CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Strategies
Business Continuation for Closely
Held Businesses: An Overview
[PRESENTED BY:]
Joe Sample, [Designations per field stationery guidelines]
[Company Approved Title]
[Firm Name]
[The Prudential Insurance Company of America]
[1234 Main Street, Suite 1, Floor 10]
[Anywhere], [ST] [12345]
[in required states] [<ST> Insurance License Number <1234567890>]
Phone [123-123-1234] Fax [123-123-1245]
[joe.sample@prudential.com]
NOT FOR CONSUMER USE.
0217342-00004-00 ED. 06/2015 EXP. 07/01/2017
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Important Information
This material has been prepared by The Prudential Insurance Company of America to assist financial
professionals. It is designed to provide general information in regard to the subject matter covered. It
should be used with the understanding that we are not rendering legal, accounting or tax services.
Such services should be provided by the client’s own advisors. Accordingly, any information in this
document cannot be used by any taxpayer for purposes of avoiding penalties under the Internal
Revenue Code.
Life insurance is issued by The Prudential Insurance Company of America, Pruco Life Insurance
Company (except in NY and/or NJ) and Pruco Life Insurance Company of New Jersey (in NY and/or
NJ). All are Prudential Financial companies located in Newark, NJ
Prudential, the Prudential logo, and the Rock symbol are service marks of Prudential Financial, Inc. and its
related entities.
© 2015 Prudential Financial, Inc. and its related entities.
2
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Agenda
•Market Overview
•Nuts and Bolts
•Funding Considerations
•Profiling
•Conclusion and Next Steps
3
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation Planning: The Opportunity
Small businesses (those employing under 500
employees):
• Comprise over 99.7% of all employer firms in United States*
• Generated 65% of net new jobs over the past 17 years*
• Only 32% of affluent small business owners have a formal
business succession plan+
• 70% of family owned businesses fail to transition to the
second generation++
• 90% of family owned businesses fail to transition to the third
generation++
*www.sba.gov/advo/research updated January 2011 FAQ
+LIMRA Market Facts Quarterly (Spring 2009) (“Affluent” =$500,000 of investable assets excluding real
estate and small business interests)
++http://public.findlaw.com/bookshelf-gwe/gwe-17-1.html (citing American Bar Association Guide to Wills and
Trusts (2010)
4
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
•A formal written buy-sell agreement
•A proper business valuation
•A funding mechanism
5
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
The “buy-sell” agreement:
• Documents the legal obligation to sell/to buy and clearly
identifies who, when and how much
• Creates a ready market for the business interests
• Protects the surviving business owners
• If properly drafted, helps to establish the value of the
business for estate tax purposes
6
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
The Valuation
• Who?
• What?
• How?
Qualified appraiser
Opinion as to fair market value
Two basic methods:
Liquidation: What would you get?
Going Concern: What would you pay for the
business as a money making entity?
7
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
Basic Buy-Sell Structures
• Stock Redemption Plan
• Entity Buyout (partnership/LLC)
• Cross Purchase Plan
• Wait-and-See Plan
8
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
Stock Redemption Arrangement/Entity Buyout
Corporation
Agreement
Shareholder A
Agreement
Premium Proceeds
Insurance
Company
Shareholder B
• Agreement between business and each shareholder
• Business is owner, premium payer, and beneficiary of
insurance on life of each shareholder
9
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
Stock Redemption
Advantages
Disadvantages
•Simple: Only one policy per
owner
•Alternative minimum tax (AMT)
may be triggered
•Business pays the premium:
This may ease the cost burden
for a younger owner or one who
has a minority interest
•Family attribution rules for
corporations
•Cash value: Treated as an
asset on the corporation’s
balance sheet
•Estate value increase
•Policy control: The policy
proceeds will be used for
buyout purpose
10
10
NOT FOR CONSUMER USE.
•No basis step-up
•Voting power may be altered
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
Cross Purchase Agreement
Shareholder A
Agreement
Premium
Shareholder B
Proceeds
Proceeds
Premium
Insurance
Company
• Agreement between shareholders
• Shareholder is the owner and beneficiary of insurance on
other shareholders
11
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
Cross Purchase Agreement
Advantages
Disadvantages
•Basis step-up equal to the price
paid
•Possible unbalanced allocation
of costs
•Family attribution rules do not
apply
•Cash value of permanent
policies part of deceased
owner’s estate
•No potential for AMT
•No estate value increase:
Proceeds received by surviving
owners do not increase the
value of the business
•Disproportionate purchase
possible by surviving owners
12
NOT FOR CONSUMER USE.
•Too many owners and too many
policies (possible solution
trusteed buy-sell)
•Entity lacks control over policy
•Potential transfer for value
issues
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Nuts and Bolts
Wait-and-See Buy-Sell
A hybrid agreement combining the entity and cross
purchase approaches:
•The actual buyer is not identified until death
•Structured as a series of “Options to Buy”
•Business has 1st option to buy
•Surviving owners have the 2nd option to buy
•Business must buy if surviving owners do not exercise their
option(s) to buy
•The order of the options is important if the transaction is
to qualify for capital gain treatment
13
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Funding Considerations
• Owner or owners need to create reserves for funding
purposes
• For premature death contingency, consider life
insurance
• Permanent insurance
• Term insurance
• Term insurance that returns premiums
• Life Insurance can provide the needed funds for death
buyout from the date of purchase*
*Business owners should consult legal counsel to determine whether notice and consent under IRC § 101(j)
is required before the policies are issued to receive tax-favored treatment. For employer-owned life insurance
policies issued after August 17, 2006, death proceeds will be subject to income tax; however, where specific
employee notice and consent requirements are met and certain safe harbor exceptions apply, death proceeds
can be received income tax-free. Life insurance proceeds are otherwise generally income tax-free under IRC
§ 101(a).
14
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Profiling
How the business is organized?
• Public or private corporation
• Pass-through entity
• Partnership
• Limited Liability Company (LLC)
• S Corporation: Always an S corporation?
• Tax-exempt entity
15
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Profiling
Who the owners are?
• Percentage each owns?
• Type of interest owned? (voting/nonvoting, limited
partnership/general partnership, etc.)
• Are they also employees?
• Are they related to each other?
16
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Profiling
Soft Facts
• Relationships
• Family members
• Business owners/employees
• Management style
• Who is the obvious power person?
• Who is the not so obvious power person?
17
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Profiling
Dealing with the unexpected as well as the
expected
Are successors identified?
• Selling to a third party
• Selling/transferring to a family member
Dealing with family wealth
• Minimizing estate and gift taxes
• Providing liquid funds for estate costs
Dealing with the entrepreneur’s retirement needs
• Cash flow for the business
• Cash flow for the departing owner and new owner(s)
18
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Business Continuation: Profiling
General Numbers
• Salaries (including bonuses and “perks”)
• General value of the business
• Total number of employees
• Number of key employees
19
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
Conclusion and Next Steps
•Contact Small Business Owners
•Recommend a business check up
•Recommend a funding review as a part of the
overall planning
•Utilize your firm’s resources and contact
Prudential Advanced Marketing for assistance
20
NOT FOR CONSUMER USE.
CREATED EXCLUSIVELY FOR FINANCIAL PROFESSIONALS
QUESTIONS?
NOT FOR CONSUMER USE.