Transcript No Slide Title

Business Succession Planning
Case Study
Banff School – August 19, 2007
Mary-Ellen Gaskin, CA, CFP, TEP
London Life/Great West Life
Private Wealth and Estate Services
Client Information
• Rob (65) and Marie (63) McKee
• Have three children: Cathy (40), Eileen (36) and
Mark (30)
• Rob started McKee Manufacturing (MM) in 1967
with $10,000. Rob and Marie each own 50% of
McKee Mfg
• Currently the company employs 150 people and
annual sales are around $30 million
Client Information
• Company expanded into the exporting business,
‘Jones Exporting’ in 1985 with friend, John.
• A real estate company was incorporated in 1995 to
hold the buildings in which they operate
• The companies remain very successful and their
values of the continue to grow
Meet The McKee Family
Rob
65
Cathy
40
Janelle
14
Don
44
Todd
24
Mari
e
63
Eileen
36
Charles
36
Laura
5
Chris
1
Mark
30
Meet the McKee Family
• Cathy (40) is married to Don who is a litigation lawyer
–
–
–
–
Todd is Don’s son from his first marriage.
Janelle is Cathy and Don‘s daughter
Cathy is VP of Sales and Marketing at McKee Mfg
Don works at a law firm (not with family business)
• Eileen (36) is married to Charles (36), CA
– Have two young children (Laura – 5 and Chris – 1)
– Charles is the controller at McKee and Jones
– Eileen is a teacher
• Mark (30) – not married
– not interested in businesses – interested in Music
Current Ownership Structure
Mark
10%
Marie
Eileen
Rob
John
10%
Cathy
10% 10% 60%
Realco
50%
50%
McKee Mfg
75%
25%
Jones
Exporting
Companies Value Owned By ….
Rob and Marie via Holdco
- Common shares of McKee Mfg
- Common shares of Jones
- Common shares of Realco
Mark
10% of Realco commons
Eileen
10% of Realco commons
Cathy
10% of Realco commons
$ 12,500,000
2,500,000
1,750,000
250,000
250,000
250,000
Total
$17,500,000
Where do we start?
Process:
•
•
•
•
•
What DON’T we know?
What do Rob and Marie want?
What do they need?
What do they fear?
What have they got?
Start with Rob and Marie
Social
Capital
Legacy Goal
Family Legacy
Goal
Financial
Security
Financial
Independence Goal
Lifestyle &
Opportunity
Financial Independence – What do Rob
and Marie Own?
Cash **
RRSPs **
Holdco shares
Total financial assets
House
Other personal assets
Net worth
** 60% equity and 40% fixed
$
400,000
800,000
16,750,000
17,950,000
1,500,000
500,000
$19,950,000
Retirement Goals
How much do they want?
• $240,000 of pre-tax income indexed at 2%
For how long?
• To age 90
RRSP and Investment balance with
Income Goal
Income received = $200,000 indexed at 2% each year
2,000,000
1,000,000
0
65
-1,000,000
-2,000,000
-3,000,000
-4,000,000
-5,000,000
-6,000,000
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
Income attainable from RRSPs and
Investments
Income received = $133,000 indexed at 2% each year
2,000,000
1,500,000
1,000,000
500,000
0
65
-500,000
-1,000,000
-1,500,000
-2,000,000
70
75
80
85
90
95
Actual vs Desired Income
450,000
400,000
350,000
300,000
250,000
Required Income
Income from RRSPs + Inv
200,000
150,000
100,000
50,000
0
65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
Rob's Age
Financial Independence
Are They There?
• RRSPs and Investmentswill provide
$133,000** a year from ages 70-90 if they
earn 6%
• These assets alone are Not sufficient for their
lifestyle
• Therefore, access funds from company. Need
approx. $74,000 (indexed) per year or approx.
$2,000,000 over 20 years.
Income attainable from RRSPs
With additional RRSP contributions
• Regular RRSP contributions in next five
years will increase retirement income to
$149,000.
• Still insufficient !!!
**Assuming Rob and Marie receive salaries from the
business and can contribute the maximum amounts to their
RRSPs
Financial Independence - Asset Allocation
Fixed income
$ 480,000
Equities including business 17,470,000
Total financial assets
$17,950,000
(40% of RRSP/Non-Reg)
•93% of financial assets in two ‘micro-cap’ businesses
•Build personal financial capital outside business
•Ratchet down the risk profile of these investments
•Ratchet up liquid component of these investments
2.7%
97.3%
100%
Financial Independence
Are They There?
• Real issue is
– diversifying away from the business (equity
investment)
– monetizing their financial interest (say $2$4M invested outside business) to facilitate
exit strategy/financial independence
Financial Independence
How to Diversify
•Make it a priority
•Dividends from businesses (or redemptions) of $76,700 a
year indexed at 2%
•Could borrow to fund dividends if cash flow is an issue
•Could pay higher dividend to reduce income commitment
period. Invest net dividend in:
•Portfolio investments
•Mostly fixed
•Insurance CSV can be part of the ‘fixed income’ component
Financial Independence - Business risk
President &
CEO
Rob Mc Kee
VP Sales &
Marketing
Cathy
Operations
Manager
Joel OM
McKee Mfg
Controller
Controller
Non-Family CT
Charles J
Operations
Manager
Non-Family OM
Jones Exporting
Financial Independence –
Key person
• Candidates for risk protection:
– Rob, Joel, Jones Ops Mgr., Charles Cathy, others?
• Current business debt:
– McKee Mfg - $1,600,000 bank debt
- $2,500,000 capital lease obligation?
– Realco
- $3,150,000
– Jones
-$625,000 to buy out John
Financial Priorities
Social
Capital
Legacy Goal
Family legacy
• How much?
• To whom?
Estate equity?
• Taxes and final
expenses
Family Legacy
Goal
Financial
Independence Goal
Net Worth – What do they Have?
Cash
RRSPs and non-registered **
Holdco shares
Total financial assets
House
Other personal assets
Net worth
** 60% equity and 40% fixed
$
400,000
800,000
16,750,000
17,950,000
1,500,000
500,000
$19,950,000
Companies Value Owned By ….
Rob and Marie via Holdco
- Common shares of McKee Mfg $ 12,500,000
- Common shares of Jones
2,500,000
- Common shares of Realco
1,750,000
Mark
10% of Realco commons
250,000
Eileen
10% of Realco commons
250,000
Cathy
10% of Realco commons
250,000
Total
$17,500,000
Estate Equalization
$3,200,000
16%
$16,750,000
84%
Active Children
Inactive Children
If two are active and one is inactive, IS THIS FAIR?
And in future, the inequity grows.
The Success Chart
Identifying the Opportunities
$60 mill
$30 mill
$17.5 mill
Total business interest value
= $17,500,000
Tells us to look at :
•Business Transfer
$7.5 mill
•Growing estate insurance need
•Time for estate freeze?
$10,000
1967
Year Business Started
1997
2007
2017
2027
Projected Capital Gains Tax
• We always project future capital gains tax to
highlight the “do nothing” scenario
• Current Capital Gains Tax
• Capital Gains tax in yr 20
**
**
$ 3,500,000
$13,000,000
(** assuming each of Rob and Marie claim their CGE)
Projected Capital Gains Taxes
Cost to Fund Options to Pay
Taxes
Summary of Costs to Age 85
Borrow
at death
Corporate
Savings
Corporate
Savings
Borrow
at death
Min
Funded
UL
Cumulative Outlay to age 85
Min
Funded
UL
Present Value Cost
Reduce cost to Fund
• Options to fund can be based on a
– $13,000,000 need or
– $3,500,000 need.
• Could freeze the taxes…..
Who do we insure?
Summary of Costs to Year 20
$4.0 Mill
of Max
UL
Min
UL plus
$1.5 Max
per child
$4.0 Mil
of Max UL
$13 M of
T100 on
R&M
Cumulative Outlay to year 20
Min
UL plus
$1.5 Max
Per Child
$13 M of
T100 on
R&M
Present Value Cost
Creating a New Ownership Structure
Family
Trust
Mark
Move future
growth to
Family Trust
10%
Marie
Eileen
Rob
John
10%
Cathy
Freeze to Holdco
& Insure
10% 10%
Realco
$2,500,000
60%
50%
Freeze to Holdco
& Insure
Freeze to Holdco
& Insure
50%
McKee Mfg
75%
25%
Jones
Exporting
$12,500,000
$2,500,000
Creating a New Ownership Structure
Mark
Eileen
Cathy
Marie
Rob
Family
Trust
New Holdco
10%
$1,750,000
prefs
10% 10%
$2,500,000
prefs
70%
Realco
$12,500,000
prefs
100%
McKee Mfg
100%
Jones
Exporting
Now Values Owned By….
Rob and Marie via Holdco
- Frozen shares of McKee Mfg
$ 12,500,000
- Frozen shares of Jones
2,500,000
- Frozen shares of Realco
1,750,000
Mark
10% of Realco commons
250,000
Eileen10% of Realco commons
250,000
Cathy 10% of Realco commons
250,000
Trust – Commons shares of-McKee Mfg/
Jones/Realco (could do thru Holdco)
0
Total
$17,500,000
Benefits of Holdco
• Dividend net profits to Holdco for
– Future Income to Rob and Marie
– Creditor protect the excess cash
– Good place to own the insurance
• NOTE: Freeze and Holdco can provide future
additional cash flow (dividends or redeem the
frozen shares over time) but won’t create asset
diversification
Benefits of the Freeze
• Rob can retain voting control over company
• Fixes Rob and Marie’s tax liability
• Passes future appreciation of the company
value to children and/or grandchildren
• Rob and Marie have opportunity to
crystallize their enhance capital gains
deduction (now at $750,000 each)
• Potential to creditor protect assets
• Potential to reduce probate taxes
The Trust
• Fully discretionary
– Capital and income can be distributed in any
proportion to any or all of the beneficiaries
• Trustee(s)
– Rob, Marie, trusted business advisors or children
• Beneficiaries (some or all of)
– Rob, Marie, Mark, Eileen, Cathy, spouses, children,
grandchildren, Holdco, key employees
Benefits of Trust in Structure
• Control of shares – trustees may control distribution of
shares and/or dividend income paid to trust
– Rob may be one of the trustees and continue to influence decisions
related to share ownership.
– If desired, shares are distributed only to beneficiaries whom are
involved in business
• Shares may be transferred in the future to the desired trust
beneficiaries on a tax deferred basis
– Beware 21 year deemed disposition rules.
• Offer some creditor protection
• Income splitting with “major” children. Dividends may
be distributed to low income trust beneficiaries.
• May avoid probate taxes (if applicable)
Family Legacy – Shareholders
• Rob and Marie wills
– Executor to redeem shares and distribute
– To the extent insurance funded
• Shareholder agreement
– Death, disability, marital, bankruptcy,
disagreement
– Opportunity for kids to buy each other out in the
event of their death (avoid shares in hands of
spouses)
Family Legacy – Will Planning
• Wills leave everything to each other and then to
children in equal shares
• Consider:
– Spousal trust
– Separate testamentary trusts for each child to control use of
assets after death and save up to $17,000 in annual tax per trust
created
– Will and Shareholders Agreement must work together
– If no Shareholders Agreement, Will can give active child right
of first refusal to acquire shares as part of their inheritance
Family Legacy – How much and what?
Net worth less
Less: estimated income tax
Less: estimated probate tax **
Less: final expenses
Net estate
Comprised of:
Cash shortfall
Shares of Holdco
Home and other personal assets
$19,950,000
(3,900,000)
(200,000)
(100,000)
$15,750,000
$(3,000,000)
16,750,000
2,000,000
$15,750,000
Question: Is there an upper limit on the bequest they wish to leave?
Family legacy - Other
• Estate freeze
• Grandchildren
– RESPs
– Inter-vivos trusts for grandchildren age
18+
– Life insurance
• Others?
Financial Priorities
Social capital legacy
•
•
•
Philanthropic interest?
Excess family legacy?
Social
Desire to redirect tax to
Capital
charity?
Legacy Goal
Family Legacy
Goal
Financial
Independence Goal
Social Capital Legacy
• Philanthropic interest?
• They do have millions of ‘planning capital’ to work with
but it’s tied up in business
• Notwithstanding philanthropic interest, equation is:
A $1.00 to tax
OR
B $2.22 to charity and eliminate tax
Social capital reallocation
Current
Situation
With
$8,600,000
Donation
With
$8,600,000
Donation
and
$8,600,000
Insurance
15,750,000
11,050,000
19,950,000
3,900,000
0
0
0
8,600,000
8,600,000
300,000
300,000
300,000
Gross estate
19,950,000
19,950,000
28,850,000
Bequest per child
5,250,000
3,683,000
6, 650,000
15,750,000
19,650,000
28,550,000
Family legacy
Social capital legacy–income taxes
Social capital legacy–charity or
foundation
Estate administration tax/final expenses
Distribution controlled by the McKees
In Conclusion:
What has our Process Accomplished?
• We uncovered that:
– Rob wanted to work another 5 years part time
– Rob and Marie wanted $240,000 pretax for retirement and their
current assets cannot provide this.
– Rob and Marie are financially dependant on the business.
– It is Rob’s desire to keep the business in the family.
– Assuming not all children become owners of the business, they
cannot equalize their estate between the children without additional
funding.
– Their tax liability wrt the shares will grow significantly without
planning.
• Made Rob and Marie more aware of business and family
relationship issues
• We provided suggestions/plans/solutions to aid in their
succession
Next Steps
• Introduce them to someone who can help
them in their business plan and, if
necessary, family issues.
• Keep in contact with Rob and Marie as their
management plan evolves. May be more
need for risk protection
Insurance planning Opportunities
• Marie and Rob
– Family legacy (taxes)
– Social capital legacy (estate donation)
– Health risk management (critical illness, long term care)
• Business risk management
– Business succession (buy-sell)
– Key person (life and health)
• The children
– Income replacement
– Family legacy
– Health risk management
Summary – Prioritize
• First generation issues
Then: financial security for future generation
Banff School – August 19, 2007
Mary-Ellen Gaskin, CA, CFP, TEP
London Life/Great West Life
Private Wealth and Estate Services