Transcript of Why Do Business Owners Need a Succession Plan?

[Music] Welcome to Future Focus a financial strategies   podcast where we make the complex simple. This  is part two of our conversation with the Ameritas   advanced planning team. If you haven't had a  chance to to go look at part one you certainly   should. Now let's go ahead and get into it. So let's dive back in so I think part one was   awesome as we talked about individuals and estate  planning and how it's for everyone we spend a lot   of time you know talking about you know talking  about talking to business owners in what we do day   in and day out talk about talk about the business  owners that sometimes think about think they don't  need a secession plan and so I don't end up  in a jargon jar a secession plan is what's   going to happen when I'm no longer a part  of the business in fact sometimes we talk to  folks and we ask them the question you  know like how do you want your business   to continue when you're no longer a part  of it that's a oftenus question that our  team uses when we're talking to business  owners like how do you want your business   to continue when you're no longer a part of it  and that usually you know constitutes a deep  pause and it forces many people to think about  a lot of times for the first time what do I want   to happen with my business so that's where  we're going to focus in on estate planning  and how it relates to you know to sucession  planning so we often hear about owners that that   say "I don't you know I don't need secession  planning or I don't have a plan because  they either have a partner or a trusted  person that they think is going to take   over." What would what would this group say  to a business owner that actually said those  words i guess I'll Yeah go ahead okay so my  favorite saying is you're going to leave your   and this is I give Troy full credit this  is what he came up with you're going to  leave your business in one way or another it's  going to be either in a box or you're going to   retire but no matter what you're going to  leave your business at some point in time  business owners true story you What are those  the four the four Ds right oh yeah what does   death disability departure and death  divorce i death divorce disability we call  it disengagement but you know a partner shows  up or someone shows up at at a business and   says "I'm out pay me my money you guys  can have it I'm leaving right that's  the four Ds that we think about when  a business moves on triggers is what   we would call them but those are what we  call the four Ds is what you're talking  about yeah but business owners have a  really hard time imagining that they think   this business is my baby i'm always going to be  here what is it going to do without me so again  you have to get them thinking about okay  well you know it's an inevitability we're   not going to survive this nobody survives this  you're going to leave one way or another so why  is business planning really important for  business owners well we need to start thinking   about why like what you want to happen with  that business like you said when you're no  longer there do you want your partners to be  working with your spouse do you want your kids   to take over how do you want your business  to be run without you do we want to make  sure that there's no gap in our like ability  to run our operations so on and so forth.  well even with that is you know even those  conversations does the spouse or a family member  like the children even want  to continue the business.  i mean are maybe there's not maybe  the kids aren't in the business or   are they are they wanting to continue it without  the parent yeah i mean there are some times  where there's like we're all from Well you're   not from Nebraska are you from Nebraska i've  been here a while i'm from Nebraska yeah  that's what I thought so we're from Nebraska  it's a farming state and usually you find   like if you have a bunch of kids maybe not  a bunch of kids maybe two or three one child  is usually really involved in the farming  business that wants to take over while the   other kids may not be so involved so we need  to make sure that okay that one child who does  want to be involved in the business actually  does get the business that it has a smooth   transition for them that they can actually  have ownership and that business operations  in this case in the farm don't stop just because  mom and dad had passed and so what do you say   in the cases where business owners because the spouse one is what like that's the one   right like I want to like I want my business  to continue so my spouse is just going to   step in like describe that like describe because I know we've all been on those   calls so like what would you say to  the business owner that says spouse   is going to step in i say have you even have you have you talked about that with your spouse i mean   a lot of spouses yeah they may be involved in the  business and they may not have plans to want to  continue that or work with you know if it's a  you know a business that has multiple owners   they may not want to work with those other  owners so have they had that conversation  and is that part of the succession plan for  what they want to do with that business not   just talking to your spouse but also  just talking to your business partners  Do your business partners really  want to work with that spouse?  They may be best friends now but when  you're no longer in the picture to   mediate and to make sure everybody's playing nice, do they still want to work with them?  it's a totally different animal  so what would you if you had to   tell someone to begin the steps to for succession by the way we're using the word you know sucession   plan so we should all put money into the jargon  jar it's really like a buysell agreement or what  else would we call it operating agreement  shareholders agreement shareholder agreement   buyell agreement those are all sort  of things that has that restriction  of disposal of your Yeah like how am I  going to give stuff away what's going to   happen when we decide to break up whatever  that document is whatever they call it  that's the document where however that  may happen whether it's retirement   death disability dis like like what you  mentioned there yep So yeah but so what steps  would you or how would you begin that process  or how would you suggest maybe beginning that   process if you're sitting down talking  to a prospective business owner or owners  so the first question to ask is do they have  a plan in place if they don't have a plan in   place the second question you need to ask  which comes from what we like to call our  source and six questions which are just  open-ended questions to kind of get the   conversation rolling is again what do you want  to happen to your business in the event that  you're no longer a part of it just to get  them thinking of that and then if they do   have something in place we need to make sure  that we review it and make sure it's still  actually fitting the needs and the wants of  the business owner because things change you   could like strike oil tomorrow and it will  completely turn your business around so  you need to be constantly looking at those  documents even if they have a plan in place   look at it every single year. oh yeah. it's  like what we talked about last time you know  it's reviewing the plan regularly it's not a  set and forget it do it one time and that's it   need to constantly review to make sure  it's up to date and it impacts the  current situation of that business  absolutely that's interesting because   I mean I don't know why I've never sort of  put the two together like we always talk  about we talked about in part one of this  conversation about reviewing the estate   plan over and over again we're talking  about how estate planning relates to the  you know relates to the business owner and  then separately we always talk about how   how we should be reviewing the buy sell  agreement shareholder agreement low whatever  it may be you said every year from the ones  that we look at that's a little that's really   ambitious if they do it every 18 months  to 36 months that's really on top of it  right like what we talk about what you hear  and I agree with having kids what the days go   slow but the years go fast i mean how you  you talk to a business owner when was the  last time you had your buy sell agreement  reviewed or your business valuated they   may think "Oh I did it recently but you look  back could have been five six 10 years ago."  Years go fast like really it's it's funny  to go "Well when's that when's the last   time you looked at it?" "Hey what day  did we sign that?" Yep there you go  that'd be the day and before you know it's 10  years later exactly you're like "What's that   worth?" Oh it's worth four times that  now oh I better make sure that I have  money in place to buy those shares back exactly  to try to take care of all those things okay so   that's the why we should be  thinking about it and how you  know it sort of relates estate planning and the  business owner and we want to review and all those   things okay so I want to change gears much like in part one we talked about the tax   cuts and jobs act and and how it related  like how it changes the way people think   about what actually is estate planning versus what it ends up you know who it's actually   for versus who they think it's for so there was a  like there was a case I'm not going to say like I  heard there was a case like I know that  there was a case right like so we know   that there was a case called Connelly  i think it was Connelly v commissioner  Connelly Commissioner v the I don't know  the the exact name but most people will   refer to it as Connelly now again we live in  this world so we're going to try to keep the  jargon you know to a minimum but Connelly  was really important let's try to tell the   people why Connelly was one was important  and two how it relates to the buy sell  and if we can get crazy three how that  relates to estate planning. may I so   one Connelly she's excited about this i'm just  setting this up for her right like so one what  is Connelly you know so what is Connelly two  what you know why it's important in relation to   you know buy sales or shareholders agreements  or you know business you know continuation and  three how does that relate to estate planning   you got the assignment I am so excited I  feel like if we were playing basketball  you'd be throwing up that alley loop right  now so this is a conversation I really love   to have so Connelly. What is it connelly?  Is a recent Supreme Court decision it was  actually decided in June of 2024 so very  recently and it impacts buysell agreements   not just buysell agreements but entity  buysell agreements what is that's when  the company itself is buying the shares back  from the shareholder versus a cross purchase   agreement when the shareholders are buying  the shares from each other so how does it  impact this i want to rewind to the rule  that this impacts the rule is when it comes   to estate planning is that when we're valuing  the taxable estate the fair market value of  your assets are what's used fair market  value being the current value no when we   get the jar that one goes in that's fine  you can bill me so fair market value is  pretty much what you can get on the market  for the asset in that time what is it worth   today now there's an exception to that rule  there's many exceptions to it but one of  the exceptions is having a valid buysell  agreement what is a valid buysell agreement   well it's a bonafide business transaction what  does that mean? it essentially means that you  have a good business purpose for doing this  being a buysell agreement pretty much is   the definition of that second and this one's  going to be a rough one but staying with me  I will translate it cannot be used as a  testamentary transfer for less than full and   adequate consideration between family members  translation: too many words don't give your  family a discount number three oh  I get that there you go that That's   actually really good like don't give your  family a discount like it needs to be like  this is what it costs this is what you're  going to get you don't get the hometown   discount no and to me for a business owner you  know most business owners most you know they  are putting a lot of their time effort  and dollars back into their business they   may not be saving for retirement in a lot of  different areas i mean a lot of you know a lot  of their net worth may be their business  so from a business owner perspective it   probably makes a lot of sense not to give that  family discount because that's what they may  be looking to use to fund their retirement.  oh absolutely. now number three it has to be   an agreement that can be reached at in  an arms length transaction don't give  your friends discounts either no family  discounts no friend discounts. Finally   four it has to be binding during life and after  death. well that's number four. there are five  things what does that mean it means if you  have an agreement in place you need to abide   by it you can't just put it and set it and  forget it and never follow the terms of it.  finally number five there must be a fixed  and determinable price as in the court must   be able to look at your buy sell agreement  and figure out what your company is worth  without talking to the people who signed  it. right so Connelly so I'm going to   try to spit that back to you okay so  one is the bonafide agreement right  business purpose bonafide okay the  bonafide business purpose so and   you said that the buy sell agreement is  generally considered a business purpose  i want to be able to I've thought about  ahead of time to be able to pass my business   at a you know so I can like Jacob talked  about get the value for my business when  either I decide to sell it or sell it  by these terms or if I pass away and   the people that I love and care about  are going to end up benefiting from the  sale of the business yeah essentially you  have a legitimate business purpose you're   not just doing this because it benefits you  it's something that needs to be done for the  business okay that's one two is  no hometown discounts for family   correct three is no hometown discounts for  friends correct four is what was four has to  be binding during life and after death  so we sign it an agreements like we're   not just going to wash our hands of  it when you pass away okay and five is  fixed and determinable price i just need to  be able to look at it and go you said it's   worth this like this many shares times  this and that was determined in some  reasonable manner and that's the  cost of the business now. I do want   to qualify that so you can't just say my  business is worth 2 million okay because  it needs to be the fair market value or  the exception to that value as of the   date of death okay so when we're talking about a  fixed and determinable price we're talking about  like a formula or a calculation or we agree  to get an appraiser that's going to appraise   this using this method or that's going  to take these factors into consideration  something that I can take and go okay that's  the value so it can be something as simple as   your value is the previous 12 months gross  receipts aka the money you got in from  your sales or whatever practice you're  doing divided by the total number of   shares outstanding that's an acceptable formula  that makes it fixed and determinable saying it's  worth 4 million today not good enough okay so  we can't just stick our finger in our mouth   and hold it up to the wind and go "Feels  like 4 million." Correct okay all right got  it so those are the rules connelly two brothers  ignored all of those rules everything it's   like a case of bad facts they just did  absolutely everything wrong so they had an  agreement right and in this agreement it  said "Okay we agree to a price every year."   That's an agreement to agree is no  agreement at all that's just saying we'll  figure it out when we get to it that's not  really making your buy sell agreement binding   backup was if they couldn't agree or didn't  agree they went they every year they were  supposed to agree if they didn't do that  they were going to go get an appraiser and   the appraiser would be the one to figure out  the value of the company cool well brother  number one Michael he dies Thomas goes "Oh well  we never agreed on a price and I never got an   appraiser i think it's worth about three  million how much have we gotten in life  insurance proceeds to fund this agreement  about three million i think that's good   the IRS stepped in and went "Who no that's  not how this works you need to get an actual  appraisal." And it only was til 9 months  after Michael's death that they actually   started getting an appraisal for this company  and if I'm and if I remember correct they  weren't very far off like no they were they  were pretty close the number wasn't very far   off but valuation is an art not a science  so you can pretty much I don't want to say  manipulate those numbers because that's  not correct you can take you have a lot   of discretion when it comes to what is used in  that calculation so not only that but before we  even had the appraisal Thomas goes to  his nephew which happens to literally   his name is actually Michael Jr and they decide  3 million sounds good right yeah 3 million sounds  great Uncle Tommy that works for me and again  the IRS steps in and goes "Yeah that's not   cool we're not going to do that." So the  court's like "Okay you didn't respect this  during life and during death you didn't give  me a fixed and determinable price you're you   could be giving your family a discount sure  but I mean it was pretty close so we're  not going to worry about that it's not a friend  issue and it is a bonafide agreement." So our   two issues are one it was not binding  during life and after death they didn't  follow the agreement whatsoever until the  IRS started poking their nose in and two   that they didn't have a fixed and a terminal  price okay so what happens we'll use the  fair market value of whatever the business  is we'll get an appraisal that'll be great   okay well that's what the rule is so what  does the case do what does the case change  anything the case doesn't change the rule  the case just imposes what the consequence   is before there was no consequence and this  is kind of why business owners don't ever  like deal with buy sucession at all because  they can just blow off their agreement they   can just ignore it completely and there's  no consequence they'll just use whatever  they figured out so the IRS ended up taking  this case and using them as an example and   you never want to be used as an example  and the court ended want your name in the  title of the case that usually doesn't work out  well no not at all so what the court ended up   doing they're like "Okay you don't fall in this exception where the fair market value is well   you're using something other than the fair  market value you don't have a valid buysell   agreement so we're going to figure out what the fair market value is." And before this   case that would be like okay you have all  these assets we're going to value them you   have these liabilities we're going to offset them but when we fund these type of agreements   we tend to use life insurance because  you don't want to liquidate assets   and sell them in your company right it's going to cost you a lot of money that's   the state equalization that gives you  liquidity right yeah that life insurance   death benefit gives you those funds to be able to you know complete the purchase   agreement the buy sell agreement without  having to sell other things and divide   assets that may be illquid or hard to divide yeah not just that's a lot of assets that you'd   have to liquidate because keep in mind  you're trying to buy the business back   in this case it was a 77% ownership stake that's going to cost you a lot of money   if your business were to liquidate 77% of its  assets in order to do this buy sell agreement   you won't have a business a little difficult so usually when we do these valuations we go okay   we have all this insurance money awesome that's  an asset and again I'm I hate to do the jargon but  it is an accounting thing assets and liabilities  right it's going in okay so you have assets right   you have all this money here you have  this life insurance proceeds from the  death then you also have this liability this buy  sell agreement they have the obligation to buy   these shares in the event that Thomas  does not and Thomas never planned on  buying these shares so the company has to  do it so the company comes in and they ar   well the estate comes in and argues well like  all previous case law we have this asset and  this equal offsetting liability put them  together we have zero so it's going to add   nothing to our fair market value but the court  goes well actually that's not going to happen  here we're going to include the value of the  death benefit in the value of the company now   why is that a big deal again they're buying  77% of this company so if we're increasing  that valuation by 77% now it's 177% is the  value of the company not just 100% that's   a lot and that's just the valuation for the  tax that's not how much money that Michael  actually Michael's estate actually received he  received what it was worth he didn't receive   177% of that to me for someone then we talked  about last time for you know the lifetime  exemption amount yeah it's 13.9 million per  person for this year then it potentially   drop into 7 million but for so for someone  that's in a high net worth you know their  net worth is above the exemption amount that  definitely bringing that amount up and now   you're really starting to inflate what  those that estate tax potential liability  may be and I think that's the word  and inflate like you're I think what   Connelly did is it inflated values  and numbers that previously we didn't  think about oh yeah and you know what the  consequence is when you have a taxable   estate what's the tax rate jumps to 40% pretty  quick 40% well 40% after the first million  right million dollar yeah 40% so he was pushed  into a taxable estate he had a taxable estate   already so 40% of let's see it would be  about I think it was like 3.86 million is  what he received but he was taxed at  177% of that that is not a small bill   to have so what does Connelly do Connelly  says okay the rules are the name of the  game is still the same but now there's  a consequence if you do not follow your   buysell agreement you don't have a valid one  you're not setting that fixed and internal price  hitting our fivestar checklist well then  we're going to punish you and we're going   to punish you by making you include the value  of the life insurance proceeds in the value  of your estate so to me I mean all of that  you know to me the way to summarize it up   I feel like it's it's proper planning and  it's regular planning it's you know if you  didn't plan yesterday plan today and then review  that on a consistent basis to make sure you're in   line with all what all the requirements  need to be. oh yeah because think about  what the brothers did wrong. first of all  they never had well they first said an   agreement to agree which is no agreement at all  but let's say it was an agreement they never met  and talked about it never did it they  never followed up on it never once that's   probably the override you are right that's  probably the overriding theme which is plan  it like think about it plan it follow up continue  to plan oh but the best part is they had a plan   B if they didn't get together and agree  they were going to get an appraiser but  they never did that again they never got  the appraiser so they could have I guess   it's all you know happen stance and we don't  know but they probably could have avoided if  they got the appraiser and the business  is worth this yeah and that's probably   with a lot of problems you know it can be  avoided you just need to follow through  with the planning steps and it all starts  with having those conversations so it's   really easy to avoid the consequence  of Connelly we can avoid this by having  a valid buysell agreement in the first place we  hit all of our five checklists that bonafide no   discounts to family and friends we abide by  it at all times life and death and we have  that fixed and terminable price if we abide  by that well then Connelly doesn't apply to us   they're going to respect our buysell agreement  and we're going to be able to use something  other than what's considered the fair market  value when we determine what that tax is and   that can be significantly different as long as  it's reasonable at the time that you executed  the agreement reasonable being the an  average person of reasonable and prudent   intelligence i wasn't going to put you in a  jargon jar for reasonable i wasn't going to  get jargon jar for a reasonable all  right last question cuz that's a lot   of law school sounding stuff so no it's  all right though 'cause we needed to  talk about it's probably why you like having  me at this table help have someone without   that law school background to help some  regular words right some regular words  some slike dollar words not them $5 words.  that's right. when I play Scrabble it's   usually those three and four letter words  that I'm good at. oh no you throw around  some big ones too okay so just as we think  about you know Connelly and the reason   why I wanted to talk about Connelly  because it just dominated the second  half of 2024 where everyone was you know skies  falling Connelly and it on its face it did   change quite a bit as the way we thought about  like buysell agreements business continuation  but for the average business owner again I'm not  even thinking about someone that's pressing up   against any sort of you know exemption limit or anything like that for the average business   owner what can they take from and maybe we've  already talked about it and it's okay to sort   of reiterate those things what can the average business owner take away from   Connelly and what it does going forward i can  go for it so what should they take away first   of all we need to have a buy sell agreement in place even if you don't think you're going to   have a taxable estate it's not just about  that it's about planning for your business   and making sure your needs are met and outside of that if you're doing an entity purchase agreement   you need to know how much your company is  worth so you can be able prepared to make   that purchase when the time comes but not just that we need to be constantly not abi like just   abiding by the agreement but also checking  it our business evolves over time like I   said your business can strike oil tomorrow or invent some new technology that changes the   world and that'll completely change how we want  our buysell agreement to operate or maybe you   add a new shareholder regardless you need to  have some kind of plan in place and you need   to review it periodically. my suggestion is  always going to be at least annually but I   know that's not possible for a lot of people especially business owners who tend to be very   busy but at least semianually. once every  five years but I would prefer more than   that if you could so regularly periodically  whatever frequency that may be that fits into   people's you know schedule. maybe not put in like  a specific year but if something changes in your   business a new shareholder or if you have like a lot of success one year that you're like "Wow   we just killed it this year." Then you might  want to go back to your buysell agreement and   look at it yeah life happens you know  no different than personal planning you   know let's say a you know a family member joins  the business or you have that key employee that   may want to eventually take over the business as or that business is growing either number of   employees or profit so yeah I agree all right i  was going to say I was thinking about it's doing   it early doing it often and or doing it early.  following up as often as feasible but certainly   having those conversations when everything's  good. going back to family's fight if to  bring the conversation full circle from part one  and to part two since families fight. let's make   these decisions when everyone's sort of happy  with one another and while we love each other   if we wait until there's money on the line  and we don't love each other as much anymore  that's you know that's usually a recipe  for problems even you know beyond the   things like Connelly so I would say have all the  conversations not it's not just the conversations   between the business owners may know it's the  conversation between spouses or you know the   the business owner and their children if they  have children or key employees so you know  you can't just have one conversation and  skip two or three so if there's multiple   conversations need to be had making sure you're  having it with all parties to make sure that   there is planning in place now I would be remiss  if I didn't also throw out there if the argument   with the family and friends is not enough to  persuade you to get a business plan put in  place let me tell you if you do nothing at all  your business interest will go to probate and   it'll be tied up for a very long time and  you will not be able to make any decisions   for your business in that period of time if you  want your business to continue on without you   whether it goes to your family to your friends  to your business partners you need to have a  plan in place so that they can smooth  that transition over and make sure that   the decisions in your business can keep going  we'll say this well it's not the time to emulate   an ostrich like we don't want to bury our head  in the sand so something's going to have to be   done with it. would you rather be your wishes  or someone else's wishes? what do you say the  Uncle Sam the unintended beneficiary that's  we talk about that around the office when   you if you don't plan if you don't think  about what you want to do how you want to   do it and go through a little bit of those that  uncomfortable conversations and feelings you're   going to have an unintended heir and and his name is Uncle Sam. With that,   thanks. This has been awesome. This is hopefully,  we weren't too complex. Hopefully we were able   to take some things and make it and make it  simple for folks. I'm Troy Branch with Keali   Jo French and Jacob Messick. This has been Future  Focus: a Financial Strategies podcast. Thanks for   watching. We'll see you next time. [Music]