Transcript Exit Planning for the Professional (and service) Firm
June 17, 2011
Exit Planning for the Professional And Service Firm
Steve Parrish
, JD*,CLU®,ChFC® National Advanced Solutions Consultant
Principal Financial Group
* Does not practice law on behalf of Principal Financial Group For CLE ONLY. Not for use in sales situations
Disclosure
While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that the speaker is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements. Although the speaker is employed by Principal Financial Group, none of the information necessarily represents the opinions or products of The Principal Financial Group or its subsidiaries. No part of this presentation may be reproduced or used in any form or by any means, electronic or mechanical, including photocopying or recording, or by any information storage and retrieval system, without prior written permission from the speaker.
For CLE ONLY. Not for use in sales situations
Agenda
• Financial and Tax Challenges • Exit Planning Principles – Common concerns
and solutions
– Resources • Special issues
and solutions
for Professional and Service firms For CLE ONLY. Not for use in sales situations
Business Transition
• Seven in 10 small business owners have thought about who would run the business in their absence • Only 25% have formal retirement succession plans • Only 35% have formal continuation plans in the event of their deaths.
Source: LIMRA, Small Business Owners: Full Report, 2009 For CLE ONLY. Not for use in sales situations
Financial Issues
• Cash flow, credit and receivables • Compensation and fringe benefits • Business valuation and continuation • Financial Gaps and Rebuilding For CLE ONLY. Not for use in sales situations
The Retirement Gap
filling the gap that Social Security and your qualified plan doesn’t cover
For CLE ONLY. Not for use in sales situations
The Market Gap
filling the investment gap that the recent market downturn has created
For CLE ONLY. Not for use in sales situations
The Business Value Gap
Helping to secure the gap between your business’s
fair market value
and your
book value
For CLE ONLY. Not for use in sales situations
The Government Gap
filling the gap in your plan caused by reduced government benefits For CLE ONLY. Not for use in sales situations
The Yin and Yang of Budget and Taxes
FEDERAL BUDGET
• Budget Deficit: $1.65 trillion or 9% of GDP • National Debt: $14.3 trillion • Four Largest Expenditures: Debt, Social Security, Medicare, Defense • Medicare Solvency – With ACA: 2029 (
now 2025
) – Without ACA: 2017
FEDERAL TAXES
• Bush Tax Cuts remain through 2012. Cost of extending income tax for 2 years is approx. $100 billion • Social Security payroll tax reduction 2011 only • Estate Tax increased $5 million exemption for 2 years, then reverts to $1 million at 55% For CLE ONLY. Not for use in sales situations
2010 Tax Relief Act Cumulative Rates
2010 Earned Income Top Marginal Bracket 1 36.45% 2011 36.45% 2012 36.45% 2013 41.95% Unearned Income 2 35% 35% 35% Up to 43.4
% Qualified Dividends 3 15% 15% 15% Up to 43.4
% Capital Gains 4 Up to 23.8
%
Special Tax and Exit Issues:
Professional and Service Firms
• Employment taxes and flow through taxation • Flat tax for P.C.s
• Accumulated Earnings • Fringe benefits for flow through entities • Special as to exit – Discipline involved – “Of Counsel” – Earn outs – Non-competes For CLE ONLY. Not for use in sales situations
For CLE ONLY. Not for use in sales situations
Step 1:
Business and Personal Survival
Financial Analysis Firm Dynamics Analysis BUSINESS
•Business Valuation •Benefits Review
PERSONAL
•Financial Needs •Financial Gaps •Firm/Family Issues Integrate with Overall Business Plan for the Firm For CLE ONLY. Not for use in sales situations
Step 2: Exit Plan for Owners/Partners
Determine Objectives Assess Exit Techniques • Maximize value • Minimize taxes • Maximize flexibility • Sale • Capital transfer • Gift For CLE ONLY. Not for use in sales situations
Step 3: Funding Transfer Plan
1. Determine Funding Events 2. Funding Opportunity Review Target Dates ( retirement, sale date, etc ) Contingent Events ( Death, Disability, Divorce ) 3. Create Funding Plan 4. Pre-Funding 5. Execute and Monitor For CLE ONLY. Not for use in sales situations
Business Liquidity
Needs
when Owner is Exiting
• Costs of disruption • Lost loyalty (revenues and receivables) • Debt called or not extended • Costs of fulfilling sale/transfer • Possible estate taxes For CLE ONLY. Not for use in sales situations
Business Liquidity
Sources
when Owner is Exiting
1. Funding from Cash Flow 2. Sell the Business 3. Borrow at Exit 4. Borrow from Government 5. Borrow now (recap.) 6. Capital Markets 7. ESOP 8. Life Insurance For CLE ONLY. Not for use in sales situations
Special Considerations for Professional (
and service
) Firms
• Ownership – Founders vs Partners vs Associates • Governance • Licensure • Franchise / Dealership • Multi-owner nature • Cash flow and capitalization • Valuation For CLE ONLY. Not for use in sales situations
North American Industry Classification System (NAICS):
Professional, Scientific & Technical Services • 541191 Title Abstract & Settlement Offices • 541199 Other Legal Services • 541211 Offices of Certified Public Accountants • 541214 Payroll Services • 541219 Other Accounting Services • 541511 Custom Computer Programming • Services • 541512 Computer Systems Design Services • 541519 Other Computer Related Services • 541613 Marketing Consulting Services • 541614 Process, Physical Distribution, & • Logistics Consulting Services • 541618 Other Management Consulting Services • 541921 Photography Studios, Portrait • 541922 Commercial Photography For CLE ONLY. Not for use in sales situations
Valuation of Professional Practices
Expertise Education Reputation/Recommendations Substitution Maintenance of Expertise Goodwill For CLE ONLY. Not for use in sales situations
Rules of Thumb
• Dental Practice: 1–1.5 X annual net earnings plus fixtures, equipment, inventory • Law Practice: 0-100% annual fee revenue, dependant on client retention • Accounting Practice: 1-1.5X gross annual revenues • Medical Practice: 1.5–3 X annual net earnings, plus fixtures, equip. &inventory • Real Estate Agency: 20-50% gross annual commissions For CLE ONLY. Not for use in sales situations
Current Business Valuation Issues
• Multiples • Discounts – Judicial – Legislative • Life Insurance • Formula or Amount in Buy Sell? For CLE ONLY. Not for use in sales situations
Buy Sell Review Principles
• • •
When is disposition of the business? (“5 Ds”, etc) Correct parties to contract? (should spouse sign?) Valuation (Amount, Formula, Reference to life insurance)
• •
Does agreement work with the chosen entity type (S, C, LLC)?
Is Life Insurance ownership compatible?
For CLE ONLY. Not for use in sales situations
Exit Planning Resources
•
Business Enterprise Institute
– John Brown • Robert Gelder -
CBIZ
• John Warrilow –
Built to Sell
• • Christopher Meyer
Pinnacle Equity Solutions
– John Leonetti For CLE ONLY. Not for use in sales situations
Exit Planning Solutions
• Cross Purchase versus Entity • Multi-owner Buyout • Stay bonus • ESOP • Control: Nonvoting shares, Partnership • Select Reward Plan to fund buyout • Reduced value sale with additional benefits For CLE ONLY. Not for use in sales situations
BCGP How it Works
For CLE ONLY. Not for use in sales situations
Multi-Owner Buyout Strategy
GOAL
: Provide the liquidity necessary to owners departing a business while protecting the viability of the business for younger owners.
Owners Near Retirement
Financing: Sinking Fund
Business (Remaining Owners)
Common Triggering Events •Death •Disability •Divorce •Dissolution •Departure
Newer Owners
Financing: Life Insurance
For CLE ONLY. Not for use in sales situations
Multi-Owner Buyout Strategy:
Cash Flow for Continuity Plan
Sinking Fund and Life Insurance Cash Flow Funding Year-by-year exits: retirements, deaths, terminations, disabilities, etc For CLE ONLY. Not for use in sales situations
Example: Litigation Law Firm
• High, but fluctuating value • 2 founders, wanting $7.5 MM buyout • Result: – $10 million on founder partners – $5 million on other partners – $1.2 million annual premium – Ancillary funding: Disability Income, etc For CLE ONLY. Not for use in sales situations
Family or Internal Management Sale
Selling at Lowest Defensible Cost
Transaction:
• Value sale by note at lowest defensible valuation • For Owner – Deferred Compensation – Consulting and non compete agreement • Fund agreement with Life Insurance, etc.
Results:
• Payments to owner tax deductible to the company • Lower net outlay for purchase by children or management • • Life insurance is corporate paid and can help in living or death buyout. Can fund the deferred comp as well
Beware: IRC 2703
For CLE ONLY. Not for use in sales situations
Selling to Family / Internal Management
Selling at Lowest Defensible Cost
High Payments
Cap Gains
Estate Tax True Value $1 MM Defensible Value $800 K Deferred Comp $200 K
For CLE ONLY. Not for use in sales situations
Lower payments
Lower Taxes
Buyer Tax Deductions
Spreads gain
Stay Bonus
• • • •
Problem
– non-owner key employee retention after loss of owner
Solution
– stay bonus for period of time
Profile
– family owned, special expertise, transition planning
Implementation
– side fund, life insurance (company or ILIT owned) For CLE ONLY. Not for use in sales situations
Funding the Stay Bonus
Practice Purchase or Loan ILIT Death Proceeds Additional Income Key E’ee For CLE ONLY. Not for use in sales situations
Internal Sale
• Closely held corporation funds a deferred compensation account for current executives who are potential future owners • The account is set to vest and distribute on a Change in Control of the company • Provides incentive/reward for key executives and retains options for current owner For CLE ONLY. Not for use in sales situations
Internal Sale
Example:
Sale of Business Change of Control Sale to insiders Sale to outsiders NO YES YES NO Vesting Account vests and distributes to executives and is used to execute purchase Account vests and distributes to executives as reward for years of service Optional triggering event can be retirement
For CLE ONLY. Not for use in sales situations
Equity versus Ownership:
Control
• Ownership: – Shares: voting, nonvoting – General and Limited Partners • Equity – Bonuses –current and LTIP – Deferred compensation – “Non-partner” career track For CLE ONLY. Not for use in sales situations