Exit Planning--Structured Financial Partners: Building value for your company's tomorrow ℠

What is a TCLAT and should you even care?

My partner was at a meeting this morning where her reputation had preceded her. She was accosted by an attorney who by way of introduction said, "You're Susan Laine, you do Exit Planning. You must use TCLATs in your practice…" Susan just stood there and allowed him to continue. "What about 368…?" He continued. Susan knew, of course, that these were tools that might be used by a business owner in his or her planning. A Testamentary Charitable Lead Annuity Trust or TCLAT is a trust which may be created by a living trust or will which requires the trustee to make a stream of payments to a charity (for which it gets a tax deduction) and at the end of the trust period pays out to a family beneficiary. The "368" the attorney referred to is Section 368(a)(1)(A) of the Internal Revenue Code which allows for tax-free treatment of certain mergers and reorganizations.

All this is immaterial when put in context. Exit planning is not about the tools we use. It is not about the hottest new asset protection trust or captive insurance company. Exit planning is not about buy-sell agreements whether or not funded with life insurance. It is not about ESOPs. All these things are tools. Just like "368," TCLATs, 83(b) elections, SARs and Phantom Stock. Until we know the specs of the job TOOLS AND TOOL VENDORS are immaterial. Some professionals (accountants and attorneys) get enamored with a certain planning technique or product and push it as aggressively as any salesperson.

Imagine you're building a custom house. As you sit down with your architect, you ask the architect what kind of nail gun the general contractor's carpenter is going to use while framing the house. That is what this attorney looked like to Susan. Like the architect, with each client, we develop a plan—a blueprint. And for each client we assemble a team of professionals who will work together to execute the clients wishes. Each team has a CPA and one or more attorneys, and other team members will be added as the project dictates. But NO ONE comes to the table with a preconceived notion of what tools will be used.

The importance of buy-sell agreements

In a corporation with more than one owner, there is no business document more important than a shareholder's agreement, more colloquially known as a buy-sell agreement. Yet, in our Exit Planning practice, it is shocking how often we find successful companies, with intelligent co-owners deficient in this area.

The buy-sell agreement has been likened to a business will or a business pre-nuptial agreement. And for good reason…

I was called in not long ago to meet with two owners of a commercial refrigeration company. They told me they DID have a buy-sell agreement, but their insurance agent said they should review it. They we're really keen on the idea, but one of the partner's $250,000 term insurance was up for renewal, so they had to at least look at the agreement. The agreement was written 20 years ago, when they guessed the business was worth $250,000. They guessed it was currently worth $2 million.

When they gave me the file, the first thing I saw was a life insurance company's SAMPLE buy-sell agreement. These are used to give to an attorney as a guide to help them with their own drafting. It is not uncommon, however, to see lazy agents and cheap clients just filling in blanks and signing them to avoid paying attorneys…I pointed out that this one was not signed. "Oh no," Eddie, the older owner said, "that was too complicated. Here it is." And he proceeded to pull out a one page document. It said "BUY-SELL AGEEMENT" across the top, but other than that, it wasn't. They wrote it themselves. It said a few things about the disposition of the life insurance policies, (which weren't owned by the corporation, so it had no authority over the proceeds) and DIDN'T MENTION A WORD ABOUT THE PURCHASE OR SALE OF STOCK. I tried to help these two gentlemen understand that this document would not help and, in fact, was an invitation to expensive litigation on behalf of the surviving spouse of the first decedent's spouse. But my message went unheard.

Buy-Sell agreements are only important if something bad happens.

Here are the things to consider: You die. Your partner dies. You get sick. Your partner gets sick. Okay, I'm going to stop the repetition here because you get it. Your partner's wife gets cancer and he wants to quit to be by her side. Your partner gets divorced and her lawyers want the company sold to pay the divorce settlement. You and your partner can't stand the sight of each other and one of you has to go.

The Four Phases: Phase Three—Putting the House in Order

To review what we've done so far in the process, in phase one, by framing the issues, we have really dug down deep and built a foundation in the owners objectives. She has told us how much longer she would like to work in the business. We have done some analysis to determine how much income she needs from the sale of the business to meet her income needs in retirement. And we have an idea as to whether she wants to sell to third parties or insiders. In phase two, we have focused on the systems and people that will make the business more valuable in the eyes of the buyer.

Now in phase three, we must look to protect the value of the business and do some planning to coordinate this exit plan with the owner's personal estate plan.

In phase two we talked about how important the CPA is, here in phase three the attorney becomes important. If the owner has already done some estate planning, that existing planning will need to be reviewed in light of impending sale of the business. Certain planning steps may be taken prior to sale for income OR estate tax shifting.

Other things that need review during this phase are shareholder (buy-sell) agreements for co-owned business. A well written buy-sell covers not only death of a shareholder, but other triggering events such as: divorce, irreconcilable differences between shareholders, retirement. It should also have a valid valuation formula.

Likewise, leases and other legal obligations should be reviewed and deemed clear of any possible obstructions to a sale.