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Family Business Succession — It’s A Marathon, Not A Sprint Gary Bottoms, CLU, Ch. Family Business Succession — It’s A Marathon, Not A Sprint Gary Bottoms, CLU, Ch. FC President The Bottoms Group, LLC 180 Cherokee Street NE | Marietta, Georgia 30060 -1610 | 770. 425. 9989 [email protected] com | www. thebottomsgroup. com Securities offered through Registered Representatives of NFP Securities, Inc. , a Broker/Dealer and Member FINRA/SIPC. Investment Advisory Services offered through Investment Advisory Representatives of NFP Securities, Inc. a Federally Registered Investment Adviser. Not all of the individuals using this material are registered to offer Securities products through NFP Securities, Inc. The Bottoms Group, LLC is a member of Partners. Financial, a division of NFP Insurance Services, Inc. , which is a subsidiary of National Financial Partners Corp. , the parent company of NFP Securities, Inc. 1

“ The nicest thing about not planning is that failure comes as a complete “ The nicest thing about not planning is that failure comes as a complete surprise, rather than being preceded by a period of worry and depression. 2

A sampling of what’s on the plate: deferred until later? Which items can be A sampling of what’s on the plate: deferred until later? Which items can be most easily 1) Making payroll 2) Marketing 3) Innovation 4) Managing cash flow 5) Managing employees 6) Income tax planning 7) Retirement planning 8) Compliance (Cobra, HIPPA, OSHA, etc. ) Your Legacy 9) Estate Planning 10) Succession Planning 3

AGENDA Two Complex Projects: Succession Planning and Estate Planning There is no deadline There AGENDA Two Complex Projects: Succession Planning and Estate Planning There is no deadline There is no legal requirement Seems so final Need to get it right 4

Generally when clients engage us, what is on their mind? “ There are people Generally when clients engage us, what is on their mind? “ There are people in my life that I love. I have worked hard for all of this and don’t know what to do with it. I am going to die at some point. I might get old and sick. I do not know how to best arrange things. I think my plan needs work. I do not understand the options. I need your help. 5

Succession Planning • A 2007 survey of family businesses found that – 40. 3% Succession Planning • A 2007 survey of family businesses found that – 40. 3% of business owners expected to retire within 10 years. • Of those business owners expecting to retire in 5 years – only about half (45. 5%) had selected a successor • Of those expecting to retire in 6 – 11 years – only 29% had selected a successor. 1 6

Significant Challenges • Psychological and Emotional Perspectives OLDER - Comfort level with letting go Significant Challenges • Psychological and Emotional Perspectives OLDER - Comfort level with letting go - Concerned about financial security - Identity connected to business - Family dynamics and fairness - Will we live too long and run out of money? YOUNGER - How long do I have to wait? • Tax and Financial Planning – Minimize income and transfer tax consequences. 7

FACT: Experts estimate that 85% of the crises faced by family businesses focus around FACT: Experts estimate that 85% of the crises faced by family businesses focus around the issue of succession. 2 8

Three Legs of the Stool Structure Taxes Psychology Compensation Ordinary Income Family – in Three Legs of the Stool Structure Taxes Psychology Compensation Ordinary Income Family – in Business Ownership Capital Gains Control Charity Family – not in Business Non-family Employees Financial Security for Founder 9

Two Scenarios: 1) Owner dies prematurely - a buy/sell agreement funded with life insurance Two Scenarios: 1) Owner dies prematurely - a buy/sell agreement funded with life insurance is relatively simple to understand, commit to and implement. BUT… 2) If the owner lives to a ripe old age, - maybe develops memory issues and refuses to let go, what do we do? 10

Someday, Son, all this will be yours – assuming I can get my father Someday, Son, all this will be yours – assuming I can get my father to give it to me. 11

Practices of Successful Families 1) Articulate a clear vision 2) Communicate 3) Build unifying Practices of Successful Families 1) Articulate a clear vision 2) Communicate 3) Build unifying structures that connect family, assets, and community, such as philanthropic activities/entities and family councils. 12

The Six Transition Model 3 1) The founder’s transition - Personal and professional direction The Six Transition Model 3 1) The founder’s transition - Personal and professional direction and identity? Financial? 2) The family’s transition - Roles and relationships 3) The business transition - Need strategic plan 4) The management’s transition - Family, non-family or both 5) The ownership’s transition - Who and how 6) The estate’s transition - Fairness and function 13

Issues • Should the business be sold during owner’s lifetime? • Should the business Issues • Should the business be sold during owner’s lifetime? • Should the business be continued after the owner’s death? • Who will own the business after the succession of the business? • Who will control the business after the change of ownership? • Will the owner’s children be treated equally in the distribution of owner’s estate either before death or after death? • What provisions will be made for the present owner 14

“ If I had eight hours to cut down a tree, I would spend “ If I had eight hours to cut down a tree, I would spend the first six hours sharpening the ax. — Abraham Lincoln 15

What Might the Planning Process Look Like – Five Steps 4 STEP ONE Get What Might the Planning Process Look Like – Five Steps 4 STEP ONE Get a commitment from all family members to work on succession planning. - Preparation of heirs is one of the more important responsibilities successful parents face. - The money may transition well, but the family may not. 16

An Observation • Leaving no money but passing values to heirs is acceptable. - An Observation • Leaving no money but passing values to heirs is acceptable. - They likely will manage their lives well. • Leaving money and passing values to heirs is usually a positive situation. - They just may change the world. • Leaving money to heirs who have poorly developed values is asking for trouble. 17

STEP TWO Help family members set aside competitive ways and teach them more constructive STEP TWO Help family members set aside competitive ways and teach them more constructive ways to work together. – It is clear that an unknown and additional benefit of philanthropy is its use as a tool for preparing heirs. – Including children in philanthropy is a significant way to get children making decisions together. – A donor advised fund is an excellent vehicle. – Consider community volunteer opportunities. 18

“ Almost all conflict is a result of violated expectations. — Blaine Lee, author “ Almost all conflict is a result of violated expectations. — Blaine Lee, author of The Power Principle 19

STEP THREE Adopt a business planning process that begins with a mission statement and STEP THREE Adopt a business planning process that begins with a mission statement and a strategic plan. – It helps if a family looks for ways to demonstrate what it stands for in terms of responsibility, values and purpose. Sample Family Mission Statement To create a place of faith, love, nurturing And respect where all five of us are Encouraged to find and pursue the special Path of life for which God made us To create a happy and peaceful place Where we give and receive inspiration And a place of trust where we listen to Each other and where uniqueness is valued 20

STEP FOUR Create a personal development plan for family members. – Involve all family STEP FOUR Create a personal development plan for family members. – Involve all family members in decisions, where possible. In many families, there are only one or two people making all the decisions. – Children’s first major decision regarding money may be the settling of parents’ estate. 21

A Meaningful Exercise • Write out and discuss: – What does founder want from A Meaningful Exercise • Write out and discuss: – What does founder want from the business for founder, and what does founder want the business to provide for successor. – What does successor want from the business for successor and what does successor want the business to provide for founder. 22

STEP FIVE Develop the appropriate governance structures and put in place the legal and STEP FIVE Develop the appropriate governance structures and put in place the legal and financial structures to implement the succession plan. – Family meetings – It is unrealistic for parents to expect to reach into the future and manage priorities of their children, or future generations, based upon documents developed privately with legal counsel. 23

The “fairness issue” among siblings is a typical concern. TWO POSSIBILITIES 1) Transfer the The “fairness issue” among siblings is a typical concern. TWO POSSIBILITIES 1) Transfer the business equity to all the children, so they share equally. – Advantage: Everyone has equal ownership – Disadvantage: Everyone may not be equally active or productive, which might lead to tension 2) Transfer the business equity to the active children and make equalizing transfers of other assets to the inactive children. – Advantage: Should minimize disputes among active and inactive family members – Disadvantage: Founder may have insufficient financial resources to provide his children with equal transfers. 24

Four Ideas… 1) Compensatory transfer - award ownership based upon some predetermined performance standards Four Ideas… 1) Compensatory transfer - award ownership based upon some predetermined performance standards 2) Installment Sale 3) Gift 4) Create a new business unit, a silo in which to build future value 25

Life Insurance Funding • Premium Structure • Timing of cash payment • Flexibility 26 Life Insurance Funding • Premium Structure • Timing of cash payment • Flexibility 26

Life Insurance Concepts TAX-FREE DEATH BENEFIT 1. Life insurance death proceeds are received free Life Insurance Concepts TAX-FREE DEATH BENEFIT 1. Life insurance death proceeds are received free of income taxes. 5 TAX FREE LOANS & WITHDRAWALS 3. Policy withdrawals up to the original cost basis and loans are received income tax-free. 6 LIFE INSURANC E COMPANY TAX-DEFERRED CASH VALUE GROWTH 2. Life insurance policy cash values grow on a taxdeferred basis. Income taxes are only paid on the growth if the policy is surrendered. 6 COMPETITIVE RATE OF RETURN ON DEATH 4. Life insurance can offer a competitive rate of return on the premiums versus the policies death benefit. The effective rate of return can also be increased because the death proceeds are income tax free. 7 27

The Risk Spectrum Guarantees are subject to the claims paying ability of the issuing The Risk Spectrum Guarantees are subject to the claims paying ability of the issuing insurance company. 28

Rates of Return Guaranteed Death Benefit Universal Life – Male – Age 607 29 Rates of Return Guaranteed Death Benefit Universal Life – Male – Age 607 29

Rates of Return Whole Life – Male – Age 607 30 Rates of Return Whole Life – Male – Age 607 30

Maintaining Control of Family Business, Inc. 31 Maintaining Control of Family Business, Inc. 31

One Way Buy-Sell BUSINES S OWNER THE BUSINES S Purchases Life Insurance on Business One Way Buy-Sell BUSINES S OWNER THE BUSINES S Purchases Life Insurance on Business Owner Business Bonuses Premiums KEY EMPLOYEE (OWNER OF POLICY) ce LIFE INSURAN CE COMPANY IRS es ax us T ay Bon P on Uses Life Insurance Proceeds to Buy Company BUSINES S OWNER’ S ESTATE an ur ns e I iums if s L rem y P Pa Cash from Life Insurance Proceeds 32

Irrevocable Trust Planning OWNER’S ESTATE Cash from life insurance policy Shares of stock of Irrevocable Trust Planning OWNER’S ESTATE Cash from life insurance policy Shares of stock of business Cash and other property SURVIVING SPOUSE ILIT f/b/o Child to inherit business Cash from life insurance proceeds OTHER CHILDRE N LIFE INSURAN CE COMPAN Y 33

A Grantor Trust with Life Male, Age. Insuranceat Year 14 72 – Summary $6, A Grantor Trust with Life Male, Age. Insuranceat Year 14 72 – Summary $6, 000 of Capital Assets Transferred to Grantor Trust SAMPLE CLIENT FAMILY GRANTOR TRUST Interest Payments to Grantor $2, 364, 960 Cash Gifts to Grantor Trust $480, 000 PROMISSORY NOTE $4, 800, 000 IRS Estimated Estate Taxes Paid by Grantor $1, 103, 067 from Other Estate Assets Note Repayment at Beginning of Year 14 $4, 800, 000 LIFE INSURAN CE COMPAN Y Total Insurance Premiums Paid $3, 586, 160 $8, 000 Death Benefit Value of Capital Assets and Gifts to Heirs $19, 909, 85 5 THE HEIRS Net Cash Flow from Estate $1, 103, 067 Total Trust Balance to Heirs $29, 012, 921 34

Seven Enduring Principles 1) 2) 3) 4) 5) 6) 7) Never give ownership interests Seven Enduring Principles 1) 2) 3) 4) 5) 6) 7) Never give ownership interests away unless you are prepared to lose the property because of dissolution of marriage, death or actions of creditors. In general, never structure the business such that inactive heirs are involved in ownership or co-ownership of the operating entity. With ownership comes an interest in management and collisions in expectations often occur. A major concern is how to assure the income desired by parents in retirement from the cash flow of the operation and still leave sufficient income for the others involved in the operation. Always test organizational options against both a worst case and best case scenario. In general, estate planning and business planning should be carried on contemporaneously to assure adequate integration of the two. A major concern is how to assure a perception of fairness among the children and other interested heirs. 35 It is best to start with a clear vision of the end.

Suggested Reading Family Business Succession/The Final Test of Greatness By Craig E. Aronoff, Ph. Suggested Reading Family Business Succession/The Final Test of Greatness By Craig E. Aronoff, Ph. D. , Stephen L. Mc. Clure, Ph. D. , John L. Ward, Ph. D. Family Meetings/How to Build a Stronger Family and Stronger Business By Craig E. Aronoff, Ph. D. , Stephen L. Mc. Clure, Ph. D. , John L. Ward, Ph. D. Family Wealth/Keeping it in the Family By James E. Hughes, Jr. The Seven Habits of Highly Effective People/Powerful Lessons in Personal Change By Stephen R. Covey Half Time/Changing Your Game Plan from Success to Significance By Bob Buford How to Run Your Business So You Can Leave It in Style By John H. Brown Philanthropy Heirs and Values/How Successful Families are Using Philanthropy to Prepare their Heirs for Post. Transition Responsibilities By Roy Williams, Vic Preisser The Ultimate Gift/What Would You Be Willing to Do to inherit One Billion Dollars? By Jim Stovall Beyond Survival By Leon Danco Family and Business Succession Planning Strategies By Aspatore 36

Footnotes 1 MASSMUTUAL, AMERICAN FAMILY BUSINESS SURVEY 7 (2007). 2 Id. at 1. 3 Footnotes 1 MASSMUTUAL, AMERICAN FAMILY BUSINESS SURVEY 7 (2007). 2 Id. at 1. 3 Daniel H. Markstein, III, Business Succession Planning that Meets the Owner’s Needs, EST. PLAN. J. , July 2006 (citing Doud, Challenges and Opportunities in Family Business Succession, 59 N. Y. U. INST. ON FED. TAX’N § 1401[2] (2001)). 4 Bernard Kliska, Planning for Business Succession, CHI. BAR ASS’N, Apr. 16, 1996, at 1, 4 -6. 5 Life insurance death benefit proceeds are generally excludable from the beneficiary’s gross income for income tax purposes. There a few exceptions such as when a life insurance policy has been transferred for valuable consideration. Prospective purchasers should consult their professional tax advisor for details. 6 Withdrawal of policy values in excess of the owner’s investment in the contract can cause recognition of gain (to the extent of gain) for income tax purposes. Furthermore, while an owner generally may borrow against a life insurance policy without immediate income tax consequences, a lapse or surrender of a policy against which loans are outstanding may also cause the owner to recognize policy value in excess of basis. 7 Guaranteed product features are dependant upon minimum premium requirements and the claimspaying ability of the issuer. Loans and withdrawals will reduce the death benefit, cash surrender value, and may cause the policy to lapse. Lapse or surrender of a policy with a loan may cause the recognition of taxable income. Policies classified as modified endowment contracts may be subject to tax when a loan or withdrawal is made. A federal tax penalty of 10% may also apply if the loan or withdrawal is taken prior to age 59 ½. Cash value available for loans and withdrawals may be more or less than originally invested. Withdrawals are available in the 2 nd policy year. 37