Business Continuity Planning
Purpose of Advanced Planning
An advance plan that specifies the terms by which a business owner’s interest is transferred in the event of:
Retirement of a Shareholder
Dissolution or Sale of Business
Death of a Shareholder
Disability of a Shareholder
Advantages to Deceased Business Owner’s Family
Protects the interests of the shareholder’s family.
Family receives a fair, predetermined price for the business.
Family free from business concerns.
The probate process settled more quickly because there is a value established.
Advantages to Surviving Shareholders and Business
Timely transition of ownership
Effective business management
Payment terms for sale predetermined
Methods to Fund the Purchase for Death, Disability or Retirement
From business cash flow
Establish a sinking fund
Types of Buy-Sell Agreements
Corporate Stock Redemption
Wait & See Plan
Funding the Plan with Insurance
- Key Person Insurance
- Executive Benefit Life Insurance *
Voluntary Income Protection *
* Fringe Benefits
Insurance Ownership Arrangements
Corporate (or Entity) Owned
Third Party Ownership
- General Partnership (see Below)
- Trusted Agreement
- Trust Ownership
- Welfare Benefit Plan
Valuation of a Closely Held Business
Revenue Ruling 59-60, issued by the IRS in 1959, outlines eight factors to be considered in valuing a closely held business. These factors are the basic guide employed by the IRS to accurately determine the value of a business. The factors are:
- Nature of the Business and Its History.
- The Economic Outlook in General and for the Specific Industry in particular.
- The Book Value, Adjusted Book Value and the General Financial Condition.
- Earnings Capacity.
- Dividend Paying Capacity (not dividends actually paid).
- Recent Sales of this Business Interest and the Size of the Interest Valued.
- Market Price of Similar Publicly Held Business.
Although Revenue Ruling 59-60 has established the factors to be considered in valuing a closely held business, the valuation process is not a science.
Fair Market Value
The IRC Regulation Sec. 20.2031-1(b) defines the fair market value as the price at which the property will change hands between willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts.
The book value of a business is determined by the review of its balance sheet that shows the business' net worth; its assets less its liabilities. This value may be artificially low since normal accounting methods require the assets of a business to be valued at historical cost reduced by depreciation. It is rare that the book value of a business accurately reflects its true, fair market value.
Adjusted Book Value
The adjusted book value of a business begins with book value and various adjustments are made to accurately reflect the current value of the assets. This is accomplished by subtracting the historical cost of the assets from the balance sheet and adding back in the fair market value of the assets. These adjustments result in the liquidation value of the business. The adjusted book value is more indicative of the value of a business than the book value, but is not the most accurate method in determining the true value of a business.
Capitalization of Earnings Method
The CEM is based on a simple ratio, which consists of company earnings and capitalization rate: Earnings / Capitalization Rate = Value of Business.
The Use of a General Partnership in Business Continuity Planning
The use of a General Partnership, the benefits of both an entity purchase and a cross purchase are available without the drawback of either method. In addition, the partnership funded buy sell provides several other benefits that other types of arrangements do not.
Some of the advantages of this arrangement include:
- General Partnership can fund buy-sell for multiple entities.
- Complete flexibility in the allocation burden of premiums paid among the partners.
- No life insurance transfer restrictions.
- Assets accumulate tax deferred and may be accessed tax free in retirement.
- C-corporation may distribute surplus as part of buy out tax-free.
- Death benefit paid to the partners’ income tax free.
- Policy cash values and death benefits protected form corporate creditors.
- Policy cash values protected from personal creditors.
The business purpose of the general partnership is to provide for business continuation and to accumulate additional money to enhance the partners’ retirement income. In the event of the death or disability of a partner, the interest of this partner will be transferred to the partnership. In exchange, the partnership will pay the disabled shareholder or deceased partner’s estate the amount equal to his interest in the business as described in the business continuity agreement.
It is vital that the new general partnership be coordinated properly with the business continuity agreement.