Producers had questions. Our expert panelists have answers.
During our Jan. 24 webinar, “The Ins & Outs of Exit Planning,” producers who tuned in had plenty of great questions — too many to get to during the interactive audience question-and-answer session that closed out the free, hour-long event.
But that didn’t stop panelists Guy Baker, MSFS, CLU, Tom Fowler, CLU, LUTCF, and E. Dennis Zahrbock, CFP, CLU, ChFC, from wanting to provide them with answers. The actual audience questions and the panelist responses that follow provide even greater insight into the exit planning market. If you missed the live event, you may now tune in at your leisure to the archived recording of the event, which features tons of valuable information in the three featured speaker presentations that will help producers succeed in a burgeoning business succession planning market.
Question #1: Do we need to qualify small business owners based on their ability to pay for multiple advisors, planning cost. Is there a minimum annual revenue filter we should consider when targeting this market? – Jon F.
Guy Baker, MSFS, CLU: This is an individual issue and depends on the relationship the advisor has with the business owner. Assuming no relationship — I would think the advisor should try to earn at least $5,000 in fees to handle the basic issues in the transaction. So if the company is unable to pay $5,000 as a retainer and then fund the legal costs, it probably is not a good fit.
Tom Fowler, CLU, LUTCF: Most, if not all, business owners have a CPA. They may or may not have an attorney. On my collaborative team I have a variety of attorneys who vary in their fees. Some do flat fee work. The choice of attorney is [dependent] on the personality of the client and the complexity of the case. This is like the old Fram Oil Filter commercial, “Pay me now or pay me later.” If the business owner is focused on solving their problem, they will pay the advisor fees. I agree with Guy, $5,000 in fees can be expected.
E. Dennis Zahrbock, CFP, CLU, ChFC: I agree with both Guy and Tom — most are spending a fair amount on a CPA and some have attorneys. They need to realize that professional fees will likely exceed $5,000 and by a fair number deciding on size of the business. What we do is enter into an RIA agreement with a “minimum and maximum” fee. We normally are the quarterback on these deals, so we are the guys that establish the goals, help with selection of any advisers that the client may need, etc. We therefore bid the process on a “monthly basis” and bill accordingly. If we get done very fast (which never happens, but the client wishes it would happen) then the “minimum” is all that is collected. But the “maximum” is seldom collected as billing monthly until completion causes an incentive for the client to “get done.” Once in an engagement we see things move quite rapidly as the client is smart enough to realize the longer he takes the more it costs. Most of our attorney friends work on “flat” fees once we have defined the goals.
Question #2: Aren’t the tax advantages of an ESOP significant — and can’t the control issues be managed to allow a key person to have and retain control? – Steve B.
Guy Baker: There are definite initial tax advantages to an ESOP. The sale, if qualified can be reinvested tax-deferred until the qualifying asset is sold. Then there is LTCG on the sale of the stock. More important, the stock is purchased by a qualified trust with tax-deductible dollars. So there are all good benefits. However, the cost of the loan to fund the purchase, the annual administrative costs and the appraisal are offsets to the benefits. More important, the stock is owned by the employees, which presents problems for succession management and properly incentivizing them. These are not insurmountable problems, of course. But when the owner of the company looks at the fees, the administrative burden, the costs and compares it to the benefits, they often decide to go a different direction.
As far as control, the company is controlled by the trustees who elect the Board of Directors who hire the officers of the company. So retaining control may not be an issue. However, this is an ERISA plan and it is subject to DOL scrutiny. So these issues cannot be taken lightly.
Tom Fowler: There are significant tax advantages to ESOPs but the company has to be big enough to pay the initiation fees and the annual costs, which are substantial. The company has to have a good management succession plan or an ESOP becomes a revenue opportunity for attorneys. I presented a leveraged ESOP to two business partners last year. The finance company came in with an offer of $190 million but they didn’t take it because of a number of reasons. ESOPs can be a China Egg where you spend a lot of time, effort and money and come away with nothing. I saw a young agent chase them for a year until he washed out because of no production.
E. Dennis Zahrbock: Yes, there are tax advantages to both the seller and the buyer but, as I stated on the call, we seldom see ESOPs installed due to the confusion of understanding and the various costs. We feel we must discuss it so that “no rock is unturned,” but we have yet to see an ESOP as the choice by the seller (who is the command person on this issue). Someday, however, it may be chosen, so we need to remain knowledgeable about the option.
Q&A continues on next page
Question #3: In the [January Life Insurance Selling Producer Roundtable] article, you mentioned using 401(k) to fund the buy-sell life plan. Can you please elaborate on that? – Raymond L.
E. Dennis Zahrbock: Yes, we bring this up in all cases and in about 1 in 10 it is chosen. A Profit Sharing Plan (which must be the foundation for a 401(k) Plan) may allow a participant to purchase insurance on anyone in which they have an insurable interest. Thus, one owner may purchase insurance on another owner (insurable interest) with his plan paying the premium. This may be term, UL, VUL, or WL. One-hundred percent of the participant’s account may be used to fund life insurance if the money is at least two years old OR the individual has been a participant for 5 years. What must be done to allow this transaction is an amendment to the plan to have these two provisions. Most plans in the USA use the same document providing service and both of these are standard provisions but they are seldom elected by the TPA that handles the plan. My guess is because they, themselves, don’t understand their benefits. All that needs to be done is to explain that they are available, and “presto” you can use plan dollars for premiums. You do have PS-58 (now called Table I) charges. When we find it used is the case where cash flow is tight and the owners feel their Profit Sharing/401(k) is not their retirement while their business ownership will be. In our company, both of my partners own insurance on me via our Company Profit Sharing/401(k). It’s simply a convenient place to pay the premium with pre-tax money. The DB remains income tax-free because of the PS-58 rules. Call me if you want more info on how this is done.
Question #4: Can you elaborate more on the specific role and responsibilities the banker has as a member of the collaborate advisor team? – Steven H.
Guy Baker: The Banker controls the purse strings. So it is important they understand the ramifications of the business transition plan. So someone from the team has to give them a full briefing of the plan and how the cash flows work. The banker needs to see the cash flows will work to the benefit of the company and to the bank. If not, then the bank could lose confidence and decide to pull any lines of credit outstanding.
E. Dennis Zahrbock: The Bank provides the money and they must be comfortable that it will be paid back. Sometimes “creative funding” doesn’t work because bankers don’t understand it. Thus we try to bring bankers to the table that understand what we are doing or we educate the new banker into how we might structure a deal and still give them the comfort they demand.
Question #5: Do any of you have strategic relationships with Commercial Lines agents to cultivate opportunity? – Michael S.
Guy Baker: P&C Brokers are a good source of business. If you can cultivate a relationship with them, it is NOT hard for them to understand the benefits to them if the business transition is successful. With only 33% of the businesses successfully transitioning from one generation of ownership to the next, this provides a very real potential loss for the agency. They should want to assure the business clients have the highest probability of safe passage in the transition.
Tom Fowler: Commercial P&C agents have played a major role in my career. They have instant access to their clients. They have a high degree of trust and they can assist you in closing the case. Their biggest fear is you will embarrass them by being too pushy and cause them to lose their client relationship. If you show them you are not a tomato-faced insurance salesman, they can become a great ally.
E. Dennis Zahrbock: We currently handle all of these sorts of issues for two P&C firms. We find them to be good friends when they get a grasp of our value. The issue can be that they want a piece of the action because they are licensed. We do this in some cases, but generally we do not.