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Exit planning: All questions answered

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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.

Q&A continues on next page

Question #6: In doing joint business, do you have a “qualifying” process or questionnaire for me — the other agent? – Steve B.

Guy Baker: I am most interested in the quality of the prospect, but I don’t have a questionnaire. I use a different method for splitting the compensation than the MDRT formula. I ask the joint agent to help me determine the overhead in the case and then apply some of the income from the case to the hard costs. This can be 30–40% of the revenue. We then split the profit 50/50. If the joint agent does not have overhead other than their time, the entire overhead contribution will go to pay for my staff costs required to work on the case. A traditional split is 60/40 or 70/30 depending on the type of case and the amount of service and staff time required. If we cannot agree on this arrangement, I won’t work on the case. If someone calls and wants help, I will do what I can to assist them. Like Denny, I believe we all need a helping hand from time to time. If it turns into business, that is a blessing to us. If it doesn’t, then it is likely the person won’t call again.

Tom Fowler: Questions for each other: What exactly are you seeking to accomplish in doing joint work? What is your definition of the joint work relationship? How do you split compensation? (I use the MDRT Guideline 20% for the client introduction, 20% for the fact finder, 20% for the plan development, 20% for the close, 20% for the servicing. It usually comes to 50/50). Make it clear all future business from this client is split according to your agreement.

E. Dennis Zahrbock: We look at each case on its own. I’m happy to work with an agent on the phone and simply share some quick ideas based on what he or she describes as the case. When the agent asks me what he owes me, my standard statement is, “If you find what I have just shared with you helps you close the deal, then pay me what you feel is fair.” Some pay me nothing and some pay me 10-20%. Those that pay me nothing I have less interest in helping on case No. 2, those that pay me something retain my interest! But I love to help other people in our business, so I never do not help someone that calls. When an agent wants to engage our full service, then we teach the agent our six-step process and split the case on a similar basis as Tom mentioned. At this stage in my career I’m not looking for more service and the agent is finding the prospect, so the agent is going to receive 40% … with the exception of some cases where the agent wants us actively involved in the annual review. Then we split the 20% for servicing and the agent gets 30%. As we advance to case No. 2, case No. 3, etc., we are ultimately reduced to a 20-30% for us and 70-80% for the agent. It really depends on a lot of things in the relationship. Telephone or Internet assistance requires less of our time then face-to-face. My experience is that it takes about three joint cases to turn a rookie into a pro. Once the basic concepts are understood and the agent sees how they are applied, they can become the pro after about three cases.

Question #7: Isn’t Def Comp Challenged by IRS now? – Robert C.

Guy Baker: This question may be referring to 409a rules. Not sure what the concern is here as I know of no reason to be concerned.

E. Dennis Zahrbock: As I stated on the call, we do not put these in place long in advance. They are put in place the day before they begin. Thus some of the problems with 409(a) are not problems. We have had no problems. Frankly, many attorneys are glad we’re there to help them through the minor 409(a) inconveniences.

Question #8: If the business owner does not have a family member that wants to take the business, do you help him create the ideal “new owner” profile and have him start looking to hire that person? – Thomas S.

Guy Baker: If the business owner does not have a possible successor among the existing employees or with family members, then it is important to start the planning process as soon as possible. This may include trying to hire and groom a possible successor. We work with clients to recruit and identify possible buyers.

Tom Fowler: Agree.

E. Dennis Zahrbock: Yes, I agree too. You now are looking for an outside buyer or you must train an insider. We refer business brokers to the owner when we have no inside options. Once the broker finds a buyer we then represent the owner. If we do our job right, we impress the buyer and then gain a new client when it is all over. If we find an insider, then we set a timeline to help groom them for the ultimate ownership role. This may mean a purchase of a minority interest in 2–3 years at minority (20%) discounts (20% of 100% = 20% discount) and lack of marketability (20%) discounts (20% of 80% (after first discount) = 16%). This allows the new person the opportunity to get their oar in the water and then pay back themselves or the bank with 100% S-Distributions and only owe 64% or so to the bank. What we find is that the new person then causes the business to grow and this means when the ultimate sale (the remaining portion). The new person increases revenue and profit and receives an S-Dist to pay back the bank. The bank sees that he is servicing the loan and is happy to loan the remaining portion later. Generally we find that the first phase is 20-30% of the business and the second phase is the balance. Often “the balance” is worth equal or more than 100% was worth at the time of the first phase! This is because the new minority owner has his or her oar in the water!

Q&A concludes on next page 

Question #9: Any suggestions on how to handle the situation where after crunching the numbers the current owner realizes that he will not be able to support his current lifestyle with what is left over from the sale after taxes, commissions & fees etc.? How do you address the current owner’s concern about the deferred comp fund not being guaranteed? – Larry W.

Guy Baker: This is exactly why the business owner needs to start early to plan his exit. The owner needs to understand the math and so they can decide the best direction for them to go. The math only defines the problem. The owner then has to figure out how to solve it, if it is even possible.

The security of the buyout is definitely an issue. But you must remember, the terms of the sale are the terms of the sale. All we do is help them define the problem and then find creative ways to solve it. If the deferred comp is at risk, then any installment sale would be as well. You can always bring in covenants that give the owner the ability to take back the company, if the new buyer fails to meet their contractual obligation. There are no guarantees in this business. But there are ways to do these plans that give a high degree of probable success. This is much more likely to happen with your help than without it.

Tom Fowler: Great answer from Guy. The answer to this question could be another webinar.

E. Dennis Zahrbock: I agree with Guy, too. And Tom is correct; a whole new webinar could be given. I think that Guy said it on the webinar that the business owner is always bought out with “his or her money”… meaning the future cash flows of the business. Thus there is always RISK until fully paid. If a seller wants to reduce the risk they can accept a lower sales price as then it is more bankable by the bank. Many business owners want to see their “legacy” live on so they are O.K. with the risk and helping the new owner succeed. If they want full price and want to have some guarantees, then the “combo” works well; they sell the business for a low number — 40–60% of mathematical value and the bank will generally finance this. They then take the “risk” on the remaining 40–60% on the deferred comp or consulting contract. This type of planning is where the “art” of experience can sense how all the parties can best get the deal done.

Question #10: What is the best type of life insurance to fund the buy-sell agreements? – Raymond B.

E. Dennis Zahrbock: The question on what type of life insurance to use is crucial. Do not push a cash value-type policy where not appropriate. Most business owners do not die while they own their business, so in most cases a “permanent” policy is not the solution to their problem (if they sense it is the solution to the agent’s problem, the case will be lost). This is not to say we do not use permanent insurance. We like the concept of using a UL contract with secondary guarantees and then funding at minimum funding for “X” years (generally X is the number of years until expected retirement — perhaps age 70). This approach costs a little more than term but it allows us to retain today’s products (if they are the best) by changing the premiums after “X” for a long-term policy for the insured instead of the partner. We also do some combo plans where we acquire a “high death benefit/low premium” contract (term, minimum funding UL, etc.) for the cross purchase and then acquire a “high premium/low death benefit” policy to be personally owned. We find you can generally accumulate way more money in this type of policy then a traditional “middle of the road” single policy that tries to do both.

Guy Baker: I agree with Denny. The product type should not be the focus of the sale. It is far better to get the coverage in place and make them a client. You can always come back and convert the term if it is the right thing to do. I like IUL policies because they are flexible and there is a high probability they will meet the benchmark returns if illustrated properly. I approach every client opportunity with a blank slate. I do not presuppose the answer is life insurance (although it often is part of the answer.) I want to be seen by the client as a competent, fair-minded advisor who is creative and can bring value to the collaborative team. If I am only about selling insurance, I become a commodity and I am fungible. So I earn the right to be at the table by being able to bring creative thought to the discussions. Value added should be the key factor in our efforts and thinking. If we are always looking to bring value to our clients, we will get referrals and be respected as an integral part of the team.

  • Click here to view and listen to the full webinar, The Ins & Outs of Exit Planning.
  • Click here to read the Producer Roundtable article on exit planning from the January issue of Life Insurance Selling.

For more exit planning coverage from the January issue of Life Insurance Selling, read: