mbeck – Page 2

WHAT’S IN YOUR BUSINESS PLAN?

Business plans typically only focus on the growth and market success of the company – but seldom address protecting the value and income your business generates.

Your business plan is a guide to success. It sets the direction for the business and identiﬁes potential weaknesses. It communicates the Mission/Vision to stakeholders and can assist in raising capital when needed. A Business owner’s focus is entirely on operating and growing the business.

As the business grows and achieves greater success it becomes a more signiﬁcant part of an owner’s wealth. The challenge, however, is this is concentrated and illiquid wealth. This exposes a deﬁciency in traditional business planning. There are no provisions to protect the wealth and income of the business for the owner, the owner’s family and key stakeholders. Also absent are clear and deﬁned strategies to ultimately unlock the wealth in the business.

The standard business plan document contains a well thought out plan for growth and success but nothing about protecting and unlocking the wealth being created.

A failure to plan and budget for protecting and unlocking business wealth is a huge oversight. As a result it often never gets done or comes too late resulting in great expense and potential loss of value.

Business Value Protection Planning™ completes the business plan. It beneﬁts all stakeholders. It includes planning to protect business wealth and anticipates how owners will unlock the wealth. Annual Valuations both measure progress and guide planning decisions.

By making this a part of the overall business plan it puts it on the agenda. This increases the likelihood that it all gets done and remains current. It creates accountability. Over time this planning, just like Growth planning, will evolve as the business grows and changes.

Key Questions

• What is your plan if something happens to you, your partner or a key employee? Do you have the right legal documents and insurance in place to mitigate wealth and income loss?

• What is your plan to unlock the wealth concentrated in your business? Is your plan written and coordinated with your personal planning? Is your plan tax eﬃcient and designed to help you keep more?

Summary

Business plans have been around for a long time. The next generation of business plans will include strategies to protect business and ultimately unlock owner wealth. Does your current business plan do all this? You spend a lifetime building your business/legacy. You deserve to protect and receive the maximum value. We can help make that happen. Call us a to learn more about getting a more comprehensive plan for your business.

Contributed by Doug Marshall

Wealth Management Success Guide for Business Owners

KNOW THE VALUE OF YOUR BUSINESS – Start by changing the way you see your business in relation to everything else you own. Your personal wealth is typically diversiﬁed and liquid. Your business wealth is concentrated and illiquid. Managing your business wealth is diﬀerent and its value can grow to more than 50% of everything you own. Know where you are today, know what your business is worth and what is at risk. This is the best place to begin.
SET UP A BUDGET TO MANAGE YOUR BUSINESS WEALTH – Managing and protecting your business wealth will have a cost as it should. You pay people to manage your personal wealth. Managing your business wealth should be no diﬀerent. A good place to start is setting an annual budget in the neighborhood equal to .5% to 1% of the value of your business (Chris Mercer – Unlocking Private Company Wealth – The 1% Solution).
WHAT DO YOU WANT? – Your planning is all about your vision. Ultimately it should respond to what you want for you, your family and your key stakeholders when the expected and/or the unexpected happens. This rarely happens in a vacuum. Find someone you can talk to who can give you the right perspective.
THE RIGHT ADVISORS FOR YOUR PLANNING TEAM – Make sure you have the right advisors for the right roles/ seats. You want a strong team. For most of your planning you will employ a legal advisor, tax advisor, wealth advisor and Insurance/Risk advisor. If you’ve outgrown an advisor be ready to make a change.
SET THE EXPECTATIONS FOR YOUR PLANNING TEAM – Get all your advisors committed to your vision and what you want. This helps to get all of your key advisors moving in the same direction. Everyone must be a team player. Failure to get everyone moving and headed in the same direction is where most planning gets derailed.
ACCOUNTABILITY FOR ALL TEAM MEMBERS – Accountability is a key component of the planning process. Select the quarterback/integrator for your advisory team. As the owner you can choose to be the quarterback/integrator for the planning however it will take you away from running the business. It takes time. Find a quarterback/integrator you can trust to coordinate the team and manage the details by holding the team accountable.
UNDERSTAND THE FOUR PRIMARY PLANNING AREAS – They are Succession, Retirement, Estate & Key Stakeholder Planning. Understand what the planning areas do for you, why they are important and also what they do not do. Together they are the foundation for protecting the Wealth, Income and Legacy of your business. Together they will help protect your downside, save you taxes and ultimately unlock the wealth of your business.
USE A PLANNING SYSTEM/PROCESS TO GET THE JOB DONE – Business Value Protection Planning™ is one system you can use. It is a three part planning system developed by Marshall | Viliesis, the parts are Evaluation – Guidance – Execution. Using a Planning System keeps people and tasks on track, saving time and expense. It is simply more efficient using a planning system.
KNOW YOUR PLANNING OBJECTIVE – Planning should not be an endless process. When your planning is Current – Complete – Coordinated for all four planning areas you know the work is done. Start with the end in mind. It helps to know where you are going.
SET UP A PLANNING REVIEW SCHEDULE – Keep your planning meaningful. Set up a schedule to revisit it on a regular basis to keep it on track and working for you.

Contributed by Doug Marshall

Successions: Is Contingency Planning Enough?

We all know the scenario: An owner wants to retire, has someone in mind to be their successor, and needs a professional to structure the transition.

So, they contact you and you set about putting together a solid plan for their succession. You help them clarify their needs. You help them value their company. You help them structure the buyout with respect to taxes and their estate. And you help them structure the transfer of ownership.

Additionally, because you have much more experience at this than they do, you include strategies to protect them if things don’t go as planned.

Frequently, to protect the owner’s interest and the company’s value, transfer of ownership is phased in over time. This helps the owner retain control of the company as the successor takes on more and more responsibility. It also gives the successor incentive by giving him or her increasing stock ownership. This works well as long as the successor does well.

But what if the successor doesn’t do well? While it’s true that the owner still retains ownership, the reality is that – years after the transition plan was developed – they’re left with no successor and will need to either find a new successor or sell to some outsider.

An effective way to minimize the likelihood of successor failure is to have a professional help groom and guide the successor, thereby increasing the likelihood that he or she will succeed. With so much at stake, it’s a smart investment. It’s why we offer Successor Development.

Alternatively, if the owner wants to completely step away from the company upon signing the transition papers, ownership is transferred to the successor immediately and the owner takes back a promissory note that the successor will make payments on over time. A good contingency plan provides a solution in the event that the successor defaults on his or her loan payments. Typically, the owner gets the stock back and returns to run the company.

But if that happens, there are a number of serious problems that arise. One is that the owner will have to come out of retirement (after several years of being retired) to run the company once again. The second problem is that the company will no longer be as valuable as it once was (as evidenced by the poor cash flow causing the loan default). A third problem is that, just as in the previous scenario, the owner no longer has a successor.

And the last problem is that (years after the original transition) the market will have a sizable surplus of seller over buyers, resulting in a buyer’s market with lower multiples and buyers who are more demanding. (I’ve written about this in a previous article.)

Once again, an effective way to minimize the likelihood of failure is to have a professional help groom and guide the new owner, thereby increasing the likelihood that he or she will succeed. With so much at stake, it’s a smart investment. It’s why we offer New Owner Coaching.

Finally, even with additional guidance and grooming, the successor sometimes turns out to be a poor choice and doesn’t succeed. In that case, recruiting a new successor may be the best solution for the owner because it will provide the full value of the business and will keep the business locally/privately owned. It’s why we offer Successor Recruiting.

Contributed by Michael Beck

3 Common Mistakes a New Owner Needs to Avoid

Taking over the ownership of a company is an exciting event. It’s a time filled with hope and dreams, opportunity and vision, fear and insecurity, and broad responsibility.

Your family relies on the business doing well. Employees and their families rely on the business doing well. Customers and suppliers rely on the business doing well. Even the previous owner relies on the business doing well (if for no other reason than to ensure that all the buyout payments get made).

Because of all these things, it’s important to avoid the following three common new owner mistakes.

Mistake #1: Making Changes Simply to Prove the New Owner Is in Charge

There are two aspects to this mistake that need to be addressed. First, newly acquired power, responsibility, and authority can be intoxicating. It can be tempting to flex one’s new ownership muscles. This temptation can arise from years of having ideas without the authority to implement them or it can arise if the new owner feels he or she must establish his or her leadership competence in the eyes of employees. The second aspect pertains to the successor’s relationship with the founder. There may be a tendency to arbitrarily make changes simply to establish that he or she is now in charge, not the founder.

In either case, making changes simply for the sake of change is a mistake. A wise owner will reflect on his or her motivations for wanting a change, show restraint, and reflect good judgment before making any changes. Change for the sake of change is destined to cause problems rather than solve them.

Mistake #2: Continuing to Think (and Act) Like an Employee

In many cases, a new owner has spent his or her entire career as an employee. The mistake is to continue to think and act like an employee. There are several differences between the way an employee thinks and the way an owner thinks, and if a new owner doesn’t make this shift, problems will arise.

Employees tend to think narrowly. They usually focus on the task at hand and/or on their specific domain of responsibility (operations, finance, engineering, etc.). In contrast, an owner needs to consider the bigger picture and how his or her decisions impact each aspect of the business.

Employees tend to think short-term. Their focus tends to be on current matters, current revenues, current expenses, and current profits. In contrast, an owner needs to consider both short-term and long-term success, needs to be able to make decisions without having all of the information about the future, and must learn to balance risk and reward. Rarely is a decision about the future risk-free, and an owner needs the ability to assess and minimize that risk.

Additionally, employees tend to focus on doing good work while at work but generally don’t take their work home with them. Owners, on the other hand, learn that the business becomes their life, and they think about it all the time, wherever they are.

And finally, employees know that if they make poor decisions, or they become dissatisfied, or the business just doesn’t do well, they can always find a new job elsewhere. Owners understand that failure is not an option. Generally, there is no “Plan B.” They understand that the business is their only future, and this understanding colors their decisions and actions.

Mistake #3: Not Earning the Trust and Respect of Others

The degree to which an owner earns the trust and respect of others determines the effectiveness of their leadership. There’s a big difference between the results gained from people who simply comply with orders and those gained from people who are committed to the success of the company. Exceptional leadership elicits excellence. In order for an owner to be effective, he or she must earn the trust and respect of those around them. A new title doesn’t automatically earn the trust and respect of others. Industry knowledge can earn professional respect, but a leader earns trust and respect through everyday actions.

Trust is earned by demonstrating integrity. It is critical for an owner to follow through on his or her commitments. Actions truly do speak louder than words, and good intentions won’t cut it. Owners may have the best intentions when they agree to a list of commitments, but if they don’t follow through on those commitments, they’re viewed as lacking integrity. Likewise, if an owner states that certain values are important to him or her but then acts in a manner at odds with those values, they demonstrate a lack of integrity. And when that happens, people learn not to trust them.

Respect must also be earned. The most effective way to earn respect from people is to show them respect. As leaders, we show respect when we listen to what others have to say. People often feel they have good ideas and have something to contribute. Whether we agree with them or not, soliciting input from others demonstrates that we value them and their ideas, and that goes towards earning their respect. The most effective means of showing respect for others is asking good questions of people and then listening to their answers.

How to Avoid These Mistakes

It’s often difficult for new owners to bridge the gap between where they are and where they need to be. And bridging that gap can be the difference between a successful business and one that languishes in mediocrity. However, an owner’s ability to evolve generally relies on two things.

Having a Confidential Sounding Board
Often, the evolution of a company is conceived during open discussion of ideas, but most owners don’t have the right “sounding board”. It requires an environment within which an owner’s inklings, ideas, and concerns are brought to light, challenged, and expanded. The best strategies will leverage strengths, minimize risk, and balance long-term needs and goals with short-term needs and goals.

Gaining Unbiased, Outside Perspective
Outside perspective is essential as a catalyst for creative, game-changing strategic thought. Outside input is necessary to uncover blind spots and move past them. Every owner needs an objective, supportive confidant with whom to complain, vent, confide in, and talk things out. Owners must carefully think through possibilities, assess and manage risk, and then select the strategic plans with the best potential.

If you’d like help as a new owner, please give us a call. Our team of executive coaches works with clients around North America. Executive coaching can help an owner grow revenues, increase profits, and improve cash flow. You are welcome to call me on my direct office line: Michael Beck, 503-928-7645 (Portland, OR).

Contributed by Michael Beck

Strategic Planning for a High Value Sale Price for a Business

A common question asked of IBA M&A professionals, as the oldest and largest business brokerage firm in the Pacific Northwest, is “What Should I Do to Prepare My Company for Sale to Maximize Market Value and Facilitate the Smoothest Transition of Ownership?”.

This is a great question. Our common follow up response is, “When Do You Want to Sell?” If you are looking at selling on a short-term time horizon (3 – 6 months) there are few things you can do to significantly change the market value. However, if you are willing to defer the sale until 2023 there are multiple things that can be done to enhance value and mitigate turbulence during the transition of ownership.

The following is a brief overview of some of the activities we recommend. We would also welcome the opportunity to meet or talk with you, if you are based in Washington, Oregon, Alaska, or Idaho, and provide a free strategic planning consulting session on preparing a business for sale. These sessions are provided by IBA’s knowledgeable, experienced, highly skilled team of business brokers on a complimentary basis as we look at the meeting as an opportunity for us to introduce ourselves and begin to develop a relationship with an entrepreneur early in their process of selling an asset, they have invested significant time, energy, and capital nurturing & developing. IBA has successfully sold over 4200 businesses in the Pacific Northwest since 1975, we have a long horizon perspective on helping the entrepreneurial community. We simply desire to be included in the interview process by a business owner seeking professional representation in a sale whether a transaction is desired in 2022, 2023, or 2025. If we cannot demonstrate why we are the preferred option in the region for selling a business for six, seven, or eight figures then we are likely not the best choice.

Financial Records

Accurate, transparent, detailed financial records are a foundational component in achieving a premium market value for a privately held company or family business. On the buyer side of the table multiple parties will review this documentation. It is important that the financial records pass scrutiny by the buyer, their accountant, CFO, acquisition financing lender, and/or investors or the deal will be at risk of failure. The most important documentation in the sale of a business will be the federally filed tax returns with the most recent year bearing the most weight. The opportunity currently exists to incorporate strategies related to the 2022 tax return that are no longer available for 2021. Each dollar of profit for a company is multiplied during the business valuation process. The greater the profit the greater the value. This fact creates an incentive for the seller to mitigate discretionary expenses run through the business in the tax year prior to sale. A case can be made for adding back certain non-reoccurring and discretionary expenses by a persuasive, professional intermediary to try to preserve value, but it is always preferred to not have to go to court with the buyer and their professional advisors and explain how imbedded expenses are not necessary (The approximately 30 cents per dollar saved in taxes by running personal expenses through a business have the potential to cost 3 – 6 dollars each, if the addback is rejected). If addbacks are going to be made, it is recommended that transparent records exist to support the addbacks that can be shared with the buyer (e.g., Matching business leased Teslas provided to the shareholders of the company are corporate benefits of ownership and not necessary to run a manufacturing company with limited local customers). Outside of the income statement revenue activity (e.g., cash or barter not run through the business) should also be mitigated. Again, every dollar not reported could result in a loss of $3 – 6 dollars at time of sale. 2022 Sale Note: If a sale is desired in 2022, it is recommended that an entrepreneur be first in line to get their 2021 tax return filed with the IRS by their accountant. Q1 & Q2 business sales have the potential to be held up while a buyer, their CPA, and bank wait to review the final tax return for the prior year. Tax returns are valued higher than internal profit & loss statements and balance sheets by the buyer side of the transaction because the information is accountable to a third party, the Internal Revenue Service (IRS). It is also prudent to establish a receipt file that can be made available during due diligence to the buyer documenting any discretionary or one-time expenses that are being presented as addbacks in establishing the adjusted cash flow of the company.

Asset Infrastructure

You only get one chance to make a first impression in sales. This is true whether you are personally selling a used automobile or privately held company. Deferred maintenance and management activity will be reviewed by a buyer. It is recommended that a seller assess items like their website, equipment condition, and inventory prior to going to market. A website that is not up to current standards in terms of graphical presentation, navigation, E commerce, and security will be perceived as an opportunity by a buyer, it will not enhance value. Equipment in need of service & repair will be seen as a reflection on the management of a company and can result in a discount in business sale price. It is often cheaper to pay for and schedule service with known, trusted providers than to have the buyer value or ask for a credit for the activity as a deal term. No business buyer wants to purchase damaged, obsolete, or slow turning inventory. Best practice prior to sale is to sell or dispose of the items, so they are not taking up space or generate a discussion/negotiation subject. Insider Seller Note: The maximum a buyer will pay for inventory is the purchase or current wholesale market value. Sales to the public 5% above this value will be better for the seller than a sale to the buyer of the business. Sales of damaged, obsolete, or slow turning inventory can also enhance revenue and profit for the company immediately prior to sale. In a best practice sale, the seller should deliver, and the buyer purchase sufficient inventory, so business operations can continue without impact prior to and after the sale in a normal manner.

Staff

The less important ownership is to business operations commonly the higher the multiple of EBITDA paid by a buyer. In a strategically staged sale to maximize value, ownership will develop management underneath them that can run the company or assume executive positions in the future. It is also prudent to mitigate the number of employees lost at time of sale. A family run business can be successful and profitable for many years, however if five key employees (President, CFO, COO, and the two top salespeople) all want to leave the company at one time business operations will be impacted resulting in a buyer discount in value, if a buyer can be found at all. Strongly run companies have systems in place for transitioning leadership positions and retaining employees. A knowledgeable, experienced business broker can often be a source for ideas & strategies in this area.

Contracts

Agreements can be significant value creating assets for a business. A long term, reasonably priced lease for a waterfront restaurant with a view can create stability and profitability that results in the business being sold for a premium value. Similarly, long term contracts with customers and suppliers can create competitive advantages that enhance value. Often existing ownership will have established personal goodwill that can help tip the scales toward achieving the best available terms for a contract. If a contract is expiring, it is often prudent to lock up a relationship prior to going to market. Seller Warning: It is true a long-term contract can increase company value, but long-term contracts can also enhance post transaction liability and risk. This most often occurs when a party requires a personal guarantee, most commonly in the situation of facility leases. It is often difficult to get personal guarantees removed at time of sale from contracts, so it is recommended as a long-term tenant that efforts be made to remove this lease component once it has been established the business is a good credit risk as a tenant.

The sale of a privately held company or family business is a sophisticated, nuanced process. It is prudent for an entrepreneur seeking to sell their company at a premium value in a transaction employing best practices to surround themselves with a quality team of professional advisors to help navigate the path. The better lit the path and detailed the road map, the higher the probability for achieving desired transaction goals. If you are looking to sell your Pacific Northwest business in 2022, 2023, or 2025 IBA would welcome the opportunity to interview for the position of lantern bearer and trusted guide for the journey.

Gregory Kovsky, the President & CEO of IBA since 2000, has personally facilitated over 300 transactions involving privately held companies. He is recognized nationally for his knowledge & experience as a “sell side” broker in the manufacturing, international import, industrial, marine, construction, technology, and horticulture industries and a commonly published author and seminar speaker. Mr. Kovsky has held a real estate brokers license in one or more states since 1994 and has the ability to comprehensively represent entrepreneurs in the sale of their privately held companies and commercial real estate. He is honored to represent IBA as a member of the Seattle chapter of The Professional 50 along, Bill Southwell, and have Stephen Cohen represent the firm in The Professional 50 chapter in Portland.

Contributed by Gregory Kovsky

The Cost of Inaction

Many owners (if not most) wait until they’re ready to retire before they get serious about the planning of a transition. That timeframe is usually about 6 months before they want to sell the business. And while it’s true that most deals can be completed within 6 months, getting a deal done and getting the price and terms you want can be very different things.

There’s a cost to waiting until the last minute to plan an exit.

EXTERNAL SALES

Typically, when an owner plans to sell his or her company to an outside buyer, they’ve imagined a scenario where an advisor reviews their company, puts a value on it (which ends up being equal to what the owner feels it’s worth), and goes about finding a buyer. Once the buyer is found, they come in, look over the books and the operations, and write the owner a check for the value of the business in exchange for the keys.

But it rarely works like that…

More often, one or more issues related to price or terms surfaces and can even derail the plan.

Value Less Than Desired
When a formal valuation is done, sometimes the value is higher than expected, but often it is lower. Transition experts can help an owner increase the value of their company, but it takes time. Once changes are made and the improvements generate greater growth and profitability, that increased performance needs to be demonstrated for at least a year or more to properly boost the value of the business.

If an owner waits to address this, he or she will be forced to accept a lower value. There is a cost to inaction.

Actions to Take and The Benefits:
There are several steps an owner should take a year or more in advance of a sale to avoid surprises and to maximize value. A formal business valuation should be conducted to establish an unbiased value for the business. In addition, a preliminary Quality of Earnings evaluation and a Quality of Leadership assessment should be done to uncover any potential issues that could negatively impact value. Once the valuation, Quality of Earnings and Quality of Leadership are done, any shortcomings can then be addressed to mitigate problems and maximize value.

Price Less Than Desired
Generally, the price a buyer will pay for a company is close to the formal valuation figure. And that price is often a multiple of EBITDA. But as the wave of Boomer-owner retirements builds (it started in 2021), there will be a growing surplus of businesses on the market looking for a buyer. And with a growing surplus comes falling multiples. In other words, where the price might have been 6 times EBITDA, it may well drop to 4 times EBITDA.

If an owner waits too long to sell the company, he or she will be forced to accept a lower price due to the surplus of sellers on the market. There is a cost to inaction.

Actions to Take and The Benefits:
The Boomer owner retirement wave has begun (2021), the surplus of sellers over buyers will consistently increase over the next 3-4 years, and the surplus will persist for another 8-10 years after that. Given the dynamics of the marketplace, the best way to ensure a high multiple (and therefore a strong price), is to put an exit plan into action sooner than later.

Less Desirable Terms
Another consequence of a growing surplus of sellers, is that buyers can become more demanding and may require terms that an owner may find undesirable. They may demand a significant earn-out, where the owner must “earn” part of the purchase price based on the performance of the business following the acquisition. Or buyers may demand that the owner stay on for an extended period (1-3 years) to ensure performance. Or there may be any number of other demands that the owner may not like, which could be deal breakers.

If an owner waits too long to sell the company, he or she will be forced to accept additional terms because they’ve lost their leverage due to the surplus. There is a cost to inaction.

Actions to Take and The Benefits:
The same advice to maximize multiples holds true for deal terms. The sooner an owner acts, the more leverage he or she will have over the terms of the deal.

INTERNAL SALES

Just as with an external sale, an owner who plans on having a successor take over has also imagined a scenario. They imagine that when the time comes to retire, their chosen successor will be ready and willing to take the reins of the company and will successfully lead it into the future. The business will continue to grow, profits will continue to grow, employees will be happy, customers will be happy, and of course, all the buyout payments will be made.

But it doesn’t always happen like that…

Choosing the right person and properly preparing them to take over is essential to the success of an internal sale (succession). But many times, one or more issues exist and – if not addressed in advance – can cause major problems. There is a cost to inaction.

Lack of Preparedness
Preparing someone to take over the business is essential to the success of an internal sale. But grooming them in the mechanics of the business does not necessarily develop their ability to lead effectively, their ability of think strategically, nor their ability to make good decisions.

The result of an inadequately prepared successor can be employee turnover, loss of customers, declining revenues, diminishing profits, and missed buyout payments. There is a cost to inaction.

Actions to Take and The Benefits:
It’s very difficult for an owner to be objective about their successor. Therefore, it is essential to the success of a successor that an objective assessment be conducted and they get outside, objective coaching. It generally takes 6-12 months of coaching to develop the competencies needed for leadership and ownership success.

They’ll become a more effective leader, they’ll develop smarter strategies, and they’ll make better decisions.

Choosing the Wrong Person
Sometimes, no matter how much an owner and/or an executive coach grooms and mentors someone, they still won’t be effective at leading the company.

The problem, however, is that those shortcomings often are not evident until the successor takes over. And of course, by then it’s too late. In fact, often the shortcomings themselves aren’t apparent, but rather manifest themselves in declining business performance. Obviously, waiting until there’s no turning back is a mistake. There is a cost to inaction.

Actions to Take and The Benefits:
An objective assessment can reveal many of those shortcomings. But identifying a successor’s strengths and weaknesses is only part of what needs to happen. Having a successor work with an experienced executive coach can reveal lapses in judgment, gaps in interpersonal skills and blind spots. Usually these can be determined within about 3 months.

If it becomes apparent that the successor is the wrong person, a new successor can be recruited and groomed. The process of finding that right person can be completed in about 3-4 months. And at least another 9-12 months should be allowed to allow the successor to prove him or herself prior to the owner retiring.

Having to Choose Among Several People
When there are several potential successors, owners often put off choosing one as long as possible. They either can’t make the decision, hope that one will rise above the others, or fear the fallout that may come from one being chosen over the others.

But of course, procrastinating doesn’t resolve anything and more likely, will create even more problems and anxiety if done at the last minute. There is a cost to inaction.

Actions to Take and The Benefits:
The best way to make a decision that will be the least upsetting to people is one based on objective assessments. They will provide an unbiased picture of each person’s strengths and weaknesses. The results will allow an owner to either choose one over the others based on their strengths or split responsibilities based on their strengths. The objectivity removes a good deal of emotion from the decision process.

BOTTOM LINE

The bottom line is that, regardless of whether an owner plans to sell their company to an outside buyer or an internal buyer, waiting until months before the event usually produces less than desirable results. Taking action well in advance of a sale will either uncover issues that can be addressed (so the business is attractive to buyers), or will prove that everything is in order and will allow the owner to sleep at night, knowing their future is secure.

Contributed by Michael Beck

Congressional Committee Issues Late-Night Tax Proposal

On September 13th at 11:20 pm Eastern time, House Ways and Means Committee Chairman Richard Neal (D-Mass.) released long-awaited details on Democrats’ proposed funding for the $3.5 trillion American Families Plan. The House’s tax plan differs from President Biden’s in many respects and includes some pleasant—and unpleasant—surprises.

Investors should not panic. The House proposal is the first pitch of a nine-inning game, one that is likely to produce many twists and turns. Some—and perhaps many—of the House proposals will not be enacted. The most important takeaway from the House proposal? Estate and gift tax laws now appear likely to change, perhaps dramatically. Those who have postponed implementation of lifetime wealth transfer strategies should execute those plans as soon as possible. It’s not clear whether proposed changes in the House bill will become law, but one thing is certain: Future tax laws are unlikely to become more favorable than they are right now. Investors who can afford to act should act now.

Things to think for now:

If a client has any plans to transfer wealth to a grantor trust (IDGT, SLAT, GRAT), then they should do so immediately. That must be completed before the new law is enacted, as these tax shelters would become part of the estate again, and subject to taxes.

QSBS owners wouldn’t be 100% tax-free, and they would have to pay taxes on 50% of their shares. The change in the exclusion would be retroactive to Sept. 14, but if they had plans to gift it to a non-grantor trust, they can still do that in the future.
Proposed is a cut in the per-person estate tax exemption to roughly $6 million from $11.7 million. For married couples, the exemption drops to just above $12 million from $23.4 million. This becomes effective January 1, 2022, so if they plan to gift more than $6 million, they should do so before year-end.

The top capital-gains tax rate is bumped to 25% from 20%. If passed, the increase would apply to all transactions completed after Sept. 13, 2021. Unless the proposed legislation changes, it’s too late to sell and realize capital gains under today’s lower rates. I suppose since the marginal income tax rate is increasing from 37% to 39.6% (effective 1/1/22) plus a 3% surcharge on income over $5 million (effective 1/1/22), a client might consider looking for opportunities to accelerate income from 2022 into 2021.

The discussion below focuses on those elements of the House plan that are likely to have the greatest impact on individual investors, if enacted.

Key income tax proposals:

The top corporate income tax rate would increase from 21% to 26.5%, effective in 2022.
Under current law, 100% of up to $10 million of gain from the sale of qualified small business stock (QSBS) may be excluded from gross income. The House proposal would slice that exclusion to 50% for most QSBS shareholders, effective immediately.
The top marginal income tax rate would increase from 37% to 39.6%, effective in 2022, for married couples filing jointly with taxable income of more than $450,000, individuals with taxable income of more than $400,000, and trusts and estates with taxable income of more than $12,500. An additional 3% surcharge would apply to modified adjusted gross income of more than $5 million for married couples filing jointly, $2.5 million for individuals, and $100,000 for an estate or trust, effective in 2022. Including the new 39.6% rate, the new 3% surcharge, and the current 3.8% surtax on net investment income, the highest marginal federal rate would climb to 46.4% under the House proposal.
The long-term capital gain tax rate would increase from 20% to 25%, effective immediately, for married couples filing jointly with taxable income of more than $450,000, individuals with taxable income of more than $400,000, and trusts and estates with taxable income of more than $12,500. Including the new 25% rate, the new 3% surcharge, and the current 3.8% surtax on net investment income, the highest marginal long-term capital gain tax rate would rise to 31.8% under the House proposal.
Under current law, the 3.8% surtax on net investment income applies only to passive income. The House proposal would add active trade or business income, effective in 2022, for married couples filing jointly with more than $500,000 of taxable income, and individuals having more than $400,000 of taxable income.

Key transfer tax and related proposals:

Under current law, the gift and estate tax exclusion sits at $11.7 million per person; the House proposal would halve that amount to about $6 million (inflation-adjusted), effective in 2022—accelerating a reduction that is set to occur in 2026.
Assets held in grantor trusts will be included in the grantor’s estate for estate tax purposes. Any distribution from such a trust during the grantor’s life would be treated as a gift for gift tax purposes. Any sale of assets to such a trust will be treated as a sale to a third party, and thus subject to income tax on any gain. Each provision would apply to (i) trusts created on or after the date of enactment (i.e., when the President signs the legislation), and (ii) to any portion of a trust established before the date of enactment which is attributable to a contribution made on or after the date of enactment.
Transfer tax valuation discounts for nonbusiness assets would be disallowed, effective for transfers after the date of enactment.

Key individual retirement account (IRA) and qualified plan proposals:

No additional contributions may be made to Roth or traditional IRAs if total IRA and defined contribution plan balances (“combined balance”) exceed $10 million. Accelerated distributions would be required for combined balances exceeding $10 million. Each provision would take effect in 2022.
An IRA holding any private placement security (e.g., an investment that is available only to qualified purchasers or accredited investors) would forfeit IRA status, effective in 2022, subject to a two-year transition period for IRAs already holding such investments.

Not included in the House proposal:

Repeal of the “step-up” in basis at death
Deemed recognition of capital gain at death
Repeal of the current $10,000 limit on the deductibility of state and local taxes (SALT)
Limitations on Section 1031 exchanges

The House proposal represents the first real indication of how Congress may fund the $3.5 trillion American Families Plan. Assuming Democrats find common ground, at least some of the proposed tax law changes are likely to stick. In that spirit, certain tax planning opportunities emerge:

Investors who have been considering large gifts of up to the $11.7 million basic exclusion amount—especially gifts that would involve a valuation discount for nonbusiness assets—should finalize those transfers prior to the end of 2021. Transfers to irrevocable (“intentionally defective”) trusts may have an even shorter timeframe, as restrictions on grantor trusts would become effective as of the date the President signs the legislation. Attorneys and appraisers are already extremely busy so prompt attention to pending transfers is essential.
Owners of QSBS should consider using multiple layers of exclusions (commonly referred to as “stacking”) to maximize the avoidance of gain under a reduced 50% exclusion.
Consider early withdrawals from IRAs and qualified plans, and exercising nonqualified stock options at lower marginal rates today to avoid a “force-out” of assets at higher rates beginning next year.
Qualified purchasers and accredited investors should consider investing in certain alternatives through low-cost, “private placement” life insurance (PPLI) policies, as new investments through an IRA may become prohibited. If structured properly, investment growth within such a policy should avoid current income taxation. The proposed 5% increase in the long-term capital gain tax rate, and the 3% surcharge for those expecting more than $5 million in income, make investing through PPLI even more appealing.

We will continue to monitor the progress of any tax legislation and keep you informed. As always, we are eager to work with your tax professionals to answer any questions and develop a plan that fits your individual circumstances.

For illustrative purposes only; and does not constitute an endorsement of any particular wealth transfer strategy. Bernstein does not provide legal or tax advice. Consult with competent professionals in these areas before making any decisions.

Please reach out to Troy if you have further questions or a client who might want to discuss this further. https://www.bernstein.com/our-team/locations/seattle/troy-niehaus.html

Contributed by Troy Niehaus