Competing Concerns Ensuring Business Continuity, Preserving Owner - PowerPoint PPT Presentation

Asset Approach • Adjust Assets and Liabilities to fair market value • Subtract fair market value of liabilities from fair market value of assets • Remove Non-Operating Assets and Liabilities 25

Levels of VALUE Entity and Valuation 26

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Lifetime Gifting Dynasty Trust Grantor No transfer tax paid . Advantages  Creditor protection Discretionary Distributions to Children for Life  Divorce protection No transfer tax paid .  Estate tax protection Discretionary Distributions to Grandchildren for Life  Assets remain in bloodline No transfer tax paid .  Dispositive plan protection Discretionary Distributions to Great-Grandchildren  Spendthrift protection for Life  Consolidation of capital No transfer tax paid . Future Generations Gift should take advantage of any remaining lifetime gift exclusion and lifetime GST exclusion 28

Lifetime Gifting  Power of Compound Growth Economics:  Assumptions • $1 million contributed to trust • Trust lasts 120 years • 40% transfer tax imposed on non-dynastic trust assets every 30 years 29

Lifetime Gifting Power of Compound Growth Chart $1 Million Example: Dynasty Trust vs 40% Estate Tax Every 30 Years Value of Dynasty Trust Value of Property if No After-Tax Growth After 120 Years Trust 3.00% $34,710,987 $4,498,544 4.00% $110,662,561 $14,341,868 5.00% $348,911,561 $45,218,993 6.00% $1,088,187,748 $141,029,132 7.00% $3,357,788,383 $434,169,374 8.00% $10,252,992,943 $1,328,787,885 9.00% $30,987,015,749 $4,015,917,241 10.00% $92,709,068,818 $12,015,095,319 30

Lifetime Gifting How much is enough – with 4% inflation: $1 Million Example: Dynasty Trust vs 40% Estate Tax Every 30 Years Real Value of Dynasty Real Value of Property After-Tax Growth Trust after 120 Years if No Trust 4.00% $1,000,000 $129,600 5.00% $3,152,932 $408,620 6.00% $9,833,386 $1,274,406 7.00% $30,342,587 $3,932,399 8.00% $92,650,964 $12,007,564 9.00% $280,013,543 $36,289,755 10.00% $837,763,631 $108,574,166 31

Lifetime Gifting How much is enough – with 4% inflation? $1 Million Example: Dynasty Trust vs 40% Estate Tax Every 30 Years Real Value of Real Value of After-Tax Dynasty Trust Property if No Growth after 120 Years Trust Inheritors 4.00% $62,500 $8,100 16 5.00% $197,058 $25,538 16 6.00% $614,586 $79,650 16 7.00% $1,896,411 $245,774 16 8.00% $5,790,685 $750,472 16 9.00% $17,500,846 $2,268,109 16 10.00% $52,360,226 $6,785,885 16 32

Family Limited Liability Companies (“FLLCs”)

Family Limited Liability Companies (FLLCs)  FLLCs:  An FLLC is a partnership between family members, which exists for a business purpose.  The FLLC consists of one or more manager(s) who control the daily operation of the entity, and members who are “silent” partners not actively involved in the business.  Although operating as a business, the FLLC also serves as an important estate planning and business continuation device. 34

FLLCs  Use of an FLLC is appropriate when there is a:  Wish to transfer the business to the next generation without relinquishing immediate control.  Need or desire to shift income to another family member who may be in a lower income tax bracket.  Desire to reduce the value of the owners’ business interest for estate tax purposes and shift future appreciation to the next generation. 35

FLLCs  Use of an FLLC is appropriate when there is a (cont.):  Wish to give assets to children now, without giving too much – too soon, to the children.  Desire to protect assets transferred to children from going to an ex-spouse as a result of a divorce settlement.  Need to make it difficult for creditors to seize assets. 36

FLLCs  Advantages to the Business Owner:  The owner, as Manager, controls the FLLC and its assets.  The owner may also receive reasonable compensation for managing the FLLC.  The children, as non-voting members, have no managerial control over the underlying assets owned by the FLLC or the FLLC’s income distributions.  Non-voting members do not earn compensation in the form of a salary but may earn income from a share of the FLLC’s profits. 37

FLLCs 1. Transfer Business Parents FLLC 2. Voting and non-voting membership interests 4. Pay Premiums 5. Death Proceeds 3. Gift / sell non-voting membership interests to children GRAT fbo IDGT fbo Insurance Child A Child B Child C Company 38

FLLCs  Advantages to the Business Owner (cont.):  As a result of the gifts of non-voting membership interests to the children, the owner has removed assets from his/her estate and has transferred portions of the business to the children.  As a result of potential valuation discounts (for lack of control and marketability), the owner can transfer a greater portion of the business to the children while reducing estate and gift taxes. 39

FLLCs  Advantages to the Children:  The children now own a portion of the business.  Through regular gifts of non-voting membership interests, the children can own an increasing share of the business each year.  Members enjoy limited liability.  Distributions of net profits are generally made in proportion to the ownership interest in the FLLC and taxed individually to each member. 40

FLLCs  Tax considerations:  Future appreciation on the gifted portion of the FLLC is removed from the business owner’s taxable estate.  The donee’s basis in the transferred portion of the FLLC interest will be the same as the donor’s basis before the gift was made.  FLLCs are “pass - through entities” taxed as partnerships. As a result, individual members earn income when the partnership earns income. The income must be recognized and reported annually on the member’s income tax returns even if the income is not distributed by the FLLC. 41

FLLCs  Tax considerations (cont.):  As a result of the FLLC’s pass -through tax nature, creditors of individual partners holding charging orders may be subject to reportable income even if the FLLC makes no distributions.  This provides further asset protection against creditors, because the creditor may be KO’d by the K-1. 42

Grantor Retained Annuity Trusts (“GRATs”)

GRATs  How does a GRAT work?  Gift of property into trust.  Annuity payment is returned to Grantor annually at IRC Section 7520 rate for a set term.  It is possible to combine a trust term with a high annual annuity to reduce the gift tax value to zero or close to zero.  Appreciation in excess of the IRC Section 7520 rate is passed to the remaindermen free of transfer taxes.  If the assets do not appreciate faster than the Section 7520 rate, they are returned in kind to the Grantor. 44

GRATs  What are the advantages of a Grantor Retained Annuity Trust?  Large estate tax savings. • Transfer most of the future appreciation in growth assets to children at little or no gift tax cost.  Very low tax risk. • The IRS has promulgated regulations to govern use of GRATs – it is a “safe harbor” technique.  Easy to implement and administer. 45

GRATs  Ideal assets.  Assets that will appreciate faster than the IRC Section 7520 rate.  Stocks and marketable securities.  LLC interests, partnership interests and S corporation stock. 46

GRATs  Valuation discounts.  Transfer is a gift for tax purposes – subject to gift tax (ordinarily current FMV).  Grantor is entitled to 2 key discounts to current FMV: • Remaindermen must wait to receive the property (until GRAT term is over). • Grantor retains the “right” to get the property back if he/she dies before the GRAT term is over.  These discounts can result in substantial reductions to current FMV. 47

GRATs  Tax benefits .  After the GRAT term, the property is out of the Grantor’s estate for estate tax purposes.  All appreciation is removed from the Grantor’s estate.  No gift tax consequences unless Grantor has already used up his/her lifetime exemption. 48

GRATs  Tax benefits (cont.)  The trust is a grantor trust, so the Grantor does not realize any income tax on the annuity payments. But the Grantor is responsible for paying the GRAT’s income taxes.  Any income taxes the Grantor pays for the GRAT reduces the Grantor’s taxable estate and preserves assets for the Grantor’s beneficiaries. 49

GRATs  Drawbacks .  Grantor must survive the GRAT term to achieve the estate tax savings. • (You can “hedge” this problem with life insurance.)  Grantor must pay income tax on assets in Trust. • (But this is essentially a tax-free gift to the remaindermen.)  The GRAT is an irrevocable trust – there may be no commutation. 50

GRATs  Typical GRAT terms.  The GRAT must be established for a term of years (2 years is minimum).  Multiple GRATs with varying terms can be used to minimize mortality risk.  Multiple GRATs with different assets can be used to hedge against one of the GRATs failing.  Annuity payments may be re-GRATed, creating a “rolling” series of GRATs.  The annuity may be “back - end loaded” such that the annuity starts low and increases by as much as 20% each year. 51

GRATs  Interest Rate Sensitivity.  When interest rates are low, as they are now, a GRAT is more likely to succeed.  This is because the GRAT assets are more likely to appreciate at a rate greater than the IRC Section 7520 rate (sometimes called the “hurdle” rate).  When the GRAT term ends, the remainder beneficiaries will receive the difference between the actual appreciation and the IRC Section 7520 rate, transfer tax free. 52

GRATs  Income Tax Treatment .  There will be no income tax consequences associated with the initial transfer of assets to the GRAT, or the annuity payments back to the grantor, provided the GRAT qualifies as a “grantor trust”.  As long as the GRAT is a grantor trust, transactions between the grantor and the trust will be disregarded for income tax purposes. See Rev. Rul. 85-13. 53

GRATs  Income Tax Treatment (cont.)  In most cases, a GRAT will qualify as a grantor trust under IRC Section 677 (regarding the grantor’s retained right to income).  Since it is theoretically possible, however, that the income from the trust assets could exceed the annuity payments, consider adding another grantor trust trigger (such as the power to substitute assets under IRC Section 675(4)(C)) to ensure grantor trust treatment. 54

GRATs  Power to Substitute Assets .  Apart from ensuring grantor trust treatment, there is another reason to give the grantor the power to substitute the GRAT assets with assets of equivalent value during the GRAT term.  If the GRAT assets “overperform,” and the grantor would prefer to freeze the appreciation he or she passes on to his or her children, the power to swap assets can be very useful. 55

GRATs  Not Ideal for GST Planning .  Under the estate tax inclusion period (“ETIP”) rules, it is not possible to allocate GST tax exemption to a GRAT until after the term expires (or the grantor dies, if earlier). See IRC Section 2642(f) and Treas. Reg. Section 26.2632-1(c).  Accordingly, it is not possible to “leverage” the initial gift (which could be very low or even zero) to exempt the ultimate remainder interest (which could be much more valuable than the assumed remainder interest at initial funding) from GST tax. 56

GRATs Grantor (age 65): Contribution of Non-Voting Stock Gift of $6.5M of stock (after 35% GRAT Value: discount) $10 million Annual Annuity Payment of $731,215.55 (11.25%) Gift = $4.17 Remainder transferred to Children (or trust for Children’s benefit): Remainder after Assumptions: 10 years 10% income/4% growth: $23.4M 10% income/8% growth: $36.6M Gift = $5.61 Children Section 7520 Rate = 2.2% 57

GRATs  Bullet-Proofing a GRAT.  Grantor can make gifts to an ILIT (for the benefit of the children) to provide the funds needed to pay estate taxes (on the stock bequeathed to the children) should the Grantor die before the end of the GRAT term.  Alternatively, the children can purchase life insurance on the Grantor’s life to provide the funds necessary to purchase the stock (pursuant to a buy-sell agreement) if the Grantor dies before the end of the GRAT term. 58

Intentionally-Defective Grantor Trusts (“IDGTs”)

IDGTs  What is an IDGT?  An IDGT seeks to take advantage of the differences between the estate tax inclusion rules of IRC Sections 2036-2042 and the grantor trust income tax rules of IRC Sections 671-678.  An IDGT is an irrevocable trust that effectively removes assets from the grantor’s gross estate.  For income tax purposes, however, the trust is “defective”, and the grantor is taxed on the trust’s income.  The IDGT’s income and appreciation accumulates inside the trust gift and GST tax free. 60

IDGTs  Common grantor trust triggers:  The trust includes a power exercisable by the grantor (in a non fiduciary capacity) to reacquire trust assets by substituting assets of equivalent value. IRC Section 675(4)(C).  The trust includes a power held by a non-adverse party to add to the class of beneficiaries (other than the Grantor’s after -born or after-adopted children). IRC Section 674(a).  The trust includes a power to enable the trustee to loan money or assets to the grantor from the trust without adequate security. IRC Section 675(2). 61

IDGTs  Funding the IDGT prior to sale.  Amount of seed funds. • The “seed fund” reduces the risk that the sale will be treated as a transfer with a retained interest by the grantor under IRC Section 2036. • In PLR 9535026, the IRS ruled that IRC Sections 2701, 2702 and 2036(a) did not apply if the note retained by the grantor was bona fide debt. 62

IDGTs  Funding the IDGT prior to sale (cont.)  In Sharon Karmazin , Tax Court Docket No. 2127-03, the IRS challenged an IDGT sale on the basis that IRC Code Sections 2701 and 2702 applied, but later dropped both arguments.  In Karmazin , the trust had 10% seed money. The case was settled out of court with the only adjustment being a reduction of the valuation discount from 42% to 37%. 63

IDGTs  Why an installment sale to an IDGT works: 1. No capital gains tax on sale. Rev. Rul. 85-13. 2. Freezes value of appreciation on assets sold at the AFR. 3. Interest payments not taxable to grantor. Payment of IDGT’s income taxes by grantor leaves 4. more assets in the IDGT – gift tax free. Rev. Rul. 2004-64. 5. Back end-loading (i.e., interest only with a balloon payment). 64

IDGTs  Why an installment sale to an IDGT works (cont.): 6. Valuation discounts increase effectiveness of technique. 7. Possible discount for value of note in seller’s estate. 8. IDGT is an eligible Subchapter S shareholder. 9. Lower interest rate than used in GRATs. 10. An IDGT can purchase an existing life insurance policy on the life of the grantor without subjecting the policy to taxation under the transfer-for-value rule. Rev. Rul. 2007-13. 65

IDGTs  Disadvantages to an IDGT sale:  Requires 10% seed funding.  Note is taxable in grantor’s estate (unless SCIN is used).  Potential cash flow problems for grantor by paying IDGT’s income taxes.  Likely no step- up in basis at grantor’s death.  Possible gift and estate tax exposure (under IRC Section 2036) if IDGT has insufficient equity. 66

IDGTs  Sale Agreement / Note.  The IDGT can make a down payment or issue a promissory note for the full value of the property.  The note is typically structured to provide annual payments of interest only with a balloon payment at the end of the term.  The interest is normally set to be equal to the Applicable Federal Rate (AFR) at the time of sale.  An independent written appraisal of the asset being sold to the IDGT should be obtained. 67

IDGTs  Sale Agreement / Note (cont.)  It is common for a nine-year note to be used in IDGT transactions, which would apply the mid-term rate.  The note typically permits prepayment in kind.  The note can be a self-canceling installment note (SCIN). 68

IDGTs  Possible IRS Attacks on IDGT Sales: IRC Section 2701  Under IRC Section 2701, the amount of the taxable gift is the value of the property transferred minus the value of any “qualified interests” retained by the transferor.  If the IDGT note has a fixed due date and payments are made at least annually, the payments should be a qualified retained interest.  However, the required return for a preferred partnership interest is generally much higher than the AFR. 69

IDGTs  Possible IRS Attacks on IDGT Sales: IRC Section 2702 and Woebling , Tax Court Docket No. 030261-13  IRC Section 2701 provides that except for GRATs, GRUTs and QPRTs, any other split interest held by the grantor in a trust is valued at zero, resulting in a taxable gift of the FMV of the property sold.  If the IDGT is bona fide debt, then IRC Section 2701 does not apply. 70

IDGTs  Possible IRS Attacks on IDGT Sales: IRC Section 2036(a)(1)  If the note is a retained interest, then IRC Section 2036(a)(1) would cause the entire trust property to be included in the grantor’s estate at its date -of- death value.  If the note is respected as bona fide debt, there is no retained interest. 71

IDGTs  Avoiding IRS Attacks on IDGT Sales:  Observe all note formalities and make all payments according to the payment schedule.  Provide seed money (or guarantees) equal to at least 1/9 th of the value of the assets sold.  Don’t peg payments to IDGT’s income.  Put all of the IDGT’s assets at risk for the note. 72

IDGTs  GST considerations.  As long as the grantor allocates his or her generation- skipping tax (“GST”) exemption to gifts to the IDGT, the trust assets will be exempt from the GST tax.  The GST exemption does not need to be applied to the sale to the IDGT. 73

Grantor Trust vs. Non-Grantor Trust NON-GRANTOR TRUST GRANTOR TRUST Taxable Less: Taxable Less: Beginning Income Taxes at Ending Beginning Income Taxes at Ending Year Balance 7% 40% Balance Year Balance 7% 40% Balance 1 $10,000,000 $700,000 $(280,000) $10,420,000 1 $10,000,000 $700,000 $ - $10,700,000 2 10,420,000 729,400 (291,760) 10,857,640 2 10,700,000 749,000 - 11,449,000 3 10,857,640 760,035 (304,014) 11,313,661 3 11,449,000 801,430 - 12,250,430 4 11,313,661 791,956 (316,783) 11,788,835 4 12,250,430 857,530 - 13,107,960 5 11,788,835 825,218 (330,087) 12,283,966 5 13,107,960 917,557 - 14,025,517 6 12,283,966 859,878 (343,951) 12,799,892 6 14,025,517 981,786 - 15,007,304 7 12,799,892 895,992 (358,397) 13,337,488 7 15,007,304 1,050,511 - 16,057,815 8 13,337,488 933,624 (373,450) 13,897,662 8 16,057,815 1,124,047 - 17,181,862 9 13,897,662 972,836 (389,135) 14,481,364 9 17,181,862 1,202,730 - 18,384,592 10 14,481,364 1,013,695 (405,478) 15,089,581 10 18,384,592 1,286,921 - 19,671,514 74

IDGTs 1. Gifts $650K of 5. Excess Cash Flow / Life Non-Voting Stock Premiums IDGT f/b/o Grantor Insurance Children 2. Sells $5.2M of JJ 6. Death Proceeds Company Non-Voting Stock (Income and Estate (No Capital Gain Tax) Tax Free / Leverages GST Exemption) 3. $5.2M Note to Grantor Balloon Payment in 9 Years 4. $126,880 annual interest (Interest Rate 2.44%) Advantages : • Value of assets sold frozen at 2.44% for nine years (assumed mid-term AFR). • Grantor’s estate further reduced by the income taxes paid on behalf of the trust. • The trust property escapes estate taxation for as long as permitted under state law. • IDGT can purchase a life insurance policy on Grantor’s life. Upon Grantor’s death, the death proceeds can be used to purchase Grantor’s voting shares. 75

Installment Sales to an IDGT - Example Assumptions FMV of Assets Sold to IDGT $ 5,850,000 Gift to Trust $650,000 Interest Rate (Mid-Term AFR) 2.44% Terms (Years) 9 Payment Structure Interest-Only w/Balloon Payment Payment Period Annually Timing of Payments End of Period Year Beginning Income Installment Ending Balance 10.00% Payment Balance 1 $5,200,000 $520,000 $(126,880) $5,593,120 2 $5,593,120 $559,312 $(126,880) $6,025,552 Amount passing to 3 $6,025,552 $602,555 $(126,880) $6,501,227 beneficiaries free of 4 $6,501,227 $650,123 $(126,880) $7,024,470 estate and gift tax 5 $7,024,470 $702,447 $(126,880) $7,600,037 And income tax on trust income is paid by grantor 6 $7,600,037 $760,004 $(126,880) $8,233,161 as additional “gift” 7 $8,233,161 $823,316 $(126,880) $8,929,597 without gift tax 8 $8,929,597 $892,960 $(126,880) $9,695,676 9 $9,695,676 $969,568 $(5,326,880) $5,338,364 76

IDGTs v GRATs  With IDGT:  No mortality risk.  Can allocate GST exemption to seed gift.  Mid-term AFR is less than Section 7520 rate.  Back-loading (i.e., interest only with balloon payment vs. level annuity payment).  Not a statutory technique.  Possibility of unintended gift tax, which may be mitigated by using a “defined value” clause. 77

OVERVIEW OF BUY-SELL AGREEMENTS Brian M. Annino, Esq. Annino Law Firm, LLC 707 Whitlock Ave., Ste E16 Marietta, GA 30064 (404) 934-5978 brian@anninolawfirm.com www.anninolawfirm.com September 8, 2015 Overview of Buy-Sell Agreements 78

Roadmap • What is a Buy-Sell Agreement? • What Triggers Action in a Buy-Sell Agreement? • Funding Sources for Various Contingencies. • Federal tax considerations. • Business Valuations. September 8, 2015 Overview of Buy-Sell Agreements 79

What is a Buy-Sell Agreement? • A binding executory agreement amongst co- owners requiring a departing owner to sell his interests in a business and the remaining owner to buy the departing owner’s interests. • Analogies: Premarital Agreement; Estate Planning for Business. • Contrast with: corporate merger; asset purchase transaction. September 8, 2015 Overview of Buy-Sell Agreements 80

Types of Buy-Sell Agreements • Cross-Purchase – Remaining shareholders purchase shares (or membership interests) from departing shareholder. • Redemption – Corporation or LLC purchases shares or membership interests from departing owner. • Hybrid – Agreement includes provisions for different triggering events. September 8, 2015 Overview of Buy-Sell Agreements 81

• Buy-Sell Agreements should be drafted by counsel in coordination with a CPA or tax counsel. • Shareholders should negotiate key terms at the earliest possible stage, preferably before the business is incorporated or organized. • Importance of Business Valuations. • Ensure that there is a funding mechanism to fulfill the purpose of the Agreement! September 8, 2015 Overview of Buy-Sell Agreements 82

What Triggers Action in a Buy-Sell Agreement? • Whenever a co-owner departs the business. • Examples: – Withdrawal of a co-owner at a time before retirement. – Retirement – Disability – Death – Bankruptcy – Divorce or Familial Separation – Loss of necessary license September 8, 2015 Overview of Buy-Sell Agreements 83

• Fundamentals of Buy-Sell Agreements: – HOW will the shares or membership interests be sold? – What is a triggering EVENT under the Buy-Sell Agreement? – What is the VALUE of the ownership interest? – How will parties FUND the Buy-Sell Agreement? September 8, 2015 Overview of Buy-Sell Agreements 84

Importance of Funding Sources for Various Contingencies • At a fundamental level, a Buy-Sell Agreement is inherently useless if there is no available method for the remaining owner to purchase the departing owner’s interest. • A business owner should consider various sources of funding for the various contingencies that could trigger action under a Buy-Sell Agreement. September 8, 2015 Overview of Buy-Sell Agreements 85

Funding Sources • Savings – “Cash is King.” – Best source of funding because it can cover all triggering events. • Life Insurance Policies – Generally, each co-owner will own policy and pay premiums. – Payable upon death, therefore is intended to assist with only one of the triggering events. – Benefits may be distributed free from income tax. – Certain types of policies may generate cash-value, which could be utilized for other triggering events. September 8, 2015 Overview of Buy-Sell Agreements 86

Funding Sources • Disability Insurance – Generally, each co-owner will own policy and pay premiums. – Payable upon occurrence of disability. • Ensure that covered disabilities match definition in Buy- Sell Agreement. September 8, 2015 Overview of Buy-Sell Agreements 87

Funding Sources • Bank Loans – If co-owner is credit worthy, bank loans provide flexibility to fund all triggering events. – More difficult to obtain than in the past. – Will likely require securitization of business and perhaps personal assets. – A co-owner needs to re-visit his ability to obtain a bank loan on a yearly basis to ensure ability to obtain, or otherwise obtain and maintain a revolving line of credit. September 8, 2015 Overview of Buy-Sell Agreements 88

Funding Sources • Promissory Note/Installment Payments – If allowed, terms should be set forth in the Buy- Sell Agreement. – Beneficial to the remaining owner. – May not be beneficial to remaining owner or remaining owner’s estate. – Promissory Note should be secured with business and/or personal assets of remaining owner. September 8, 2015 Overview of Buy-Sell Agreements 89

Federal Tax Considerations • Buy-Sell Agreements requiring stock redemption – If transaction fails to qualify as IRC § 302 or 303 exemption (and treated as a non-liquidating corporate distribution, purchasing shareholder could be deemed to have received a taxable dividend. – Ensure that FMV is paid for withdrawing shareholder’s stock. • If too high, withdrawing shareholder may have received a gift from remaining shareholders. • If too low, remaining shareholders may have received a gift. • Importance of valuations! September 8, 2015 Overview of Buy-Sell Agreements 90

Federal Tax Considerations • Cross-Purchase or Hybrid Buy-Sell Agreements – Be careful of potential constructive dividend issues. • If remaining shareholders are required to purchase shares but purchase is made by corporation, IRS may determine existence of taxable constructive dividend. • Possible solution: Shareholders have the option, but not obligation to purchase shares. This provides flexibility for corporation to redeem stock without constructive dividend issue. September 8, 2015 Overview of Buy-Sell Agreements 91

What is a Business Valuation? • A process by which the value of a business is determined. • The concept of fair market value (FMV) is central to the process. • A business valuation utilizes different and additional methodology than a financial statement in order to determine FMV. • What will my business sell for in the market? September 8, 2015 Overview of Buy-Sell Agreements 92

Why Conduct a Business Valuation? • To prepare for a sale or transfer of business assets. – Asset Purchase Agreements – Mergers and Acquisitions • To prepare for selling shares or membership interests in the business and drafting Buy-Sell Agreements. • To prepare for retirement and/or winding down and dissolving the business. • To plan and prepare for current and future income, gift, and estate tax. September 8, 2015 Overview of Buy-Sell Agreements 93

Why Conduct a Business Valuation? • To prepare for the future development of your business by tracking market value over time. • To adequately determine insurance needs. • To prepare for offering employee stock plans. • To prepare for divorce. • To prepare for litigation. – External and Internal • To prepare for compliance reporting. September 8, 2015 Overview of Buy-Sell Agreements 94

Why Conduct a Business Valuation? • What is common to all of these circumstances: – Business valuations are utilized in the course of preparation and planning for the future of a business. – Business valuations are in indispensable tool in planning the fundamental development of a business and preparing for key events, such as interest transfers and sales. September 8, 2015 Overview of Buy-Sell Agreements 95

Methodologies of Business Valuations Three Primary Approaches: • Asset Approach • Market Approach • Income Approach September 8, 2015 Overview of Buy-Sell Agreements 96

Asset Approach • Adjusts assets and liabilities to FMV. • Assets – Liabilities = Net Asset Value. • Include all assets in determination. – Not just assets on financial statement. – However, calculation of intangible assets is difficult. • Perhaps not the best method for calculating going business concerns (value of business looking forward). September 8, 2015 Overview of Buy-Sell Agreements 97

Market Approach • Seeks to establish value of business by utilizing market comparisons. • What have similar businesses sold for relative to a comparable variable (sales, net income, earnings, etc.) • Requires the existence of other like-kind business for proper comparative calculations. • Utilize database and trade organization information. September 8, 2015 Overview of Buy-Sell Agreements 98

Income Approach • Values company by estimating future earnings and converting the estimate into a present value. – Based upon investor’s required rate of return and risk of investment. – Net cash flow is typical measure of earning power. • Attempts to quantify the concept that the true value of a business lies in part upon future earnings and wealth. September 8, 2015 Overview of Buy-Sell Agreements 99

Preparing for a Business Valuation • Allocate sufficient time prior to the need of the business valuation. • Locate a certified and accredited professional. – Attorney – CPA – Certified Valuation Analyst • Bookkeeping and accounting should be in order. • Be prepared to educate the professional regarding the unique characteristics of the business. • Work with your professional in a transparent and forthright manner. September 8, 2015 Overview of Buy-Sell Agreements 100