Rich Niche – Greet Need
The United Stateshas more than 28 million businesses. And the life-span of a family-owned business is 24 years, which could mean a long-term and mutually beneficial relationship for advisors.
Plus, 88 percent of family-business owners believe their family will still be controlling their business in five years, according to the Family Business Institute. But, sadly, the statistics tell a different story.
They show that only about 30 percent of family businesses survive into the second generation, 12 percent continue into the third generation and only 3 percent will make it to the fourth generation and beyond. Research shows that family-business failures can be traced back to one factor—a lack of family-business succession planning.
What does this mean to us as financial advisors? It signifies a big opportunity in the business-owner market; business owners and their families represent a large and ever-growing affluent market. It is an identifiable market that needs what we offer—good advice and life insurance products that solve their biggest succession-planning issues. And, this is a market open to our message if we tell our story with passion and enthusiasm.
During meetings with business owners, it is important to share stories about great women and men who poured their hearts and lives into building their family businesses. This is the “American dream”—to build a great business for loved ones and family to benefit from. But, we all have heard horror stories of businesses that have vanished almost overnight due to the (preventable) devastation caused by death, disability or family infighting.
There is no shortage of excuses; people will say they are too busy, too young, too challenged right now, or even “don’t worry, I will get around to it someday when the time is right.” These delays are horribly regrettable when the inevitable occurs. I do not want my clients to make those mistakes. You need to convince your clients that it is critical to their businesses and families to plan now.
The result of not planning is family pain. Our job, as financial advisors, is to talk about that pain in such a way that the business owner cannot ignore these issues. Because once they realize these are serious problems, they will take action. So then, what issues do business owners face? Business owners look at succession and continuation challenges such as: Who will take over my business in the future? What will I be paid for my business if I am alive? What will my family get if I die while I am still working in my business? And—why are life insurance and disability products the right tools to get the job done?
Life insurance and disability products are ideal tools for family-business owners to use because they serve multiple purposes and effectively fund some essential components of a succession plan. Here are three of the ways you can utilize life insurance when creating a plan for your client:
Funding Buy-Sell Agreements
Buy-sell agreements spell out what should happen when business owners die, become disabled or retire. Provisions in these agreements state who the stock of the deceased is sold to and at what price. Since many businesses lack liquidity, life insurance and disability insurance are good products to fund buy-sell agreements. Without properly structured life insurance and disability a buy-sell agreement by itself will not do the job. It is like expecting a car to take you to your destination without fuel.
We all know that permanent life insurance is the best solution for funding a buy-sell agreement. However, we also know that most of the CPAs reviewing our proposals tell the clients to buy term life because it is cheaper than permanent.
One way to bypass this objection is to propose buy-sell life insurance that not only provides the death benefit that is needed buy also will fund the retirement part of the buy-sell agreement. This is a buy-sell plan that also has supplemental retirement plan benefits and can be done using a three-step approach:
- Set up a Section 162 bonus arrangement between the company and each business owner. This bonus is tax-deductible to the business and taxable income to the recipient.
- Have the client’s attorney write the buy-sell agreement between the owners. If it is a cross-purchase agreement, each business owner agrees to purchase the other owners’ shares at their death.
- Have their attorney draft a private endorsement split-dollar agreement between the owners. In addition to paying income tax on the company bonus there is annual tax on the value of the economic benefit from the endorsement split-dollar benefit. This tax is spelled out in Table 2001 rates, which are contained in Notice 2002-8.
Who are the best candidates for these types of plans? Business owners who need to accumulate assets for retirement and also need assets to fund their buy-sell agreement. Or they can be businesses that already have a buy-sell agreement that is unfunded or funded with term life insurance.
With a flat stock market for the last decade and real estate in the doldrums, life insurance can be viewed as a safe harbor asset class. By utilizing the tax advantages of life insurance, such as tax-free inside build-up of cash and tax-free access to cash values when structured properly, life insurance is a good vehicle to provide supplemental retirement income.
Funding Key Executive Plans
Protection and incentive plans are needed to keep good employees working happily and at the same time protect the business. Life insurance can restore the financial loss to the business resulting from the death of a key executive. Financial loss to the business from the death of a key employee can be quantified into:
- Recruiting fees to find a replacement.
- Costs of training the replacement.
- Loss of profits during the hiring and training of a new key executive.
Golden handcuffs: This is a permanent life insurance policy that provides both death and living benefits. Should the key executive leave the business before the time specified in the agreement, the key executive walks away with nothing, leaving a valuable, cash-rich policy to the business ownership group.
Golden parachutes: When the key executive fulfills the terms of the agreement they get the policy with the cash or they get a supplemental income (deferred compensation paid to them over the number of years and for the amount specified in the agreement.).
Additional opportunities for life insurance to fill business owner needs:
- Collateral for loans from commercial and private lenders. Lenders are betting the owner will have profits enough to pay them back. That will work if the business owner doesn’t die prematurely. That is where life insurance is needed.
- Estate Planning —Allows for charitable gifting replacement. Life Insurance can also provide funds for low cost Federal Estate Tax payments.
- ESOP Repurchase Liability —Cash to fund the repurchase liabilities of ESOP stockholders.
- Personal life insurance needs of business owners and key executives.
To summarize, there is no better market for the career advisor than the business-owned market. Business owners are affluent, have the need for life insurance and disability products and can be seen during daytime hours. Best of all, they make decisions—because that is what they do all day, every day.
The decision to hire a financial advisor to do their business planning is the best business decision they will ever make for themselves, for their families and for their businesses.
My question is, are you that advisor? Are you ready to be the advisor that will save the family business, save the family from feuding and save the employees’ jobs?
Irving R. Katz, MBA, MSFS, CLU, ChFC, a family business coach at Katz Financial, is a life member of Million Dollar Round Table (MDRT) and an author.