Add Value Today By Helping Small-Business Clients Plan Tomorrow

By Jill Perlin

Small businesses (those employing fewer than 500 workers) comprise more than 99.9% of all employer firms in United States, according to the U.S. Small Business Association.

Yet only 27% of affluent small-business owners have a formal business succession plan, LIMRA reports. And 70% of family-owned businesses fail to transition to the second generation, the American Bar Association says.

Why such a precipitous drop-off?

The truth is that small-business owner clients recognize the current benefits that the business provides to them and their families, and understand the need to recruit and retain top talent. But many small-business owners aren’t sufficiently planning for the future.

As a trusted advisor, you can help add value to the client relationship and to your client’s business by helping them develop a plan for the future that addresses both their expected and unexpected needs. Such a plan can ideally:

Create a market for the business when an owner exits.
Minimize disputes among owners.
Prevent unwanted transfers of the business.
Fix the value of the business for estate tax purposes.
Provide liquidity.
Support talent recruitment and retention efforts.

Business Continuation – Buy-Sell Agreements

Many small, family-held businesses fail to survive beyond the first generation because the owners neglect to plan for the disposition of the business at their death or retirement, or if they become disabled. In addition, a small-business owner may depend on the talents, managerial skills and experience of a key employee.

If that key employee is lost because of a disability or death, the financial loss to the business can be devastating. Creditors may become nervous about continuing to extend credit. The goodwill that the owner has worked so hard to establish may be diminished by a change in management. A buy-sell agreement is a commonly used tool for this planning that can help:

Increase the business’s ability to prosper after major life events.
Preserve ownership control.
Provide continuity of management.
Convert unmarketable stock into cash.
Establish a fair and reasonable price for the business.
Help fix the value of a decedent’s interest for federal estate tax purposes.

There are several different types of buy-sell agreements – entity/stock redemption, cross-purchase, one-way and wait-and-see. The agreement can be tailored to provide solutions to each of those needs.

A lot depends on the structure of the business and the number of owners/shareholders. Each type of agreement has advantages and disadvantages in any given situation. It’s important that you understand which agreements best fit the client’s particular situation.

Executive Compensation - Nonqualified Deferred Compensation

Running a business also involves attracting and retaining key people. Having the right executive compensation in place can help.

A common tool used is a nonqualified deferred compensation arrangement. In its simplest form, it is an unfunded, unsecured promise to pay a stated dollar amount at some point in the future. Although nonqualified plans do not offer the same tax advantages as qualified plans, they do have many benefits. They:

Do not have to include all employees and can be offered only to key executives.
May be individualized to meet the specific needs of a key executive.
Can be designed to replace deferrals lost to qualified plan limitations.
Require no complicated government testing or reporting.
Are not subject to the early retirement tax penalty.

Funding A Plan With Life Insurance

There are a number of ways to fund buy-sell and nonqualified deferred compensation agreements. Life insurance is one tool that is frequently used.

It covers the risk of premature death by providing an immediate death benefit, as well as income-tax-deferred cash value growth and tax-favored withdrawals and loans. In addition, the death benefit is generally received free of income tax.

When structured properly, life insurance can help provide the confidence that funds will be available to complete a buyout. Life insurance can also help a business meet debt obligations, offset lost sales or cover the expenses associated with recruiting, hiring and training a replacement for a key employee.

How You Can Help

You can help your small-business-owner clients by ensuring they are making the key decisions today that will help ensure their businesses’ future as well as their families’ financial wellness. Ask them the following questions.

Could the business continue without them or another key person?
If they sold the business today, could they get the value they want?
Will their family have financial security if something unexpected happens to them?
Are they counting on the business for retirement income?

They’ll be glad you asked!

Jill Perlin is vice president of advanced markets with Prudential. Jill may be contacted at [email protected].