Exit Planning Tools for Business Owners

preserving wealth

Impressions of Value in Exit Planning

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Business owners, advisors, and buyers frequently have widely different impressions of value when it comes to a business.

The Pepperdine Private Capital Markets Survey canvasses intermediaries who sell privately held Main Street and mid-market companies. One question is about the obstacles that prevented the sale of a business. The number one response is “Owners’ unreasonable expectations of value.”

That may be self-serving or an excuse. Nonetheless, valuation is a sensitive subject. Many owners have worked in the business for 30 or 40 years. They assume it will fund their next 20 years of retirement. Their target price is set only by their desired lifestyle after the business.

Different Values for the Same Business

Unfortunately, many owners have an opinion about the value of their business that is grounded in the multiples of public companies. Others are based on conversations with colleagues, salespeople, and articles in their trade publications.

Impressions of valueEven those who have professional appraisals of their business may not understand that the purpose for getting your valuation may skew the results. Valuations that are done for estate planning or internal transfers of equity often have little resemblance to a company’s fair market value.

Various people including H.L. Hunt and Ted Turner have said “Money is just a way of keeping score.” For many owners, the emotional tie between the perceived value of their company and their self-image of success is closely connected.

Some advisors skirt this issue by recommending that their clients get a professional opinion of the fair market value of the business. While this is certainly a safe approach, it can take substantial time. It also requires considerable assembly of the underlying data for the appraiser. This can slow down any consulting project considerably and may derail it entirely.

Impressions of Value

A coaching approach helps the owner understand the practical boundaries surrounding the value of the company without either dictating to him or taking the project in a tangential direction. We do that by helping the client model “lendable value.”

We start by explaining that most businesses are valued by their cash flow. There are certainly many areas where value can be enhanced. These include intellectual property, exclusive rights to a product, protected sales territory or long-term contracts. Owner Centricity™ or customer concentration can also reduce the fair market pricing of your business. In the final analysis, however, cash flow to pay an acquisition loan is of principal concern to a lender.

SBA minimums for financing include a cash-to-debt service ratio (1.25 to 1) and required owner compensation – usually $75,000 a year for acquisitions under $500,000 and twice that for larger deals. While not all lenders follow SBA guidelines, they are a useful national baseline for looking at your value.

The company may well be worth what you think it is, but finding a lender to finance it is a different problem. Understanding a lender’s impression of value before starting sale negotiations can save you considerable time and negotiation down the road.

John F. Dini develops transition and succession strategies that allow business owners to exit their companies on their own schedule, with the proceeds they seek and complete control over the process. He takes a coaching approach to client engagements, focusing on helping owners of companies with $1M to $250M in revenue achieve both their desired lifestyles and legacies.

Utilizing a NING Trust as Part of a Business Exit Strategy

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The most commonly stated goals of an exit plan for a business owner are to exit their business on their terms, to receive the highest possible value (or their desired value), and to do so in the most tax efficient manner. It takes time to implement the process to accommodate those objectives. When a business owner rushes to sell their business many things can be overlooked including how to set up the exiting transaction in a way that minimizes taxation.

Particularly in California, state income taxes are excessive in relation to other states, especially compared to states that don’t have any income taxes. For 2020, the top tax bracket for California is 12.3%. Upon the sale of a valuable business, the realized gains can be substantial enough to hit this top tax bracket, especially if the business has a low cost basis. To put it into perspective; if a company is sold, realizing taxable proceeds of $12,000,000.00, the potential taxation in the state of California is approximately $1,476,000.00. That’s a significant amount but, if planned carefully, this potential taxation can be avoided.

Though it is not the only solution for a California business owner, a NING Trust (Nevada Incomplete Gift Non-Grantor Trust) is a tactic that be utilized to avoid California income taxes, if the right conditions are met.

What is a NING Trust?

A Nevada Incomplete Gift Non-Grantor Trust is an irrevocable trust designed to reduce or eliminate the potential State income tax for high income earners or on a significant capital gains on a sale of an asset, and the owner lives in a high income tax state. An irrevocable trust is often a trust to which the assets placed in it are no longer owned by the Grantor (Owner). Therefore, it has a third party trustee, and the trust and the assets in it are considered to be outside of the Grantor’s estate. However, because the NING trust is considered to be trust with an “incomplete” transfer status, it is still in the owner’s estate, but we will get into the benefits of that later. Because it is a Non-Grantor trust, the trust is the entity that pays the income taxes and not the Grantor, or owner of the assets. Because Nevada does not have a state income tax, a resident or a trust in Nevada would not owe income taxes.

A NING Trust is created under Nevada state laws. It is considered to be a “self-settled” trust, which means you are the creator and primary beneficiary of the trust. The NING trust would be utilized if you have a desire to receive distributions from this trust. Furthermore, you could benefit from a “self-settled” asset protection statue of this trust, which the state of Nevada recognizes. Although Nevada isn’t the only state to recognize this statute, Nevada is a very trust friendly state and is convenient for California business owners, which we’ll get into in a moment.

Estate Planning with a NING Trust

For estate planning purposes, it is important to realize that asset transfers into a NING trust is considered to be an “incomplete gift”. Because of this, the assets in a NING trust will be included in the asset owner’s estate and will receive a step up in costs basis at death, if the low cost basis assets are still existing in the trust. But, you will have the benefit of transferring assets into the trust and not be subject to gift taxes. Furthermore, keep in mind, that the NING trust is for income tax strategy purposes and not for estate planning to reduce an estate tax liability.
So here’s the catch. In order to take advantage of a NING trust, the business owner residing in California that is looking to sell their business should first purchase a home in Nevada or another state without income taxes and establish residence there. You will need to definitely work with a business transaction attorney or an estate planning attorney that is well versed in NING trusts.

Later, the shares of the corporation are placed into the NING trust (after it is established), which then the shares of the corporation are then sold to the buyer. The business owner, now a resident of Nevada, can eventually begin to take distributions from the NING trust. You will need to work with a C.P.A. or tax attorney, but some say that after a year or so after the sale, the Grantor can begin to take distributions from the trust.

NING trusts can only own intangible assets, so shares of a corporation or an investment account. But that is okay in this instance, because the shares are sold and then placed into an investment portfolio to continue to grow.

Maintaining Non-Grantor Status

In order for the trust to maintain a Non-Grantor status or not violate the Grantor trust rules (which would make distributions taxable), the Grantor needs to exercise Powers of Appointment or Non-General Powers of Appointment. This means you retain the power to appoint anyone in the world except yourself, your estate, or creditors of your estate. For this discussion, we will refer to the “Inter Vivos Powers of appointment”, or powers during life. In this situation, distributions must be facilitated by a committee of adverse appointees. Second, the distributions need to be made in a non-fiduciary capacity and based on HEMS (Health, Education, Maintenance, and Support). Adverse committee members may include siblings, children, or other relatives that may be beneficiaries. There are many more nuances to these rules, which we won’t get into for sake of time. Besides, an expert attorney will explain all you need to know.

The bottom line is, this trust has a lot of rules and must be carefully written and set up. But it is feasible.

To Summarize, the trust needs to:
1. Be self-settled to give the grantor the ability to receive distributions.
2. Be a non-grantor trust so that the grantor won’t be taxed on the trust income at the rates of their home state.
3. Ensure the grantor be given a non-general power of appointment to direct disposition of the trust.
4. Furthermore, the transfer of the business to the trust would have to be an incomplete gift, includible in the grantor’s estate at their death.
(source: Save State Income Taxes Using a Nevada Incomplete Gift Non-Grantor Trust; Steven J. Oshins, Esq., AEP & Brian J. Simmons, CFP)

There are other solutions other than a NING trust to accommodate a business exit planning strategy. It all depends on the business owner’s situation, and what state they live in or operate the business in.

If you are interested in learning more about these tactics, or would like to see what solution is best for your exit planning needs, feel free to contact me by email: szeller@zellerkern.com.

Steven Zeller is a Certified Business Exit Planner, Certified Financial Planner, Accredited Investment Fiduciary, and Co-Founder and President of Zeller Kern Wealth Advisors. He advises business owners with developing exit plans, increasing business value, employee retention, executive bonus plans, etc. He can be reached at szeller@zellerkern.com

Wealth Management for Business Owners

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Wealth Management Considerations for Business Owners

Small business owners are at times neglected by the wealth management community as the business is commonly (not always) the owner’s largest asset rather than a portfolio of stocks, bonds, and mutual funds. You’d be well-advised as a business owner to engage a Financial Advisor who is proactive and experienced in factoring your future plans for the business, into your overall plan for managing your wealth.

 

Key Elements of Exit Planning

Impactful wealth management for you as a business owner would include at least these elements of exit planning:

  • Clarifying what “exit” means to you. For example, do you want to leave entirely at some point, or gradually over time?
  • Clarifying your financial, values-based, legacy goals, and what role the business needs to play in attaining your goals.
  • A financial needs and gap analysis with an accurate valuation (not back of the envelope – meaningful planning requires accurate data) of the business. How much $$$$ will you need to do everything you want to do after the business? Is there a financial gap? Will that gap need to be closed by increasing the value of the business?
  • Personal risk management including asset protection, insurance planning, tax planning.
  • A current estate plan — a business owner cannot do exit planning without doing estate planning.
  • A plan to preserve the value of the business (typically a small business owner’s largest asset), and a plan for it to survive during unexpected events of your permanent disability or death.
  • An appropriate plan for managing financial assets resulting from the successful sale or transfer of your business.

Exit planning is wealth management for business owners that requires assessing, preserving, and building the value of your largest and most complex asset…your business.

Invest 15 Minutes and take our FREE Exit Readiness Assessment. We do not request any confidential information.

Pat Ennis is the President of ENNIS Legacy Partners. The mission of ELP is to help business owners build value and exit on their own terms and conditions.

Preserving Family Wealth is a Generational Effort

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Wealth within a family can be a double-edged sword. It can serve as an incredible resource to benefit its family members, but it can also be destructive and divisive. Destructive in the sense that if not properly tended to and respected, wealth can destroy the purpose and outcomes of individual family members, and divisive in the sense that it can damage the bond between family members and cause a splintering of the family.

Wealth and the handling of wealth is a topic that has been discussed or written about throughout the ages, as it is mentioned in both the Old Testament and the Gospels within in the parables of Jesus. Yet often, families don’t properly plan, develop, and practice the preservation and utilization of their wealth in a way that produces favorable outcomes and continues over the generations. The reality that families face is that just because they have addressed the accumulated tangible assets with a planned strategy and structure to transfer those assets, it does not assure that those assets will last and more importantly, promote the growth and well-being of the individual family members, and promote family unity.

So how does a family address this topic? A good place to start is to change the way wealth is viewed and is approached. First, family wealth is capital, which equals potential (Family Wealth = Capital = Potential). That potential can have a positive effect or have a negative effect. Secondly, family wealth comes in multiple forms – Financial capital, human capital, intellectual capital, and spiritual capital. Wealth in a family means more than just money, assets and material resources, it includes all of the other things such as family heritage, reputation, knowledge, education, passions, purpose, relationships, achievements, personal growth, and values. In fact, the other forms of wealth that I just mentioned are arguably more important to preserve and grow than the tangible form of wealth, because without nurturing and expanding the intangible forms of wealth, the tangible wealth is not likely to survive and breaking family harmony as a consequence. The emotional bonds, unity and harmony of the family members are some of the more powerful components that are critical for preserving family wealth long-term.

Within family unity and harmony lies the development of trust, respect, and communication. These components should be developed and strengthened before financial capital is transferred and deployed. We will discuss that later.

Discussing the Four Forms of Wealth

The forms of family wealth that I mentioned are somewhat subjective but are important to realize and work to develop, grow and protect. Strengthening all 4 forms of family wealth promotes purpose, personal growth, happiness, and well-being. Furthermore, the legacy of this wealth involves every family member and spans over several generations.

Financial Capital – Financial capital consists of the tangibles – Investments, savings, bank accounts, real estate, businesses, precious metals, collectibles etc. – The movable and immovable assets that the family owns. Financial capital can provide a powerful tool with which to promote the growth of the family’s human, intellectual, and spiritual capital.

Human Capital – Human Capital is the most important capital. It is the members of the family and their physical and emotional well-being and self-sufficiency. It’s their ability to pursue happiness, having a higher purpose than themselves, their ability to make a positive impact on their community, and the centeredness of maintaining a strong family. Not only is it vitally important to focus on the strength and growth of this capital long-term, the family needs to work, communicate, and cooperate with each other as a team to help assure that everyone is flourishing to the best of their ability, and work towards common goals.

Intellectual Capital – The strength of a family rests on what it knows. The intellectual capital is the knowledge life experiences and wisdom of each of the family members. gaining knowledge, applying knowledge, and other skill sets to preserve the wealth, and apply it in ways that is conducive for the family and well-being of family members. It is also the competencies of each of the family members. Building a strong foundation of intellectual capital will help drive individual purpose, skills, and the applicable knowledge to preserve and respect the financial capital.

Spiritual Capital – As sad as it is, this subject has become controversial within our society as it becomes more secularized. But the spiritual capital ties in with the happiness, well-being and purpose of each family member, in that if they have a strong spiritual foundation, they have a higher power to live for, go to, and from a meaningful perspective, make a positive difference in the world for the sake and love for mankind through God.

Long Term Success of the Family Wealth

The Importance of Family Harmony

Family unity and harmony are vital for the survival of family wealth. The proactive building of trust and communication needs to begin early on as a family. Why? Because it doesn’t happen overnight and requires working as a team and developing the family bonds that are trusting, compassionate, and cohesive. According to some studies, 70% of estate transitions fail and to which the wealth vanishes. Within the 70% failure rate, 60% of that failure rate was due to a breakdown of trust and communication; 25% was due to the failure to prepare heirs; 10% was due to not having a family mission statement; 5% was deemed to be for other reasons.

Because of the high failure rate, due to the breakdown of trust and communication, stresses the importance of the family focusing on it and making a consistent effort to strengthen it. Hence, proactively preparing family members involves resolving the breakdowns in communication and trust. It also requires them to work together to establish a family vision and mission statement, aligning those statements with the financial capital, identifying family values, develop roles for each family member, developing performance and quality standards, and work towards family governance involving the whole family.

There is a process that a family can go through starting with the wealth accumulators, or the first generation of wealth. This journey consists of several tools including a family retreat that involves the first generation or the parents that accumulated the wealth. Later, the other generations are brought into the fold with the beginning of family meetings. From there, the building of communication, trust, common causes, the establishment of values, the fine-tuning of the vision and mission statement, etc. are pursued. When this is thoroughly completed, the family can then work towards establishing roles for each individual, develop leadership skills, and develop family governance.

Ultimately, this is the creation of a family legacy, and as I mentioned in the title of this article, it is a multi-generational process and effort. It also is likely that the family will need professionals to help them through the process, which our firm can provide.

Steven Zeller is a Certified Business Exit Planner, Certified Financial Planner, Accredited Investment Fiduciary, and Co-Founder and President of Zeller Kern Wealth Advisors. He advises business owners with developing exit plans, increasing business value, employee retention, executive bonus plans, etc. He can be reached at szeller@zellerkern.com or complete an Exit Readiness Assessment for yourself now.