Exit Planning NAME TITLE Principal Financial Group Date, 2010

t c While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that The Principal is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements. Insurance products from the Principal Financial Group ® are issued by Principal National Life Insurance Company (except in New York) and Principal Life Insurance Company, Des Moines, IA

Exit Planning What Is Exit Planning A Process Resulting In YOUR Successful Transition Out Of The Business

Exit Planning – The Process 4 Simple Steps Step 1 – Set Priorities Step 2 – Determine Value Step 3 – Sale to Outsider/Insider Step 4 – Estate/Wealth Transfer Planning

Exit Planning – Set Priorities How much longer do you want to work in the business before retiring or moving on? __________ years What annual after-tax income do you want/need during retirement (in today’s dollars)? $________________ Who do you want to transfer the business to? Family? Co-owner? Key employee? Outside Party?

Needs for Owners and Executives Specific business owner issues: –When can I exit my business? –Will my kids be able to – or want to - take over? –Will it sell for what it’s worth? –How can I avoid huge taxes? –Can it survive without me? –How do I reward key employees/management team to stay?

Considerations for Owners and Executives Retirement funds – Will I have enough? Healthcare – How will I pay for it when I retire? Survivor needs –What if I die too soon? Financial security – What if I outlive my finances?

Family Businesses: Competing Values

Conflicting Values

Determine Value Who Performs Valuations Business appraisal firm Business Broker or Investment Banker CPA Financial and Insurance Professionals

Valuation “Beauty is in the eye of the Buyer.” Value is based on reasonable expectations What are some industry standards?

Rules of Thumb Dental Practice: A multiplier of annual net earnings plus fixtures, equipment, inventory Law Practice: 0-100% annual fee revenue, dependant on client retention Accounting Practice: A multiplier of gross annual revenues Medical Practice: A multiplier of annual net earnings, plus fixtures, equip. &inventory Real Estate Agency: A percentage of gross annual commissions

Informal Business Valuation

Business Value Drivers Focus on increasing cash flow Develop operating systems that improve sustainability of cash flows Document sustainability of earnings Improve facility’s appearance Pay down debt Solidify and diversify customer base Implement a strategy to grow the company Build a solid management team, and groom a successor

“Sale Too Little” – Issues and Opportunities: Increase Cash Flow Increase Value Increase Return “More Than Enough” – Issues and Opportunities to consider: Taxes Wealth Preservation Charitable Giving The Sale Price to Income Challenge Sale Price Sale price needed to support income goal $4MM$6MM$8MM Sale Price $2MM

Motivating Employees Equity Based Stock Bonus Stock Option Stock Purchase Cash Based Cash Bonus Nonqualified Deferred Comp. Phantom Stock Plan

Sale to Insiders OR Outsiders Common Techniques Buy Sell –Stock or Assets –Cross Purchase or Redemption Capital Transfers –Compensation and Benefits –ESOP –Recapitalization Gift –Charitable –Family

Buy – Sell Techniques Cross Purchase Redemption/ Entity Purchase ADVANCED: Wait-and-See, Partnership Stock or Assets? A B Bus A

Non “Buy-Sell” Example: Stay Bonus Problem – –Family business with non-family key employees –How to keep them in the business? Solution –Stay Bonus for non-family employees –Life Insurance funds the bonus

Capital Transfers Compensation and Benefits: Consulting contract Non-Qualified Deferred Compensation Executive Bonus with Restrictive Endorsement Select Reward Plan Qualified Plan

Capital Transfers A Qualified Plan: Employee Stock Ownership Plan or “ESOP” Invests primarily in company stock Permits borrowing to finance the cost Qualified plan testing and administration Annual stock valuation S or C Corporation status

Capital Transfers ESOP: A Qualified Plan –Creates a market for sale of stock at Fair Market Value (FMV) –Cash now; Exit Later –Source of liquidity for personal planning –C Corp owners: deferral of gain –S Corp owner: avoidance of tax

Leveraged C Corp ESOP ESOP Bank Tax Deferred Reinvestment Company Buy Stock Loan 1 Loan 2 Selling Shareholders

S Corporation – Tax Elimination Company ESOP $510,000 taxed to Shareholders S dividend distributions Non-ESOP Shareholders $490,000 Tax Free! $1,000,000 Taxable Earnings 51% 49%

Family Business Issues One third of Fortune 500 companies are owned or controlled by families* 67% of NYSE companies are owned or controlled by families* Family-owned businesses represent 62% of the U.S. workforce* 19% of family business participants have not completed any planning other than writing a will, and only 37% have written a strategic plan.* * All statistics and original sources can be found on the Family Firm Institute Web site:

Sources of Funding for the Exit Plan Business Equity Financing Tax Benefits Insurance

Exiting Your Business Three Key Steps Assure the Financial Survival of your Business … and you and your Family Establish an Exit Plan, including –Valuation –Buy-Sell Review Fund your Plan

Estate/Wealth Transfer Planning: Taxes Can be the Culprit Capital Gains Tax Alternative Minimum Tax Rate Ordinary Income Top Tax Rate Federal Estate Tax Rate

Can we all agree federal estate taxes are not likely to STAY repealed?

Mixed feelings …but within a range “I think Congress won’t do anything … and the exemption will be $1 million “I’m betting Congress will retroactive the $3.5 million exemption at 45%” “The Treasury needs money” “I think there’s a chance the exemption will be $5 million” Source: “Rebuilding 401(k) Retirement Savings: Three Stages of Rebuilding,” October 2009

Tax Sources Income Asset Capital Asset Estate = Subject to taxation

Estate of Blount v. Commissioner, 428 F.3d 1338, 1342 (11th Cir. 2005). Buy sell agreement to redeem shares at pegged value at death IRS ignores estate’s business valuation Tax Court affirms IRS Circuit Court affirms on issue of valuation Estate value is $6.50 MM Must redeem at $4.00MM

Ten Estate Planning Mistakes Too much jointly held property Leaving everything to your surviving spouse Your will is not your will Improperly owned life insurance Success in wealth accumulation ≠success wealth transfer Leaving retirement plans to your children Lack of liquidity Equally inequitable Everyone must pay estate taxes No integrated estate plan

Example 1: Estate Equalization Challenge Some children are in the business; some are not Want to treat all the children equally Want to pass on majority of the wealth after the second of the two parents die Solution Treat the children equitably Set up irrevocable trust with 2 nd to Die Life Insurance policy Use proceeds to provide wealth to children not involved in the family business

Estate Equalization-Solution

Example 2: Interest Only Note Challenge Parents want business to pass to children (or key employees) Business value is appreciating Cost of a direct buyout is prohibitive Solution Sell interest in business to children for interest only note Buyer buys life insurance on seller. At death, proceeds pay off principal on note Only principal (not appreciation) is taxed in estate

Interest Only Note – How It Works

The Marketplace Market Challenges Credit Markets Capital Markets Globalization – the dark side Market Opportunities Technology potential Post-recession growth Globalization – the Force

Exit Planning – The Process Summary 4 Steps of Exit Planning Family Considerations What’s the business worth? Exit Planning many times effects your estate Maximize value Minimize taxes Maximize flexibility Put a plan in place; pre-fund, if possible

“Do it for me” “Do it yourself”

Q & A ? No part of this presentation may be reproduced or used in any form or by any means, electronic or mechanical, including photocopying or recording, or by any information storage and retrieval system, without prior written permission from the Principal Financial Group®. Copyright ©2010 Principal Financial Services, Inc.