • Making a buy-sell agreement work together with IRC Section 303 (favorable income tax on certain redemptions), IRC Section 2057 (the deduction for qualified family owned business interests), and IRC Section 6166 (fifteen year deferral of estate taxes on certain closely-held business interests). • Avoiding gift tax and GSTT on the creation of a buy-sell agreement. • Avoiding gift tax and GSTT on lifetime transfers pursuant to buy-sell agreements.

38. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Business Exit Planning is a systematic process resulting in an owner’s transition out of the business. The process: • Identifies and organizes owner-driven exit planning issues. • Creates a formal written plan of recommended actions. • Acknowledges and requires a multi-disciplinary approach to exit planning and implementation of recommendations. • Incorporates implementation and accountability timeline.

39. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Step 1: Setting Exit Objectives. • Benefits to Owner: • Clarify owner’s objectives and determine what owner wants, or needs, to whom the business will be sold or transferred, and when the owner will exit the business. • Prioritize owner’s objectives which can compete and conflict with one another. • Allows owner to control the process.

40. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Three Universal Objectives: • How much longer does business owner want to work in the business before retiring or moving on? ____ years • What is the annual after-tax income business owner wants during retirement (in today’s dollars)? $_____ • Who does business owner want to transfer the business to? Family, co-owner, key employee(s) or outside party?

41. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Additional Owner Objectives: • Shifting wealth to children • Reward employees • Receive full value for business • Take business to next level • Maintain ownership indefinitely

42. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Creating the Advisor Team: • No one professional has all of the answers. Many diversified skills and talents are necessary. Specialized skills and experience are necessary. • Who is on the Advisor Team? • Financial/ Insurance Advisor • Business/ Estate Planning Attorney(s) • CPA • Transaction Intermediary (Business Broker or Investment Banker) in a third party sale • Business Consultant • Banker

43. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Step 2: Determining Value/Price. • What Is the Business Worth? Why do you need to know? • The business is generally the owner’s most valuable asset. Financial security depends on maximizing value and converting that asset to cash. • The owner and advisors need to know the current value of the business to determine if the owner’s financial objective can be met at present.

44. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Step 3: Preserving, Protecting and Promoting Value. • If an owner is not going to transfer the business to an outside third party immediately, it is important to the owner to preserve, protect, and promote the value of the business. • Three Components of Step Three. • Preserving value from grasp of IRS. Minimizing ongoing tax consequences, as well as tax consequences at the time of sale is critically important. • Protecting value from creditors. It is important to protect value from business and personal creditors. • Promoting value through Value Drivers. Finally, it is important for most business owners to increase, or promote, the value of their ownership interest before they sell, so they are able to realize their financial objectives upon the transfer of their businesses.

45. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Benefits to Owner: • Reduce income taxes upon sale by 25 - 100% vs. no planning. • Create ability to sell the business. • Protect assets from potential business and personal creditors. • Increase business value and cash flow. • Motivate and keep Key Employees.

46. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Step 4: Converting Business Value to Cash. • Converting the business into cash almost always means selling the business to an outside third party. Most outside third parties are not interested in companies valued at less than $5 million. • Benefits to Owner of Third Party Sale: • Cash. • Minimize financial risk of exit. • Eliminate family succession issues. • Speedier exit.

47. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Step 5: Transferring the Business to Co-Owners, Employees or Family. • Surveys and actual experience show that most business owners want to transfer their business to an “insider”, like a child, co-owner or key employee. This objective makes it key to motivate these insiders and keep them from leaving the business. • Benefits to Owner: • Achieves the exit objective of selling to KEG (Key Employee Group) or family. • Motivates and retains Key Employees • Planning the sale reduces risk

48. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Step 6: Contingency Planning: “Making sure the business continues when the owner doesn’t.” • Benefits to Owner: • Retain ownership and control of company if co-owner departs. • Ability to force non-contributing owners to leave business. • Provide consistency between lifetime and death objectives. • Ensure survival of the business for benefit of others. • Ensure family receives value of your ownership interest, in cash.

49. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Contingency Planning Issues: • Continuity of Business Ownership. • Company’s loss of Financial Resources. • Loss of Key Talent – Owner. • Loss of Employees and Customers. • Business Continuity, CoOwner Buy-Sell Common Transfer Events: • Death • Disability • Transfer to Third Party • Termination of Employment • Retirement • Involuntary Transfer Due to Bankruptcy or Divorce • Business Disputes

50. VIII.) BUSINESS EXIT PLANNING: A MODERN APPROACH TO BUSINESS SUCCESSION PLANNING. • Common Buy-Sell Problems: • Valuation not reviewed • Failure to cover all transfer events • No coordination of insurance • Failure to test practical viability of provisions