The best exit plans don’t just provide the business owner an exit, but they also preserve the business owner’s wealth. They help to avoid or minimize taxes from the proceeds of selling the business and assist in achieving financial security for the former owner and their family.
Even though many factors (mainly concerning the business) contribute to the success of an exit plan, the most significant is the entrepreneur’s financial plan. The exit plan ensures that the business exit succeeds in every sense (for both the business and the owner).
Most owners likely spend a considerable part of their lives and wealth on building their businesses to a level where they can sell them at a premium price. They must think in advance about how they will utilize this wealth. Will it even be enough for them to live the rest of their lives comfortably as well as achieve their personal and community goals?
This is when setting up personal financial goals or establishing the goals for wealth preservation planning becomes of utmost importance. Once the owner accumulates that wealth, it is critical to preserve it.
Business owners need to answer questions like:
- How much wealth will you need when you exit your company so that it can fund your expenses for the rest of your life?
- If you have children, how much wealth do you want to leave to them?
- How soon will you need that wealth before you exit your company?
Answers to these questions help exit planning advisors set business owners’ personal financial goals and determine strategies for wealth preservation and tax savings. However, for the advisor, the key to successful planning is determining if the business owner’s goals are realistic. Is it possible to go from the current level to the desired level using the available resources and time?
Some areas of focus help advisors when building the business owner’s wealth preservation plan or personal financial plan.
Areas of Focus in the Wealth Preservation Plan
Cashflow modeling helps advisors forecast the financial future of the business owner. It is essential to balance cash in and cash out. Business owners and their advisors should analyze the time frame which the sale proceeds will sustain, considering the owner’s current lifestyle.
They need to identify significant future expenses likely to come up, such as home improvement, education funding, or wedding expenses for children/grandchildren. It helps to plan for potential surprises and financial hurt in the future. Business owners should also factor into the cash flow calculation of any debts they carry, significantly when their business payouts cannot eliminate them.
Another vital area of focus in the wealth preservation plan is preparing the personal investment policy statement. This includes the goals and objectives of investment and the strategies, standards, and beliefs that serve as long-term guides to the investment portfolio. Investment planning helps diversify funds by investing in different asset classes to spread risk and reduce volatility.
As the business owner prepares to sell their business and create a portfolio of investments, they must revisit their estate plan. In the light of new strategies, goals, and objectives for wealth preservation, they must ensure their assets are appropriately distributed to their beneficiaries when the time comes. Estate planning can help avoid costly pitfalls and creates opportunities for tax minimization concerning estate/gifts.
Risk management helps minimize potential financial and other losses. Business owners need to evaluate future possibilities of property loss, personal and business liabilities, illness, disability, etc.
Risk management could involve purchasing new insurance policies for health, life, disability, etc., repositioning asset ownership, and other available protections. Therefore, business owners need to identify their insurance needs, pick the right policies, and budget accordingly with the help of their wealth preservation advisors.
When owners sell their businesses, they will likely receive a large payout which will probably be subjected to annual capital gains taxes, dividends, interest, etc., requiring tax payments. Business owners should work with a tax advisor alongside a financial advisor to produce the financial plan through the exit planning process to minimize tax liabilities with vital strategies.
Wealth Preservation Techniques
Wealth preservation techniques help business owners minimize taxes and secure their finances. For example, a business owner X wants to exit. The CPA informs X that, based on the firm’s pre-tax cash flow of $4 million per year, the company will be worth approximately $24 million to a buyer/investor. X realizes that they have waited too long to start gifting part of the company to their children. Also, X does not want much cash to retire comfortably. Therefore, if X does not transfer half the value before the sale, their children will have to pay a significantly large amount in an estate or gift taxes.
The advisors helped X with two wealth preservation techniques:
Involving a Business Appraiser
The business owner hired a business appraiser to value the company as suggested by the advisors. The appraiser valued a 49 percent non-controlling stake of the company at $4 million for transfer. The calculation was based on valuation principles and then-current tax case law. The appraiser suggested a 35 percent discount for a non-controlling stake on the fair market value of the total stake of $24 million.
So, by applying the 35 percent discount, X transferred almost half of the company to their children at a gift value of approximately $8 million. Also, based on the available credit, X paid no gift tax.
Creating a GRAT (Grantor Retained Annuity Trust)
Not wanting to waste the valuable lifetime gift and estate tax exemption needlessly, the business owner wanted another answer. So, the advisors used a wealth preservation tool called a grant retained annuity trust (GRAT) to help X not utilize a significant part of the unified credit while also transferring half the credit to their children.
A GRAT is irrevocable. The business owner and the trustees of the GRAT can transfer some of their non-voting stock into it. The GRAT pays an annuity to the owner each year for a pre-determined period. After that period ends, the remaining stock is transferred to the children’s trust.
The IRS considers stock in GRAT to be a gift. Its value is calculated as the stock less than the present value of the owner’s annuity. So, the owner made a non-taxable gift by ensuring that the stock value and the current value of annuity received over the years were equal.
Just like exit planning, wealth preservation planning should start long before the actual exit. With the help of the right advisors, business owners can minimize taxes and attain financial security. As they go ahead with the exit planning strategies, wealth preservation plans and the proper techniques can do their jobs simultaneously.