How should business owners value their companies when planning for succession? Which form of ownership transfer will yield the fastest payback for sellers? What role can life insurance play when a key employee is buying the business?
These questions, among others, were discussed during two educational sessions of the Society of Financial Service Professionals annual Financial Service Forum, held here last month. The back-to-back presentations collectively covered a range of succession planning and estate planning issues. Financial advisors, the speakers said, should treat the two areas of planning as part of a package when working with business owner clients.
“The two areas are related,” said Lyne Stebbins, vice president of advance planning & professional services at Guardian Life Insurance Company of America, New York. “Succession planning and estate planning go hand-in-hand.”
John Brown, president of the Business Enterprise Institute, Golden, Colo., identified several steps in the “exit planning” process: setting objectives; determining a value or sale price for the business; and preserving, protecting and promoting value (using, for example, non-qualified deferred compensation plans to retain key employees being groomed for succession). Additional steps include converting business value to cash or selling the business for a promissory note, contingency planning, and wealth preservation (or estate) planning.
Though seemingly straightforward, the process can be an emotional one for clients, the speakers noted, with many business owners reluctant to think about leaving the business and making hard choices about succession.
One solution, according to Stebbins, is for the advisor to help business owners think about exit planning in terms of the daily business decisions with which theyre familiar and comfortable.
How the company is valued will hinge on who the business owner has flagged as a successor, Brown said. If the business is to go to an “outsider” or third party, then the owner will want to sell the ownership interest for cash at the highest (or fair market) value. If the successor is an “insider,” such as a key employee or family member, then the owners should aim for less than fair market value, assuming the transaction is not an all-cash deal (a common scenario with key employees, who typically dont have the funds for a buyout).
Why? In a word, tax avoidance. When the owner sells the business, taxes are paid twice: first by the buyer, and secondly by the seller. The lower the value of the business, the less the buyer pays in tax for the acquisitionand the less the owner pays in capital gains tax. Lower taxes, in turn, mean the seller can build up a retirement nest egg more quickly, in part funded by discretionary cash flow from the business.
“Cash flow will determine how quickly the owner gets paid, which is a fundamental element in determining how much risk [the business owner] is taking in the exit planning process,” said Brown.