Small Business estate planning

[imjulier]

I know my small business clients should have a buy-sell agreement for those that have more than one shareholder and I know there are some other things they should have in place. My question is this: how would the purchase price of the business be defined in a buy-sell agreement? They are a small engineering and surveying company. One of the owners is an engineer and does business development as well as provides services. Extra work gets contracted out when needed. The other owner oversees the surveying piece and does business development and oversees the surveyors (two employees and one contractor). I don't believe the surveyor would be able to pick up the engineering side but the engineer may be able to pick up the surveying side, if something happened to either one of them. They are cash basis and if they don't get paid within 90 days, the receivable generally has a problem and they may not get paid (problems with the general contractor, legal issues on the overall project for the main contractor, etc.) for a long time.

I'd propose something like split the cash on-hand at the time of death plus 50% of the profits of the business over the next 3-6 months. Or maybe split cash on hand at time of death plus receivables less than 90 days old at a certain margin (probably 30%). Other ideas?

I know I will be referrinf them to an attorney but they will definitely want ideas from me since I am so familair with their business.

Thanks and happy Friday!

Julie

[BulldogTom]

Julie,

I think this is an area best left to a financial planner. I know a very good one in the Sacramento area. He is the best I have ever met.

You know the issues with the company, and can be valuable as a resource to the financial planner, but I think that is all you should do. I would not go very far with the clients down that road except to make a referral for a planner and offer to be a resource to the planner.

Just my 2 cents.

Tom

Hollister, CA

[kcjenkins]

Julie, I'm with Tom on this, for the reasons stated but also because you do not want to lose them as clients, and this is a situation where you can have each of them questioning your loyalty to him. Directing them to a qualified planner who will work with you makes you a valued resource without having to 'own' the final plan.

[Guest Taxed]

If you are referring your client to a financial planner or estate planner that is also an insurance agent or broker, you may want to give a heads up to your client to ascertain how that individual will be paid. Some will charge you an asset based fee and also collect a commission for placing the life insurance policy (that funds the buy-sell) with various carriers.

The issue of compensation should be discussed and be transparent.

BTW these planners use industry standard valuation methods (I think there are 7 methods). You can check them out at SBA and Inc. etc.

[ed_accountant]

These agreements should be written by attorneys who specialize in corporate or LLC/partnership business issues.

For successful companies that can afford life insurance, I have seen buy sell agreements with life insurance provisions where the premiums are paid by the company and the proceeds purchase the decedent's interest. For example, if one partner dies the life insurance proceeds buy-out the decedent's share and proceeds go to the decedent's heirs. The life insurance proceeds of course are pre-determined and agreed upon in a written buy out agreement between the partners...

[Guest Taxed]

The involvement of an attorney who deals with buy-sell agreements is a must. Experienced financial planners will get an attorney involved to draft the documents, though I have seen many estate planning depts. of major life insurance companies provide some stock document to get it started and then reviewed by an attorney for customization.

The most difficult part is establishing a valuation that owners can agree because with family owned business there is no market capitalization.

Traditionally these were funded with whole life insurance policies, but I have also seen term life (less expensive) and universal/variable life type policies. Obviously the particular situation will determine what product may be a good fit.

[jklcpa]

I agree about going to an attorney that specializes in business, tax and estate planning to have the document written up. The accountant/tax preparer should possibly be involved to provide the attorney with information concerning the level of income of the company and the effect of the agreement on company going forward and in the event of a retirement or death of an owner. The OP said that these clients that he/she was concerned about were small business clients but didn't mention the type of entity that the business was. When deciding whether to use life insurance to help fund payouts made as determined by buy-sell agreement, we need to think ahead to the time that proceeds may be issued and the tax impact.

Tread carefully when using life insurance to fund a buy-sell agreement involving a C corporation. It can give the corporation greater exposure to the corp AMT because of its effect on yearly book income, and the payout to a corporation at death can also trigger the corp AMT. A cross-purchase agreement can work there are only two shareholders where they maintain insurance on each other, but that technique does not work when there are more than 2 shareholders because of the transfer for value rule. Also, life insurance will cover death, but the company needs to consider how it will fund the payout to a retiring shareholder as well.

Years ago I acquired a client whose existing stock redemption agreement had some big problems. Its valuation formula was poorly designed and had been worked out by the 3 owners. Whole life insurance was purchased by the corp with the corp named as the beneficiary, and the corporation would have paid a lot of money in corp AMT on the proceeds at death. This would have resulted in the corp not having enough to fully fund the redemption, and the widow would have ended up with an extended payout over years. This was far from what the owners intended or wanted. The entire agreement was redesigned with the life insurance placed in a partnership that would shelter the proceeds from the corporate AMT.

[kcjenkins]

And where death is certainly an issue that should be covered, it's far from the only issue. What about one of them in a debilitating accident or a stroke? If one of them is unable to work, for any reason, that needs to be planned for.

[Guest Taxed]

I seem to recall NATP offering a seminar or course on small business buy-sell few years back. I went to a local seminar offered by SBA on business valuation and many of these concepts were discussed.

jklcpa is right on point that there are many traps and one size does not fit all. You need a competent estate planner, attorney and accountant working as a team.

[SaraEA]

I don't think your E&O insurer would want you to go near this with the proverbial ten-foot pole. Any untoward consequences (already mentioned are corporate AMT, not enough left to pay heirs in full) and they will be looking for someone to blame. Guess who, you. Direct them toward professionals who do this type of thing, cooperate by supplying any financial info needed, and when they get to the point of having to make a decision be a good listener but don't proffer an opinion. The owners might trust you more than they trust their own families, but those families might not feel the same way when the owner is gone.