Small Business, Large Returns for Financial Advisors

Here are 11 strategies to help you thrive.

Financial Planning magazine
By Ann Marsh
July 1, 2012

Advising clients about their small businesses is not for the control freak, the timid or the egocentric. But for planners who venture into this terrain, working with entrepreneurs may provide some of the most satisfying experiences - financially and emotionally - of their careers.

"When you graduate from just traditional planning, be prepared," warns Seth Streeter, co-founder of Mission Wealth Management in Santa Barbara, Calif., who likens the work to life coaching. With small business owners, "you are dealing with fertile minds that are going to paint with wild colors."

… FP spoke with planners around the country who've spent decades … dealing with clients whose wealth is tied up with the businesses they are building, inheriting or looking to sell - sometimes, all at once. We have distilled 11 strategies planners can use to thrive in often choppy waters.

Landing a Bigger Fish
… Cameron Thornton of Burbank, Calif., … met Mary DeMartinis about 13 years ago. She and her partner in their Los Angeles-based fresh food company, Okami, had received a $1 million offer to buy their company. If you've ever bought sushi from the refrigerated section at Trader Joe's, Walmart, Sam's Club or Costco, you've likely bought an Okami product. … After getting the acquisition offer, DeMartinis recalls, "I didn't have a concept of how you sell. We were trying to understand our value."

Thornton brought in a business consultant from the CPA and consulting firm Moss Adams to help value the company. Based on Moss Adams' input and Thornton's own analysis, he told DeMartinis and her partner that, if they invested more time to growing in their niche, they could create much more value. Rather than continuing to do everything themselves, he urged them to hire a sales director and manufacturing director.
The founders took that advice. In December … they sold the company to Fuji Food Products in Santa Fe Springs, Calif., a larger competitor. This time, the deal was in the double-digit millions.

"There's so much that we learned" from working with Thornton, DeMartinis says. … But knowing that he provided her with invaluable counsel that possibly no one else in her life … could have offered was the best reward, he says. "I do what I do for more than money. Hugs are an important part of it."

That is, when things go well. Tom Fowler of Fowler Financial Group in Bellevue, Wash., listed some of the innumerable pitfalls …, chief among them incomplete planning. Take the case of two clients who were co-founders of a perfume factory.

"The younger partner was the 'Nose,'" Fowler says, and the older partner was an investor. On the advice of Fowler and a team of advisors, the pair created a buy/sell agreement (see Step 6 below) to compel one of them to buy the other out if one of them died or left the company. The investor also bought a personal life insurance policy on the Nose.

Not long after, the Nose died, triggering a $1 million life insurance payment to the partner. When it came time to hand some of the money over to his late partner's widow, they discovered the Nose had neglected to sign the buy/sell documents. "The older person said, 'He never signed it and you don't get anything,' " Fowler recalls. "One of the land mines in planning is when they don't complete the planning process. ..."

Key Strategies
Advisors offer these key strategies for working with small business clients:

1. The Confidante
A key role that small business financial advisors play for their clients is that of a listener. … "I want to be your confidante," Edward Wacks, an Ameriprise advisor and CPA in Plantation, Fla., tells his clients. …
Wacks took time to listen intently to a client who owns a yacht-servicing company, Mendol USA in Dania Beach, Fla. In doing so, he realized the client needed better bankers. New bankers found by Wacks provided financing for a new warehouse, which helped the company expand its business substantially.

Many business owners don't have people with whom they can share their struggles or their dreams. Nick Niemann, an Omaha, Neb., lawyer with McGrath North and a member of the board of directors of the Nebraska chapter of the FPA, says he can't understand a business owner's needs without listening first. … Niemann, … has … written a book on the subject, The Next Move for Business Owners. He also offers a phased plan for working with business owners through his website, ownersnextmove.com.

As Thornton puts it: "The most important thing you can do is to establish an environment of safety and trust with this business owner that will allow him to be heard. Give them the gift of listening to what their ideal outcome would be."

2. Exit Strategy
Start by asking a business owner to describe her ideal exit strategy. … Many business owners are so caught up in day-to-day demands that they can't readily answer the question. … Fowler asks them, "Do you have a tax-favored plan to get your money out of your business?"

He tells them there are three main exit routes: selling, turning it over to family members or liquidating. Personal preferences, market forces and family dynamics will help determine the right choice. Another potential factor: tax laws in the state where the client ultimately wants to retire.

In several cases, Niemann has helped clients sell their companies but retain the office buildings or warehouses that housed the enterprises. By leasing that real estate back to the company, a founder can create a reliable stream of income for his retirement.

In Santa Barbara, Streeter has helped his client Andy Erickson, founder of nano-scale microscope maker MultiProbe, consider the opportunity costs of not starting several companies simultaneously. "I have more business ideas than one man can possibly pursue," Erickson says. He says Streeter helped him to understand that "it hampers my lifestyle to be tied down to just one business when I have so much else to contribute." To that end, Erickson recently started a new software company and is on the verge of launching a third business. He is taking money out of MultiProbe to fund both ventures.

"I don't think those things would have happened without Seth's input," Erickson says. "He has walked me through those strategic decisions."

3. Team Builder
Entrepreneurs must assemble a strong team of advisors. "In the past, too many advisors have just left this to the client, but the typical business owner is not in a position to assemble the right team," Niemann says. A team may include … a mergers-and-acquisition advisor, bankers and, in some cases, an organizational psychologist or a marriage and family therapist. … "I make sure the client understands what the other advisors are saying and I make sure the advisors understand what the client is saying," Fowler says.

"The best advisors aren't about themselves," Streeter adds. "You have to be selfless and truly have a mind-set of serving. Your higher goals are the goals of helping the clients achieve their objectives using their natural talents. If you've done that, then you should be fulfilled."

4. Choose the Quarterback
… After gathering advisors together, Thornton says he states his intention to create "a safe environment where everyone can be honest about the value they can bring to the process." His goal is to encourage everyone on the team to speak up if any of them lack particular skills needed to take the client's company to the next level. …

5. The Intermediary
Sometimes a client needs a planner to deal with others on the team directly. In 2008, the business of one of Wacks' clients hit a rough patch and the client worried his bank would pull his line of credit. "I said, 'Let's go in and talk to the banker,' " Wacks recalls. "The banker said, 'I really respect that you came in to discuss the note six months before it's due. That means a lot to us.' " Soon after, the bank renewed the loan. If not, the client told him, he would have gone out of business.

6. Use Buy/Sell Agreements
This critical tool for companies with co-founders is a binding agreement stipulating that, if one party leaves the business, the other must sell to the other party, and the other party must buy it at a price and on terms that have been predetermined. Without a fully executed agreement in place, the death or departure of one partner can spell disaster for the late partner's family or for the surviving partner.

7. Cover the Bases With Insurance
Life and disability insurance play crucial roles in the continuation of small businesses. If a founder dies with most of his net worth wrapped up in his company, estate taxes can gobble up half the value of a company and force its sale. "The IRS only wants one thing and that is cash and, so, if a business owner has not planned for this, he basically has a forced sale" upon his death, says Mark Weber, a business succession consultant with the SilverStone Group in Omaha, Neb. …

Fowler worked with a client who ran his family's casket manufacturing company. The client's broker told him, "You are crazy to buy life insurance. ..." Fowler prevailed. Four months after the life insurance policy was issued, the business owner was diagnosed with a terminal brain tumor. Later, the company's CFO told Fowler that, without the insurance payout, the company would have gone out of business.




Fowlers: four generations (Photo credit: KF-in-Georgia)

8. Treat the Kids Fairly, But Not Equally
Even in a large family, often just one adult is capable of taking over the family business. In some cases, planners have helped a single family member buy out the founding parent using a note to be repaid with cash flow from the company. … Sometimes, feuding families will do better to sell or liquidate a business and distribute profits rather than try to execute a succession plan that may be doomed to failure.

9. Be Prepared to Be Ignored
Karl Frank, owner of A&I Financial Services in Englewood, Colo., says business owner clients are unpredictable.




NOT ALL BUSINESS OWNERS TURNED OFF THEIR ADVERTISING SIGNS DURING THE ENERGY CRISIS IN THE PACIFIC NORTHWEST IN THE... - NARA - 555438 (Photo credit: Wikipedia)

"You've got to be flexible. You're going to put a plan into cement, but a client will call you on Monday and say, 'I decided to buy that vacation home in Hawaii.' You either have to say, 'No, you're not, and here's why,' or 'I'm not surprised that you did that.' They are going to make mistakes on you."

10. Expect Referrals
Planners who develop the skill sets to work with business-owner clients will receive referrals from other planners who need help.




English: Zumbro Falls, MN, September 28, 2010 -- Business owners clean debris from their businesses after the town was by flood waters from the Zumbo river. FEMA and the Minnesota Emergency Management Agency was in town conducting damage assessments which will allow the Governor to determine if the state is eligible for federal assistance. Photo by Patsy Lynch/FEMA (Photo credit: Wikipedia)

11. Be Comfortable With Messiness
"I'm not afraid to ask questions," Thornton says, "and I'm not afraid to listen until there's a level of clarity so that something that initially appeared to be messy is crystal clear."

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Your Family Matters: The Importance of Succession Planning in Family Held Businesses

 Corporate Finance Associates Newsletter 2Q 2012

By David Sinyard, Managing Partner
Atlanta Office, Corporate Finance Associates

Developing a succession plan may be the most important business plan a company owner will ever make - it secures their family's future long after they are gone. Yet, the vast majority of family owned businesses do not have a succession plan in place and statistics show that nearly three quarters of family owned businesses do not survive the transition from founder to second generation. Given the importance of such a plan, understanding the obstacles that stand in the way of a successful business succession is the first step to putting a plan in place.

Most family business owners fully intend to keep the business within the family's control, but choices made by the founder can derail such a plan from coming together. One common reason for inactivity is that the founder fears losing control of the business. … Research demonstrates that founders tend to remain at the helm on average between 25 and 30 years. This length of tenure has an effect on how second generation family members view their opportunities.

Choosing a successor from the next generation when there are multiple children presents another challenge. How do make everyone feel as if they have been fairly treated, fairly considered? The natural inclination is to avoid conflict, yet this step often pits one child against another, at least in the mind of the founder.
Equally important, how do you insure that the successor has the skill, experience and leadership qualities needed to carry the company through to the next generation?

…The financial security of the founder is a fundamental concern. …[How] is long term security insured? Often, the founder finances the sale to the successor via a promissory note. Does this really give him any freedom? Are there other choices?



English: Belongs to The Organic Business Guide. (Photo credit: Wikipedia)



…[With] no plan in place, the death or disability of the founder can be disastrous. Unplanned estate taxes or unexpected health care costs can place an inordinate financial burden on a company, severely retarding its short term and long term prospects.

The purpose of a succession plan is to clearly identify a successor, define key leadership and management roles for both family and non-family personnel and formally outline the goals of the business. In addition, it will provide a financial blueprint for transferring ownership. Ideally, a succession plan is simply part of a company's overall strategic business plan.

Components of an effective succession plan include:

• Defining Goals & Objectives - provides the basis for the entire succession plan
• Family Involvement in Decision Making Process - defines a process for open communication and dispute resolution
• Identify the Successor - specifies who will take over ownership of the company and how they will be groomed
• Estate Planning - in the event of illness or death, provides a process for handling inheritance and income streams for both active and non-active family members with specific attention paid to taxation
• Contingency Planning - lists a series of "what ifs" and anticipated actions
• Comprehensive Organization Chart - updates the organizational structure of the company with line of succession and includes potential roles for the retiring founder, shareholders and key advisors like accountants, lawyers and lending partners
• Business Valuation - required as a baseline for determining
• Exit Strategy - explores ownership transfer options including timing and the potential sale or partial sale to a non-family third party

Once a formal succession plan has been created, it must also be reviewed on a regular basis to make sure the plan is amended to account for any changes of circumstance. An annual review may be sufficient.
Given their entrepreneurial traits, founders give much of their energy, time, and emotional well-being to the startup and growing phases of their businesses. Founders hold an influential role over the succession planning process and the decisions of the succession plan lay primarily with them. Without their willingness to embrace a formally constructed succession plan, it will likely not exist and a business without a succession plan is somewhat like an individual without a will. In the unlikely event that disaster strikes, there is no emergency plan, no predetermined leader. Effective succession plans provide a guiding light in times of transition or trouble.

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Managing Conflict in a Family-Owned Business (Part 1 of 2) - CEG Worldwide, LLC

CEG Worldwide, LLC

By Tom Hubler (Part 1 of 2)

What advisors frequently overlook can land their clients—and themselves—in hot water (first in a series)

Key Takeaways

• Most families avoid talking about death and money, yet that's exactly what is needed for good business succession and personal estate planning.
• Families avoid discussions because they fear it will create family disharmony, when just the opposite is true.
• Families should develop together a common vision and prayers for each other that reinforce the needs of individual members reflecting their common good.
• Optimize your global tax portfolio/position by understanding where the income gets taxed, and then analyze the after-tax income.

Death, money and sex. In our culture these are the three most difficult things for families to talk about. … Virtually everyone avoids talking about death, money and sex in their families. Do you?



nothıng takes placε but thε placε . . (Photo credit: jef safi)

Unfortunately, when a family-owned business is having a conflict, it is likely that two of these topics must be talked about—death and money. That's because conflict in a successful family business commonly occurs when it's time for succession planning—when the family must decide who will continue the business and how. Many families make the mistake of just assuming who it is that will take over the company and that succession will happen when the time is right. That's where the problems begin.

Estate planners tell us succession is a highly unpleasant subject for families. It requires them to think about death in the family, life without a loved one, taking or transferring assets, and changing responsibilities. For a family business, the discussion seems especially filled with potential landmines.

Family businesses avoid succession planning
Succession planning is not only an issue for the owner-entrepreneur, it's also an issue for the entire family. Many families unconsciously conspire to avoid talking about ownership and management-succession planning. …




Pugh's Garden Centre A family-owned business at Morganstown, near Radyr. The wooded edge of Garth Hill can be seen beyond. (Photo credit: Wikipedia)

My clients will say, “It's too early; we have years to think about this.” Or “I don't have time right now.” Or my favorite, “We don't need all that structure and formality because we love each other.”

Actually, it is because you love each other that you need all that structure and formality. It helps you avoid the emotional tripwires and makes the rational path more visible. However, that path must include more than just plans for ownership and the estate.

As I stated in a previous article, it is futile to produce a succession plan by focusing on just the ownership (and estate) plan. A smart succession plan must also consider the owner-entrepreneur's overall intention. It must reflect a core purpose that includes legacy and family intentions as well as the business purpose.

Legacy is more than an entrepreneur's wish for “how I want to be remembered.” A sense of legacy drives the entrepreneur to develop a succession plan. Concern for a legacy creates the motivation.

Start by discussing legacy



Motorhomes lined up for sale This family owned business developed from a haulage firm. They now sell new and used motorhomes. (Photo credit: Wikipedia)

… There are two aspects to legacy: your gift to the future and how you want to be remembered. The first aspect, discussed by Laura Nash in the Harvard Business Review article “Just Enough,” defines “your gift to the future” as a means by which “you help others find future success.”

The second aspect—how you want to be remembered—is my definition. It focuses more personally on how an individual wants to be remembered and is highly emotional because virtually everyone in their 60s and 70s wonders at some point whether their lives have meant something. …

A technical planner can ask:

• “How do you want to be remembered?”
• “What is your gift to the future?”
• “How can I help you achieve those goals?”

Ask legacy questions like these so that owner-entrepreneurs will engage in succession planning. This helps avoid a lot of unnecessary conflict that could surface later.

Conflict accumulates when differences are not discussed

Conflict in family-owned businesses can also increase because family members simply try to avoid it. When I taught the Family Business Management class at the University of St. Thomas, I regularly brought up the famous Hubler Speck of Dust Theory to explain what I often saw happening in family-owned businesses.

 

Nursery Center has been a family owned and operated business since 1990. Website: nursery-center.com (Photo credit: Wikipedia)

In my Speck of Dust Theory, an issue or irritation triggers differences in the family-owned business. Family members say to themselves, “If I bring that issue up, it will upset the entire family and ruin our 4th of July picnic at the lake.” That speck of dust—that issue—is not discussed.

Sometime later, another issue surfaces. The conflict isn't mentioned because it could spoil Thanksgiving or Christmas, or an upcoming wedding, birthday or graduation. Irritation accumulates into ever-greater annoyance because no one is willing to bring up an issue. The family creates the very disharmony they are trying to avoid by failing to talk about their differences.

Speck-of-dust issues can grow into a ton of discord. Yet these issues are normal and should be aired. (See my partial list of potential issues.) Every family and family-owned business has issues. They become problems only when they are avoided and not discussed.

How to prevent and manage problems in family-owned businesses

The best way to avoid conflict is to keep issues from becoming problems in the first place. To do this the family should create a common vision that unites everyone at a superordinate level. …

Typically, one would urge compromise … Yet when individuals are asked to compromise, they generally feel like they are conceding or giving in. Instead, the family should be encouraged to understand that this is a negotiation that involves cooperation. Everyone is working together for the common good of the family and the business…



individual -v- group (Photo credit: Sean MacEntee)

Individuals recognize that it is unrealistic for each person to get 100 percent of what he or she wants. Instead, each family member is contributing to reflect what's best for the family vision. … Each understands that “just as I contribute, other members of the family will do the same when their turn comes.” And the others' turns always come.

Develop a family vision
To begin, the family creates a list of values that everyone can embrace. These high-level principles are discussed and developed into a brief paragraph that truly reflects what the family believes about themselves and their values. …

I also encourage families to adopt or develop their own family prayers. Here is a typical example:

Family prayer for loving kindness
May our family be filled with loving kindness.
May we be well.
May our family be peaceful and at ease.
May our family be happy.




NEOSHO, MO- JUNE 17: A Twister Safe sign for a small family business that specializes in constructing safe rooms stands June 17, 2011 in Neosho, Missouri. A surge of interest in safe rooms has been seen since an F5 tornado tore through Joplin, Missouri in May. (Image credit: Getty Images via @daylife)

As family members cooperate to develop their family vision statements and prayers, I encourage individuals to prepare their own personal value statements. …

The prayer and vision statements should be clear and brief enough to be recited daily. Because they are developed through family cooperation, these statements resonate across the family and truly reflect the interests of everyone.

Finally, I encourage family members to think about each other daily through brief kything prayers. Kythes are the vision statements of family members. They are put in the third person and reflect what that person wants, needs or values….

Conclusion
By encouraging your family business clients to talk openly and strategically about death and succession, you can help them preserve substantial wealth and family harmony—and solidify your role as a trusted advisor and confidant.

About the Author
Tom Hubler (tomh@thehublergroup.com) is president of Hubler for Business Families (hublerfamilybusiness.com) and an adjunct professor at the University of St. Thomas.

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The Role of the Board in Family Business Succession

How to help smooth leadership transitions

Trusts & Estates Magazine
By David Thayne Leibell, partner at Wiggin and Dana LLP in Greenwich, CT




Board of Directors (Photo credit: Wikipedia)

A relatively unexplored area of family business research is the role that an active, independent board of directors can play in perpetuating the family business from one generation to the next. A recently published book, Building A Successful Family Business Board[1], seeks to close that research gap. In fact, according to the book’s authors, an active, independent board can serve as an objective steward, overseeing the creation and execution of a leadership succession plan that works for both the business and the family.

Definitions

The authors state that an “active board” refers to a board that meets three or more times a year. An “independent board” is one with three or more independent directors; which is the minimum number that the authors believe is necessary to have a meaningful impact on governance. An “independent director” is an individual who has no ties to the business, other than being a director. The definition of an independent director doesn’t include employees, shareholders or outside advisors to the business or the family.

The Problem



Mawarid Board of Directors (Photo credit: Wikipedia)

Even in the healthiest of families, the leadership succession process is often a difficult task that, for a variety of valid reasons, the family chooses to avoid. The authors cite a 2007-08 survey of family businesses by Price Waterhouse Coopers, which found that while one-quarter of the businesses surveyed were due to change leadership hands in the next five years, roughly half of the family business that participated in the study had no succession plan in place. According to the authors, an active board with independent directors should avoid this problem by requiring the development of a succession plan as a natural part of family business governance.

Family Business Boards



2011 Board of Directors Retreat (Photo credit: sfbike)

In connection with writing the book, the authors conducted a study of 360 family businesses regarding the state of their boards. Although every business must legally name a board of directors, the majority of family businesses surveyed had boards in name only. Only 48 percent of respondents had boards that met more than twice a year. According to the authors, boards that meet less than three times a year provide little effective support of management or the shareholders. Of the active boards, only 25 percent featured two or more independent directors, and only 21 percent had more than three independent directors, the number that the authors feel is necessary for independent directors to have sufficient voice to influence family board members in an effective manner. Surprisingly, even for businesses with sales greater than $100 million, only 58 percent had active boards, and only 33 percent had three or more independent directors.
It’s the authors’ view that independent directors are the richest resource available to family-owned companies. The survey results bear this out. Respondents with independent directors on their boards reported a much higher level of board effectiveness (83 percent) than respondents with no independent representation (54 percent). Not surprisingly, board effectiveness increases with the amount of independent representation. Respondents with a majority of independent directors on the board reported 93 percent board effectiveness.

General Benefits

The authors explain that active independent boards: (1) provide in-house experience, empathy and expertise; (2) encourage self-discipline and accountability; (3) act as a sounding board for family and management; (4) provide honest, objective opinions; (5) encourage strategic planning; (6) provide insight into key people; (7) ask challenging, proactive questions; (8) provide confidential and empathetic counsel; (9) engender creative thinking and decision making; and (10) encourage better corporate relations with constituents ranging from employees and suppliers to customers.

Succession Planning

Many, if not most, family business leaders have a difficult time handing over the leadership reigns. As such, many family business leaders delay or avoid succession planning, which can have devastating consequences, not only for the business, but also the family. According to the authors, active, independent boards can be invaluable to the succession process by: (1) ensuring that a succession plan is in place well in advance of the time it is needed; (2) helping the current leader examine various options; (3) ensuring the successor is being adequately prepared; and (4) helping plan for, and complete the process. No other resource provides as comprehensive a source of support to help the company and family achieve continuity as the business passes from one generation to the next.

Endnote

1. Jennifer M. Pendergast, John L. Ward and Stephanie Brun de Pontet, Building A Successful Family Business Board, Palgrave Macmillan (Jan. 2011).

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How IPO Founders Keep Their Taxes Low

Via a popular way of going public, founding partners can enjoy whopping capital gains without the usual tax bite. Investors may be less than happy about it, though.

CFO.com
Robert Willens -
July 26, 2011

When a partnership goes to the public market for funding, and the offering is successful, the founding partners can enjoy a huge capital gain. …

By means of a popular going-public technique called a tax receivable agreement (TRA), however, the founding shareholders can enjoy hefty tax benefits. … For their part, though, investors may find it hard to factor the effects of TRAs into their calculations of the price of the offering.

TRAs are often used in combination with an "Up-C structure." The Up-C structure enables companies to acquire assets by issuing operating partnership units. Those units may make it possible for the founding owners from whom the company acquires assets to defer recognizing taxable gains until the company disposes of those assets. For example, among many other entities, DynaVox employed this structure in connection with its initial public offering last year.

When a partnership transforms itself into a corporation to make a public offering of ownership interests, the newly formed corporation often becomes a partner in the "operating" partnership. The remaining units in the partnership also continue to be held by the founders of the business. In such cases, the founders will be awarded "high-vote" stock in the corporation — equity that enables them to maintain voting control over the corporation's affairs. For their part, public investors will acquire low-vote stock.

Sometimes the IPO's proceeds will be used by the corporation to buy partnership interests from the founders. In addition, the founders will typically acquire an "exchange right" entitling them to trade partnership interests for low-vote shares issued by the corporation. When these exchanges are separate from the incorporation, they're taxable to the founders because immediately after the exchange the founders aren't in control of the corporation.

But the founders can gain a tax benefit through the use of a TRA. Each time the corporation buys a partnership interest in the partnership, or acquires an interest in a taxable exchange for its stock, the corporation's taxable income derived from the partnership will be diminished (because the purchase increases the amount of amortization and depreciation deductions the purchasing partner will enjoy) and, correspondingly, its tax liabilities will be minimized.

… But the TRA, which is almost standard operating procedure in these types of incorporations, shifts the tax benefits to the persons who transferred the partnership interests to the corporation.

The … TRA … provides that ". . .we will enter into a TRA with our existing owners (the founders) that will provide for the payment by [the company] to our existing owners of 85 percent of the (tax) benefits that [the company] is deemed to realize as a result of the current tax basis in the intangible assets of. . . (the partnership) and the increases in basis resulting from our purchases or exchanges. . . ." The corporation goes on to say that these payments will be "substantial."

TRAs may be fully legal; however, the entire import of these agreements in the price of an IPO might not be fully appreciated by all investors. To the extent the TRAs are not taken into account by such shareholders, they may lead to market inefficiencies.

Robert Willens, founder and principal of Robert Willens LLC, writes a biweekly tax column for CFO.com.

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Tech Professionals Say Venture Capital Model Has Changed Forever

Portfolio.com - a bizjournals property

A slower market for initial public offerings is likely the new norm, and venture capitalists are likely to make smaller bets on smaller companies and make their returns from mergers and acquisitions of their portfolio companies.
That, at least, is what tech honchos surveyed by DLA Piper expect. That’s a major change for one of the most glamorous corners of the innovation business.
It may well mark the end of the big, bold, VC plays, said Peter Astiz, global co-head of the DLA Piper Technology Sector Practice.

Image via Wikipedia“This is a profound, game-changing development," Astiz said Tuesday in a statement. "If there is a long-term expectation that the IPO market will not rebound, that means a reduction in the number of dramatic ‘home runs’ for venture capital investors and lower overall returns. Fewer IPOs also means fewer small and medium-size public technology companies, which traditionally have been the acquirers for venture-backed company exits.”

Astiz went on to say that tech companies would continue to move forward and investors would still be active, but that the venture model is changing. "For startup tech companies, the bar is being raised, capital will be harder to come by, and pressure to perform will increase.”
Those expectations are reflected in the third-quarter report on venture exits by the National Venture Capital Association’s report in conjunction with Thomson Reuters. (Download a PDF of the report by clicking here.)

Image via CrunchBaseThe market for public offerings of venture-backed companies is recovering from the disastrous 2009 period. But it’s nowhere near the levels seen in the boom times of the late 1990s, and there haven’t been any blockbuster IPOs like that of Google.

Instead, venture capitalists have made their money through the sale of their portfolio companies to other firms. In the third quarter, there were 27 deals with disclosed values worth $3.8 billion, up from 22 deals worth $2.9 billion. As for IPOs, there were 14, worth $1.2 billion, in the third quarter. …
The technology professionals surveyed by DLA Piper agree. Nearly 60 percent say the venture model has been permanently altered. But that’s not all bad news, because with technologies like cloud-based computing available, it’s cheaper now to build a company. So VCs may be able to make smaller bets across more companies and get high rates of returns on those small bets.
In other topics, tech leaders told DLA Piper they expect:

• The economy will continue to grow, albeit slowly, with 85 percent of those surveyed expecting at least a couple of percentage points of growth in the coming year.
• Seventy-two percent expect sales increases in the coming year.
• Forty-three percent expect to keep staffing levels flat.

“While some economists and headlines question whether the U.S. economy is headed for a double-dip recession, technology leaders seem confident of a sustained recovery,” Astiz said. “Tech leaders are forecasting stronger sales and earnings across the board, yet they are not planning to invest in hiring nor R&D. This suggests that we may be in for a prolonged period of guarded investment and slow growth.”

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• IPO Plunge Has Many VC Firms 'Walking Dead' (businessweek.com)
• As Bush-Era Tax Cuts Expire, VCs Nearly Split On Impact [Voices] (voices.allthingsd.com)
• Venture capital investments decline 7% (usatoday.com)

Tax Break Promotes Big Gifts To Grandchildren

Financial Advisor Magazine

Dow Jones) While this year's one-year lapse in the estate tax hogs the spotlight, a lesser-known gap is offering many affluent older people a tax-free way to pass on some of their wealth to grandchildren.

Gifts have to meet certain conditions to get a break on the generation-skipping transfer tax, or GST, which also has been repealed for 2010. Only outright gifts qualify as opposed to, say, putting money in a trust, but the definition of a gift is broad enough: Someone who sets up a partnership and gives away units in it can get the tax break, for example.

David Pratt, managing partner of the personal planning department of the Boca Raton, Fla., office of law firm Proskauer Rose, says his firm is doing a lot of planning for gifts to grandchildren using family limited partnerships. The idea of putting a gift into a vehicle like this is to keep a youngster from getting control over assets all at once and possibly squandering them.

The generation-skipping tax is separate from income, estate and gift taxes. Its purpose is to keep people from transferring property too many generations out without paying tax. The tax is imposed if the transfer avoids gift or estate tax.

Take the example of a man who dies with a multi-million dollar estate, leaving his property in a trust with income payable to his children. On his death, trust assets are to go to the grandchildren. The man's estate would owe estate tax, but on the death of his children, the trust property would not be taxable in their name, so the family would have skipped a generation of estate tax. Therefore, the generation-skipping tax would apply.

The tax applies not just to grandchildren but to all so-called "skip" persons, including unrelated heirs at least 37-and-a-half years younger than a donor.

This year's donors still must pay the gift tax, at a top rate of 35%. That is the lowest level since 1934. The lifetime exemption this year on the gift tax is $1 million. Next year, unless Congress acts, the gift tax will rise to 55%, where it was before the Bush tax cuts of 2001 started taking effect.

Each donor is allowed to exempt up to a certain amount in generation-skipping gifts. Last year it was $3.5 million, and next year will be in the neighborhood of $1.06 million. (The government has not yet confirmed the new amount for 2011.) So, a donor will not owe generation-skipping tax on the first $1.06 million or so in 2011, but will owe the gift tax and the GST on any amount over that.

J.P. Morgan, in a recent analysis on taxable gifts, found that the net benefit to a recipient from a $1 million gift made in 2010, as compared to 2011, would be $305,565. That benefit grows proportionally to the assets' growth.

Making a taxable gift to a grandchild or other skip person, even in 2011, is still a smarter tax move than simply leaving the same amount to the person through the estate, according to J.P. Morgan. For every $100 of a gift in 2010, the grandchild gets $74, as compared to $42 in 2011. …

Image via WikipediaCopyright (c) 2010, Dow Jones. For more information about Dow Jones' services for advisors, please click here.

Related articles

• How To Ask Grandma For $1 Million (blogs.forbes.com)
• A Year to Give Gifts to Your Heirs, and Save on Taxes (nytimes.com)
• The Gift Tax Made Simple (turbotax.intuit.com)

Lenders Show Optimism

Lenders say that, spurred by other companies’ success as sellers, and fearing a tax hike, the fourth quarter of 2010 will provide dealmakers with a perhaps unprecedented M&A blizzard.

Mergers & Acquisitions news site

By JONATHAN MARINO

May 6, 2010

Lenders are anticipating a dealmaking flood to cap off an already-frothy 2010.

“I don’t think people realize the size of the wave of M&A that is out there,” said Leonard Tannenbaum, chief executive of Fifth Street Capital. “You may see the biggest fourth quarter [of dealmaking] in history; there is going to be a massive tax hike coming.”

Tannenbaum, speaking on a panel at ACG's InterGrowth conference in Miami, went on to predict that up to $500 billion of deals could unfold in just those three months alone. Others agreed. “We are seeing a flood of sellers,” said Stuart Aronson, vice president with GE Capital.

While the capital gains tax increase has been on the horizon for some time, … the dour markets forced many business owners to hold off. While their window is quickly shutting, the return of the debt markets will accommodate companies looking to sell.

2009’s first quarter saw a paltry $17 billion in new loan volume; this year, that number jumped 225% percent, to more than $55 billion. Still, that figure pales in comparison to every prior quarter—save last year’s.

Lenders are seeing more capital made available; healthy companies can secure high yield debt and even regional banks have gotten back into the act.

“There has been an enormous surge in asset-based lending,” Aronson said.

Key Man Insurance: Why It Is So Important To Your Business

Growthink Blog

Written by Dave Lavinsky on Tuesday, March 10, 2009 ...To begin, Key Man Insurance or KMI is a life insurance policy covering a business owner, president or a key employee. The business is the beneficiary under the policy.

The fact that most venture capital firms require KMI explicitly shows that venture capital firms provide funding to PEOPLE, not firms or ideas. ...

What this does NOT mean is that you should rush out to purchase key man insurance if you are seeking venture capital. What it does mean is that you need to make sure that you have a management team that is worthy of KMI. ...

What it also means, and this applies even if you are not seeking venture capital, is that you should create systems to minimize the business risk of something happening to a key employee.

These systems can include:

• Training manuals that document key tasks performed by key personnel, so that someone else could take over their job requirements in the event that they were out of the office temporarily or long-term
• A hiring plan that allows you to efficiently recruit and train new personnel
• Constantly networking and telling people the exciting aspects of your business so that there is a pent-up demand to work at your company

You and your management team are the lifeblood of your business. You always need to be thinking about how to improve, protect and grow your team, as this will have the greatest impact on the long-term success, or lack thereof, of your business.

Premium Financing

Private Wealth Magazine

By Frank W. Seneco , Alan Kufeld - 12/4/2008

As Business Owners build PERSONAL wealth, they typically want to ensure that, in the event of their death, the value of their business equity will pass to a surviving spouse and heirs.

A variety of premium financing techniques—involving permanent life insurance comparable in value to the owner’s business equity and borrowed premiums—offer a potentially attractive solution to this challenge. ...

Borrowing the premiums could be a beneficial option for the following reasons: • Permanent life insurance policies have a cash surrender value that, under current laws and regulations, can provide collateral for a secured loan. • New types of permanent life insurance offer attractive options for the policy cash value that can diversify the business owner’s portfolio and outperform the cost of financing premiums. • Borrowing has federal estate/gift tax advantages when used with an Irrevocable Life Insurance Trust (ILIT). • A thriving industry of specialty lending, called “premium financing,” has evolved to facilitate this type of transaction by arranging personalized secured loans.

Fine-Tuned Leverage ... In a premium financing transaction, leverage can work on three levels: • The contract provides the immediate benefit of leveraging a first-year premium payment into a far larger death benefit. In the example cited earlier, this leverage is 75 to 1—a $15 million death benefit acquired for a $200,000 first-year premium. • The contract creates the potential over time for the cash value to compound on a tax-deferred basis and eventually exceed the cumulative cost of premiums. • The contract can have “tax leverage” because the death benefit is normally free of federal income tax. It also can be free of estate tax when properly structured and owned by an irrevocable trust.

The advantages of borrowing life insurance premiums are tangible and valuable. The strategy can potentially increase personal net worth modestly during the business owner’s lifetime and increase the after-tax estate substantially after death. Premium financing also creates the flexibility to adjust the amount of leverage built into the life insurance contract at the time of purchase and periodically over time.

For example, a business owner could “dial up” the premium financing leverage at age 40, reduce it in increments starting at age 50 by repaying some loan principal and eliminate it by retiring the loan as retirement approaches. For younger owners who are just starting to build serious net worth, premium financing can be a bridge until personal assets grow or a sufficient income stream becomes available to fund life insurance.

The Structure Of A Typical Transaction Although each premium financing transaction is customized, the basic terms and techniques are somewhat standard, as follows: • The loan typically is non-recourse—secured by the policy’s cash value and a letter of credit (LOC) equal to any shortfall between loan principal and cash value. • The policy is permanent life insurance in which coverage is guaranteed for life or to a very high age (e.g., 110). In form, it may be whole life, fixed universal life or indexed universal life with a “secondary guarantee” of coverage. Variable life insurance is typically not used in premium financing because of regulatory restrictions on borrowing against securities. • The loan interest is a floating rate typically tied to the 12-month LIBOR plus a spread. Spreads have recently ranged from LIBOR + 2.25% for loan commitments up to $2.5 million to LIBOR + 1.75% for commitments above $20 million. The loan interest is not tax deductible for an individual, trust or business entity. • A loan arrangement fee of 1.0% to 1.25%, depending on loan size, is charged and can be capitalized into loan principal. • The policy must be owned by a “bankruptcy-remote” entity so that the premium finance lender has clear priority claim against cash value collateral. An LLC or ILIT can qualify as bankruptcy-remote. • A common arrangement is to fund the policy at the maximum level for the first seven to 10 years, which can guarantee the death benefit. This creates rapid cash value build-up and leverages policy benefits. Funding should avoid Modified Endowment Contract (MEC) status. In a “non-MEC” policy, loans and partial withdrawals of cash value may be made on a tax-favored basis. • The policy is typically purchased by an ILIT so that the death benefit can be paid free of federal estate tax (a three-year look-back period applies on policies transferred to an ILIT). The business owner normally is the insured person. Some “survivorship” or “second-to-die” policies allow two lives to be insured—a business owner and spouse—with the death benefit payable on the second death. The trust’s beneficiaries may be a surviving spouse, children or, in the case of a business buyout arrangement, the LLC or other partners of the firm.

Estate And Gift Tax Advantages The ILIT can help to avoid inclusion of the life insurance proceeds in the grantor’s taxable estate. With a competent institutional trustee, it also can provide continuing management of assets and planned distributions to beneficiaries according to the grantor’s wishes.

There is, however, complexity involved in setting up ILITs funded with large amounts of life insurance. The trust normally owns the insurance and pays premiums, and the grantor can gift to the trust an amount needed to pay premiums annually. Such gifts can qualify for the annual gift tax exclusion—currently $12,000 per beneficiary—if they are of a “present interest.” Then, any premiums gifted to the trust in excess of the annual gift tax exclusion can be sheltered under the grantor’s lifetime gift tax exemption, which is currently $1 million. At the grantor’s death, lifetime gift tax exemptions previously used will reduce the “applicable credit” for federal estate tax purposes, dollar-for-dollar. ...

By reducing the out-of-pocket premium payment obligations, premium financing can soften the impact of gifted premiums on the grantor’s estate planning. The annual gift to the trust could be limited to the amount necessary for the trust to pay financing charges, which normally is far less than premium cost. ...

Exiting The Loan ... In addition to paying off the loan with liquid cash as it becomes available, the options include: • Having the trust or estate pay off the loan after death, using insurance proceeds. • Surrendering the contract and using its cash value to pay off the loan. • Restructuring the loan. • Using a combination of personal assets and policy withdrawals or policy loans to pay off the premium finance loan. This is not usually recommended because large withdrawals or loans may jeopardize the guaranteed coverage feature of the policy. ...

Policy Performance Premium financing works best when the policy has the potential to grow cash value at higher rates than the cost of financing. An analysis of prevailing interest rates over the past 20 years by the British Bankers Association shows that one-year LIBOR rates have averaged 5.19%. A premium financing arrangement at LIBOR + 1.75% would have averaged 6.94% interest annually over this period.

Most whole life policies’ cash value growth, including any dividends paid by mutual companies, is less than 7% annually. ... Fortunately, a type of permanent policy called Indexed Universal Life (IUL) has emerged to fill the gap. IUL credits to cash values an interest rate that is the higher of a percentage of returns produced by a market index such as the S&P 500 or a guaranteed minimum annual rate, such as 2.0%. Policy values are not subject to market fluctuations. Any cash value gains from year to year are locked into the contract.

We are seeing even more attractive “next generation” IUL products emerge. They credit cash value with interest based on an averaged “basket” of leading investment indexes, including those that invest in U.S. and international stocks. Other advantages of leading-edge IUL products include: • Lowest return dropped–The index that produces the lowest performance for the basket over a given period of time is dropped from the average. • Variable basket weightings–The highest performing index in the basket is given a greater weighting in the averaging process, on a look-back basis, than lower performers. • Five-year point-to-point measurement–Index returns are measured on a five-year rolling point-to-point measurement, which helps to smooth out temporary dips and produce the most favorable cash value crediting rates for policyholders. ...

When Does Premium Financing Work Best? Premium financing strategies can work best for business owners when the benefits align with owners’ personal needs, in the following ways: • The owner has a need for permanent guaranteed life insurance coverage and has limited liquidity or cash flow to pay premiums. • The owner expects liquidity or cash flow will improve at some point in the future and would like the flexibility to “dial down” life insurance leverage. • The owner has significant personal net worth tied up in the company and is confident it will keep performing well. • The owner believes the IUL basket of indexes has the potential to outperform the cost of financing premiums. • The need for life insurance coverage is large enough to create gift/estate tax issues because gifted premiums would exceed the annual gift tax exclusion.

Because IUL cash value crediting rates can fall below financing cost over intervals, it is essential to implement premium financing programs with the help of professionals who can monitor results and maintain program advantages. If the program begins to deliver less benefit than planned, it is best to know this fact and take remedial action sooner rather than later.

In the right circumstances, and with experienced professional support, premium financing can be a valuable technique for helping business owners pursue wealth accumulation and distribution goals, including protecting and ultimately cashing out the value of their business equity.

Alan S. Kufeld, CPA, is a tax principal in the Rothstein Kass Family Office Group, specializing in the federal, state and local tax matters affecting high-net-worth individuals. Frank W. Seneco is the principal of Seneco & Co., a Connecticut-based advanced planning operation that specializes in high-end life insurance solutions for the ultra-affluent and their advisors

Top 5 Trends for Small Business Finance in 2009

Small Business Trends

January 7, 2009 By Scott Shane

The year 2009 will be a difficult one for small business finance. We’re in the midst of a recession that looks to rival, if not beat, the recession of 1980-1982 as the worst since the Great Depression. ...

Here are my top five trends for small business finance for 2009:

1. The amount of capital provided to small and start-up companies will continue to shrink

... Until the problems in the credit markets get resolved and the economy starts to grow again, it’s very unlikely that we will see a reversal of this trend. ...

2. Investors in start-up companies will continue to face a poor market for exiting from their investments

The IPO market is in a deep slump and there is little indication that it will emerge from that downturn in 2009. ... The market for acquisitions looks almost as bad. ... Until the economy gets moving again, the acquisitions market should stay in the doldrums.

3. Methods for internally financing companies will grow in popularity

... For instance, companies that help people tap their 401Ks to finance their businesses, and consultants that advise entrepreneurs on ways to bootstrap their growth, will grow in popularity.

4. Government officials won’t pay much attention to entrepreneurial finance

... Virtually of all the ideas for changes to entrepreneurial finance that had been floated previously – such as cutting capital gains taxes on start-ups and funding new high tech companies – will be driven off the agenda by a focus on fixing the problems faced by big businesses.

5. Attitudes toward financing start-ups and small businesses will change

During 2009, a new realism about entrepreneurial finance will continue to emerge. ... The shift toward greater realism about entrepreneurial finance will accelerate during 2009, bringing us back from the inflated views of recent years.

* * * * *

About the Author: Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool’s Gold: The Truth Behind Angel Investing in America; Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.