Companies that quickly adapt to a changing landscape are continuing to see growth. The current business environment, where technical expertise continues to be an asset, requires the marriage of technology and the strategic use of capital to sustain long term growth success.
Advisers for many business owners continue to stress that the best time to sell a business is when business is good. After a good year, our tendency is to pay out the success to ourselves and our key people which is well deserved, but if the goal is to build a business to sell we need a strategy to build wealth within the business.
Here are three -steps to consider if you want to leverage a good year into the succession plan you are really dreaming about:
- Pay a Bonus – As the founder of Mustang Sally’s Brewing Sean Hunt once told me, “cash is king”. Sean was a corporate attorney in mergers and acquisitions before opening the brewery in Chantilly, VA, and he saw how important it was to take care of key people. Deferred benefits (e.g., defined benefits plans, options, restricted stock) are terrific long-term incentives for key employees. When a company’s financial performance justifies and enables it and a thoughtful bonus structure is established, though, few things are more effective at demonstrating to key employees that the company values their continued contributions to its success than cash.
- Build Reserves – Business Attorney Gosia Bochenek of Cochran Allan wrote in her December 2018 newsletter about the elimination of the Alternative Minimum Tax on Corporate Owned Life Insurance and how life insurance is the preferred model to fund a buy-sell agreement to assure business continuity by providing remaining owners with cash to purchase a deceased owner’s interest. Buyout upon death can be funded with both term life insurance and cash value life insurance, but cash value life insurance can also be part of a buy-out at retirement. While term life insurance can fund the buy-sell (or key man for sole owner), cash value life insurance allows the company to build cash reserves which can be used to fund part of the buy-out for the owner(s). Life Insurance cash value looks great as an asset on the balance sheet, you have created momentum towards a business succession, and if something happens before you can sell the company, you know your beneficiaries will be taken care with funding for your buy-sell agreement.
- Golden-Handcuff Key People – cash once given doesn’t have the same impact in keeping people on board as cash promised. While phantom stock and synthetic stock may play a role in tying key people to the goals of the company, Dan Doran of Quantive valuation shared that most often the way to get cashed out of these vehicles is by selling the company (and understanding your company valuation). Term Life Insurance is often used to cover the loss of income or expenses that can result when a key person in the business dies.
Using cash value life insurance would allow a company to build cash to retain the key person. A common approach in which control is required, the company purchases the policy and owns it for 5 years while the life insurance policy builds cash, they assign the allowable death benefit to the key person during that time, then bonus the policy to the key person after 5 years, and if the key person remains for a few more years, the policy is paid in full for life.
If the desire is to provide cash to assist the company or a key-person in funding the succession plan, now you can see a path to allow that to happen. It all starts with a valuation to understand what you need, and from there you can better understand where cash, stock, and cash value life insurance can work together to allow your dream to become reality.
David Hillelsohn founded DHill Financial, LLC works with businesses and individuals to prioritize meeting responsibilities and using that as their foundation from which to build. David is an independent insurance broker licensed in the majority states around the country, and he can be reached at 703.435.6028 or by email at firstname.lastname@example.org. This article is not meant to be tax advice, please consult a tax professional for details.