Financial Insights: MONY’s Smart Assets Course Buy-Sell Agreements MONY Life Insurance Company and MONY Securities Corporation are members of The MONY Group

2 Buy-Sell Planning: SMART Business Succession/Transition Strategies Buy-Sell Planning involves an orderly business sale...  …To family, partners or co-shareholders, or outsiders  …Considering the tax, financial, and emotional needs  …Of the buyer  …And of the seller and /or his or her family

3 Buy-Sell vs. Business Succession The Difference Succession Planning:  May be accomplished by a sale, gift, or bequest at death  Main Objective: To continue the business Buy-Sell Planning:  Always involves a sale of a business interest  Main Objective: To convert an owner’s business interest into cash

4 The Buy-Sell Agreement A contract between identified buyer(s) and seller(s), obligating the buyer to buy and the seller to sell. “ Trigger events ” are specified in the contract. The contract fixes the price (by dollar amount or formula) and terms of the sale Having a “ funding plan” in place is critical! Proper buy-sell planning helps eliminate uncertainty for owners, buyers, and sellers!

5 Possible Triggering Events Retirement Disability Death Termination of Employment Divorce Bankruptcy

6 Business Survival Rates: Not Encouraging! Only 30% of businesses survive a transition to the next generation* Death or disability of an owner are two of the most destabilizing events to a business’s future *Kennesaw State University Study, 1998

7 The Chances of One Owner Dying Before Age 65 Are High Shareholder A B C Probability Sex Age Of Survival M F M (.7958 X.8823 X.8512) = 40% Source: 1985 Society of Actuaries Disability Termination Study

8 The Chances of a 90+ Day Disability are Also High 1 - (.8281 X.8189 X.8731) = 41% Source: 1985 Society of Actuaries Disability Termination Study Shareholder A B C Sex M F M Age Probability Of No Disability

9 There would be a 40% chance this company would have to pay-out at least $1,000,000 in surplus for a buy-out at death before any shareholder reaches age 65 Corporate Value Number of Shareholders Value Per Shareholder Chances of 1 Death $3,000,00 3 $1,000,00040% This May Result in a Large Financial Loss

10 When a Business Owner Dies... The owner’s family may...  Stay in business with surviving owners,  Sell to surviving owners,  Buy-out surviving owners,  Sell to a third party (alone or together),  Liquidate the business (with consent of other owners) Which option would you choose if you were:  1 a surviving owner  2 the decedent’s family?

11 The Owner’s Family Wants Top Dollar At Sale Prompt Settlement In Cash Fixed Value For Estate Tax Purposes Relief From Business Worries As Little Conflict As Possible

12 The Surviving Owners Want Full Control At Sale Business Continuation Minimum Payments Smooth And Prompt Transition No Interference from Heirs Uninterrupted Access to Credit

13 Everyone Can Lose!!! Without an Agreement Possible:  Liquidation  Litigation  Loss of Value  Conflict and Delay  Bad Feelings and Unhappiness

14 With an Agreement Everyone Can Benefit!!! Smooth and orderly transition Binding value for estate tax purposes Agreeable price and terms Avoidance of conflicts No forced liquidation A known plan reduces trepidation & turmoil Certainty vs. uncertainty can make all the difference!

15 Professional Corporations-- Special Considerations Sale must be made to other qualified professionals--  CPAs  Attorneys  Engineers  Physicians Often, “goodwill value” is not accounted for, and there are few hard assets in the corporation PCs are typically valued differently from other business structures--perhaps only 1x-3x annual income!

16 Professional Corporations-- Implications …Buy-sell proceeds may not be sufficient to support retirement, disability income needs, or surviving family in the event of a buy-out at death. Integrating buy-sell planning with overall retirement, disability, and survivor-income needs is especially important!

17 Family-Owned Businesses-- Special Considerations Not all children may be active in the business Children may not be ready to run business when it suddenly becomes necessary A surviving spouse may still depend on income derived from the business Estate “equalization” may be an issue

18 Family-Owned Businesses-- Special Solutions Intra-family buy-sell agreements can be part of a solution Equalization of the estate among children can be addressed using non business assets Non-family key employees may be given incentives to stay, such as “golden handcuffs” benefit programs Integrating buy-sell planning with overall retirement, disability, and survivor-income & estate planning is especially important!

19 Basic Types of Buy-Sell Arrangements 1. Entity Buy Out 2. Cross Purchase 3. Wait-&-See (a.k.a. combination or hybrid)

20 Entity Buy-Out The business purchases the business interest from the withdrawing owner or his/her estate upon triggering the agreement.

21 Entity Buy-Out Sells Shares To Business Receives Cash Owner A or A’s Estate Business Business Owner B

22 The remaining owners purchase the business interest from the withdrawing owner or his/her estate upon triggering the agreement. Cross Purchase Buy-Out

23 Cross Purchase Buy-Out Sells Shares To Remaining Owners Receives Cash Remaining Owner B Business A or A’s Estate

24 Case Study: Cost Basis Comparison Entity Buy-Out vs. Cross-Purchase Bob and Abby started ABC, Corp. many years ago with $100,000 each. Current Value of business: $3,000,000. Bob retires in 2001; buy-sell agreement is triggered. Bob’s share is purchased for $1,500,000 Abby runs the business and sells it in 2009 (8 years later) for $6,000,000.

25 Cross-Purchase Planning: Reduces Gains Taxes At Subsequent Sale Entity X-P Sale at B’s retirement: $1,500,000 $1,500,000 Initial basis (each): (100,000) (100,000) Increased basis to A: 0 (1,500,000) A’s basis After Sale: (100,000) ( 1,600,000) Sale price $ 6,000,000 $ 6,000,000 Taxable capital gain: $5,900,000 $ 4,400,000

26 Wait-&-See Buy-Sell: A Combination Agreement Buy-Sell contains option for either corporate OR personal purchase of withdrawing/deceased’s shares Funding is cross-owned outside the corporation. (ie; A owns assets which will pay for B’s interest) Provides flexibility to help meet needs when triggering event occurs.

27 Which Type is Right? Entity:  Less complex to arrange  Funded with corporate assets  May be best choice if business will NOT be sold after an owner’s death Cross-Purchase:  Increased cost basis to survivors  Can fine-tune ownership %  No Corp. AMT or excess surplus worries  Often the best choice for family businesses Wait-&-See  Maximum flexibility at execution + captures advantages of each  No effective difference to owner/estate doing the selling

28 Buy and Sell Essentials Written Agreement Accurate Valuation Adequate Funding

29 What the IRS thinks at estate tax time? What owner might accept for it? What a buyer would offer for it? What the book/adjusted book value is? What the liquidation value is? What is the “True Value” of a Business? Maximum Value Minimum Value

30 Court Cases on Valuation

31 An Accurate Business Valuation can Help... Lock in a sale price Reduce estate taxes Reduce legal costs Improve lines of credit Reduce delays and disputes Provide fair treatment of heirs

32 Buy and Sell Essentials Written Agreement Accurate Valuation Adequate Funding Review periodically; update as needed

33 Adequate Funding 1. Existing Capital 2. Borrowing 3. Installments 4. Sinking Fund 5. Sale of assets to raise cash 6. Life/Disability Buy-Out Insurance

34 Existing Capital Will it be there when the need is? Who’s got that kind of money? Lost business opportunities? C-Corp. accumulated earnings problem?

35 Borrowing Will buyer qualify? Can borrower repay? High interest charges? EXPENSIVE!

36 High Cost of Borrowing Cost of Repaying A $500,000 Personal Loan - Over 10 Years Percentage of Original Loan 163% Interest Rate 10% Annual Payment $81,373 Total Interest Paid $313,730 Total Payments $813,730

37 High Cost of Borrowing Pre-Tax Income Required to Make Cumulative Payments Over 10 Years Interest Rate 10% Cumulative Payments 28% Bracket 39.6% Bracket $1,352,860

38 High Cost of Borrowing Corporate Sales Required To Generate Pre-Tax Income Needed To Pay Off $500,000 Personal Loan Pre-Tax Income 20% Profit Margin $5,674,500 $5,674,500 Pre-Tax Income 20% Profit Margin $6,764,300 $6,764,300

39 Installment Payments Can buyer afford it? Will buyer default? Installments may outlast business? False sense of security?

40 Sinking Fund Lost Business opportunities? Will money be on time? Corporate income tax due on accumulations? C-Corp. accumulated earnings problem?

41 Sale of Assets Forced sale is NOT conducive to best price! Will it cover the need? Was it desirable from a business perspective?

42 Life & DBO Insurance 1. Easy to use 2. Cost-effective AND those costs are known in advance 3. Helps eliminate risk 4. Provides an income tax free death/disability benefit 5. Premium can be waived during disability w/purchase of appropriate rider (life ins.) 6. Can provide tax-deferred accumulation to help fund RETIREMENT buyout at the same time (life ins.) 7. Premiums must be paid and owners must be insurable

43 Funding Using Insurance: Paying the Premium Business can pay…one way or another  Directly, in entity arrangement  Split dollar  Executive bonus or double bonus Make premiums deductible

44 Owners Receive Proceeds Owners Pay Premium Shareholder or Estate Sells Shares Business Pays Cash Capital Contribution Combination Agreement--Funded with Life / Disability Buy-Out Insurance Insurance company Business Remaining Owners Insured/ Owner’s Estate

45 Business Succession Arrangement Insurance helps stabilize a business by providing funds that can help---  Pay income and estate taxes  Provide working capital  Meet payroll  Pay suppliers and creditors  Expand, diversifying, reorganizing  Replace key employees  Buy unmarketable shares

46 Buy-Sell Life Insurance What If It Were Tax Deductible?

47 Insurance owned by your profit sharing plan lowers your costs… Deducting a Business Succession Arrangement Insurance Face Amount Annual Premium Income Tax Bracket After Tax Cost IRS Share $1,000,000 $1,000,000$30,00040%$18,000$12,000

48 Deducting a Business Succession Arrangement What if the insurance were on the life of your business partner? Purpose: To help fund a buy and sell arrangement at death.

49 Pure Death Benefit Annual Premium Cash Value Deducting a Business Succession Arrangement Insurance Company Profit Sharing Plan Account of Shareholder #1 (Insures Shareholder #2) Shareholder #1 Pays Tax on PS58 Receives Death Benefit income tax free

50 CashStock Pays Taxes Provides Income Deducting a Business Succession Arrangement Shareholder #1 Buys Stock From Estate Of Shareholder #2 Estate Of Shareholder #2 Receives Cash for Stock

51 Deducting a Business Succession Arrangement Living Buy Out At Retirement Each shareholder’s profit sharing account can also tap the cash value of the insurance it owns to buy the shares of a withdrawing or retiring shareholder.

52 Deducting a Business Succession Arrangement Special Taxation Of Shares Distributed From Buyer’s Profit Sharing Plan Cost basis is ordinary income Built-in gain is capital gain if sold after 12 months, or it’s IRD at death After distribution, additional gain is capital gain if sold after 12 months, or is stepped-up at death

53 Buy-Sell Planning & the 2001 Tax Law The Estate Transfer Tax is eliminated in 2010 only......But, it’s replaced with a modified carryover basis plan in that year......And the Estate Transfer Tax returns in 2011, at 2001 levels.

54 First Death Planning: What if Bob were Single and Dies in 2010 or 2011? Sale Price at B’s Death: $ 3,000,000 $ 3,000,000 Bob’s Initial Basis: (100,000) (100,000) Basis Step-Up To Children (1,300,000) (2,900,000) Taxable Gain $ 1,600,000 $ versus -- Taxable Estate Repealed $ 3,000,000

55 First Death Planning: Transfer Costs On Buy-Sell At Bob’s Death Year 2010 “Sunrise” Gains Tax on $1,600,000 Federal Gains Tax $320,000 State Gains Tax 80,000 Federal Estate Tax State Death Tax 182,000 Total Taxes $582,000 Year 2011 “Sunset” Estate Tax on $3,000,000 Federal Gains Tax $ State Gains Tax Federal Estate Tax 763,000 State Death Tax 182,000 Total Taxes $ 945,000

56 First Death Planning Options Replace cash used to pay expected transfer costs with personal insurance owned out of the estate. Reduce the value of the buy-sell to reduce the gains and estate taxes due. Replace lost value to family with life insurance owned out of estate.

57 Buy-Sell Agreements: Thinking outside the Box What if an owner has no co-owners?  Agreement with key employees?  Agreement with competitor?  Sale using business broker or M & A firm?

58 Sale to An Outside Buyer-- Prepare 2-5 Years in Advance! Consider a professional valuation Consider co-owners’ exit strategies Focus on profitability Keep running the business!

59 A Buy-Sell Agreement is a Good Idea When... There is a high degree of financial risk for the family of the retired / disabled / deceased owner It’s important to guarantee a market at retirement, death or disability for the sale of an otherwise unmarketable business interest It’s important to fix the value of the business for federal estate tax purposes

60 A Buy-Sell Agreement is a Good Idea When... A surviving owner is unable or unwilling to remain in business with the deceased/withdrawing owner’s heirs It’s important to prevent outsiders from taking over the business The owner / owner’s estate needs cash and the business is unable to provide it

61 Buy-Sell Planning: Critical Components A written agreement  Address ALL appropriate contingencies  Provide for valuation  Address funding Type of agreement is a secondary issue…  but, when appropriate, consider opportunities!

Business Succession: Buy-Sell Planning MONY Life Insurance Company and MONY Securities Corporation are members of The MONY Group