Tuesday, July 28, 2009

Is There Such a Thing as Being Too Responsible?

Is there such a thing as being "too responsible?" Is there such a thing as being "too cautious?"

Well, it depends on the consequences. For instance, in firearms training, students are taught to be extremely cautious and responsible, as the consequences of mishandling a firearm can be, and often are, deadly.

To answer the question "How much responsibility is enough?” we have to understand what the consequences are of not being economically responsible.

What do we know about life? We know that it rarely goes as planned. We know that not everyone lives to an advanced age. We know we can't really predict the future. We don't know what the driver in the next lane or the next mile is or will be doing. We don't know if our company will get bought out. We don't know if our knowledge or functionality will become obsolete. We don’t know if there is a stray virus hanging around somewhere. We do know there is so much out there that is out of our control.

We know that bad things happen to good people.

So, the consequence of not being prepared, of not living economically responsible, has high consequences at times. Not everyone will die early and suddenly. Not everyone will become disabled. Not everyone will loose a job. But, like the consequences of mishandling a firearm, when these things happen, and they do happen, the consequences can be devastating.

In light of the nature of life, it makes sense to create a minimum level of precaution. I love that word, precaution. It's "pre-" and "caution:” being careful ahead of time. The time to be cautious when handling a loaded gun is before it goes off, not afterward! The time to put mechanisms in place to handle the crises that are an inherent part of life is before they have a chance to happen, not afterward.

At a minimum, it's my opinion that everyone who has people depending on his or her paycheck out to have enough life insurance so that the survivors can live indefinitely with out having to touch the principle. Or at least enough income for the dependent children to grow up. And, since people can loose jobs, it makes sense to have 6 months worth of income socked away too.

Overly cautious? It depends on if you're going to be one of the people who won't make it to old age, or looses a job. We just don't know. We just don't know when that firearm might discharge.

There are other precautions--being careful ahead of time--which I think are important: no consumer debt. No credit cards. No car loans. I know, not everyone is willing to do that. It's inconvenient and gets in the way of our desires. We all have a long "want list." I want a new car. I want a nice vacation this year. I want a new set of clothes. I want to eat out at a nice restaurant. Funny how those wants fade into insignificance when life gets tough.

Bottom line: the consequences of mishandling life can be tremendously painful and devastating. Being careful before you have to be creates a powerful safety net that is not wasted and, if needed, is indispensable.

Thursday, July 16, 2009

At The Risk of Sounding Like a Scratched CD....

OK, I was going to title this blog "At the Risk of Sounding Like a Broken Record", but thought that would completely date me as so 1960's. But then, come to think about it, referring to a scratched CD is so 1990's. What do you call it when an MP3 player hits a bad track?

Anyhow, maybe my cliche's are a bit dated, but the focus of keeping more of your money in the face of big government spending is very timely. The latest cost for the universal health care bills in Congress is $1,500,000,000,000. That's $1.5 Trillion. And that only goes out 10 years. Add on top of the "bailout spending in the past year at 3.5 Trillion (http://forums.qrz.com/showthread.php?t=182335 referencing www.bailoutsleuth.com) and we are talking about more than a third of the GDP.

The money has to come from somewhere. That means taxes, levies, and fees. And with the battle in congress indicating that "everything's on the table" (it was a sound bite of one of the politicians who was being interviewed), I take that to mean that the every source of revenue that is politically acceptable will be looked at to fund these expenditures.

The signals to me can't me any clearer. The time to lay the ground work for sheltering our income from the needed tax increases is now. You will need time to plan and execute a strategy. You will need time to meet with your tax advisor or accountant. If you and I wait until taxes are higher to start, it will already be too late.

What am I doing? Well, as a business owner, I am taking advantage of the IRS rules that allow me to have a Keogh plan, sheltering up to $49,000 of income from taxes. I also have an IRA, and a deferred annuity.

Since I need life insurance anyhow, I have a return of premium policy, also called a "cashback" policy. Sure, I'm paying almost twice what a regular term policy is. But if I bought just a term policy and invested the difference, I would have to get about 7.8% interest tax free. That's just not likely in this environment. I will get back all my premiums (if I'm lucky enough to live to the end of the term) and won't pay taxes on that since it will be considered a return of my own money and not capital gains or interest.

The bottom line for me: spend less, shelter more. Think about it like this: if I can shelter $1000 from taxes, and I'm in a 33% tax bracket, I automatically have made 33% on my money (because I'm avoiding $330 in taxes). To me, that's economically responsible.

Tuesday, July 14, 2009

Gifting to Non-Profits, Part 2

I had the pleasure last week to meet with an attorney who specializes in helping non-profits run more effective business organizations. The attorney's name is Carlye Christianson (carlye.cb@cox.net). We shared the perception based on common experience that many non-profits are good at their mission, but often are less than stellar at constructing an organization to support that mission.

During our discussion, Ms. Christianson shared with me a surprising statistic: more than 85% of non-profits have an annual revenues of $1,000,000 or less. But then when I thought about it, most of the non-profits I've been involved with fall into this category. And probably most U.S. businesses have annual revenues of less than a million too, since most US businesses are small businesses.

Of course, Ms. Christianson's practice is to assist the non-profits get the most out of their operating funds. Look at it this way: if she can get a $20,000 efficiency out of the operations of a $500,000 annual budget, she has just effected a 4% increase in available funds. That's economic responsibility: using what we have for better results.

Of course, I operate on the supply side. On of my favorite seminars is on Charitable Giving. Without expectation, I have helped host charities increase their revenues by showing individuals how to use the tax code to subsidize their gifts at 100% to their estates.

The bottom line for me: non-profits are a critical element in our society. They perform a service that government or single individuals can't do or can't do well. They are formed and staffed by people who are passionate about what they do. We need them and their work. Helping them more fully achieve their mission is part of what it means to me to be "economically responsible."

Thursday, July 9, 2009

Business Continuity, Part 3

Paving the Way for a Smooth Business Transition

Dan owned a paving company. He started it 35 years ago with a used dump truck, a used paver, and an old steamroller he bought at an auction. Now, he has 15 dump trucks, four pavers, six flat beds, three graders, a couple front-end loaders and a half a dozen pick ups, and some other miscellaneous equipment. His three sons in their 20’s work in the business. His wife died of a heart attack three years ago. Dan is 56 and is making plans to pass on the business to his sons.

His attorney and accountant valued the business at $9,500,000—assets minus liabilities. Dan was shocked to learn that the estate tax bill would be something like $5,500,000 if he were to die before his sons owned it. He and his attorney put together a plan so that the three sons would be equal 30% owners in 10 more years. Dan wanted to keep 10%. His concern was “What if he died prematurely like his wife did?” The son’s would be hit with a huge tax liability. Maybe they could borrow the money and pay it back over 10 or 15 years. If so, the total cost would be around $8,000,000, maybe more. Maybe the IRS would let them pay it back over time, at 6% interest. Again, we’re talking millions of dollars.

If they couldn’t do either, they would have to sell the business. In such a time, they would have to get out of it what they could, and it wouldn’t be close to the full retail figure. Again, millions of dollars lost.

That’s when he called me. We put together a 10-year term policy for $6,000,000. Why the extra $500,000? The sons weren’t in a position to run the company themselves at the present. So Dan wanted extra money to hire a COO while his sons made the transition to business owner. It was all spelled out in the transfer documents drawn up by the attorney.

What did such a huge policy cost Dan? Would you believe $19,900 a year? That may sound like a lot, but remember we’re talking millions of dollars that are at risk as an alternative. As Dan said, “That’s not even the cost of a pick up truck.”

So, in 10 years, Dan will pay out a total of $199,000 in premium to protect his business from more than $5,000,000 in estate taxes. He is paying that to protect his legacy, and provide a lifetime of income for his children, and he hopes his children’s children. As he said, “That’s not even the cost of a couple dump trucks. That's well worth the cost of making sure I can pass intact what took me my whole like to build to my three sons and their children.”

To his credit, he paved the way for a smooth business transition.

Wednesday, July 8, 2009

Business Continuity, Part 2

In my previous blog, I laid out the case for business owners to save hundreds of thousands of dollars by funding their business continuity through life insurance. The following is a case study of what happens when there is no planning and no life insurance.

"Restaurant Partners"

It had been 5 years since I had seen a former coworker, Jen. She was in her mid-30’s when she left the company I was working at, and had started a pizza restaurant with a family friend who was 15 years her senior. He owned 51%, she 49%. Now, Jen looked like she was in her 50’s. I asked her how her restaurant was. I knew it was next to the campus of a big university—25,000 students. “Busy,” she said. “Too busy.”

“Great!” I said. It must be nice to have a place that is so successful.

“Not really,” she said. Then she explained. Her partner had a heart attack and died 2 years before. He was the kitchen manager. She was the business manager. Now she had to do it all, and was working 70 and 80-hour weeks.

“Why don’t you just hire someone to be the kitchen manager?” I asked.

“I can’t,” she said. “I don’t have enough funds.”

“Wait a minute. I thought you said the restaurant was doing very well.”

“It is. But Joe was married, and his wife is now my partner. She’s not doing any of the work, and expects half of the profits. She got a lawyer, and I fought it in court for a while, but I’m stuck with her. So I’m doing my job, Joe’s job, or now his wife’s, and I’m only getting half the profit. I’m stuck.”

This encounter with a former coworker demonstrates a common example of the often-ignored need for business continuity planning. People go into business because they’re good at something, and don’t’ think to make plans for the business to survive them or their partners. And they end up in a bad situation.

Facts are, businesses represent the major asset for business owners and their families. Jen had put a lot of money into the business, as had Joe. It was her only source of income. It represented her largest asset as well. Furthermore, I guess I couldn’t blame Joe’s wife for wanting to hang onto the business. She essentially had no job skills, and the restaurant was her meal ticket. She was entitled as Joe’s survivor. But the lack of a plan left Jen in a world of hurt.

What were Jen’s options at this point? She could just walk away, but she would be liable for half of the businesses debts. This would cost Jen hundreds of thousand of dollars.

The business could be sold. Jen wouldn’t get nearly what she had invested for the restaurant equipment. I don’t know how she would have fared on the sale of the commercial space. But it could have taken a lot of time to sell it. Plus there’s the cost: broker’s fees, etc. There might even be a legal dispute between her and Joe’s wife. Besides, she was now the majority shareholder, which left Jen in a vulnerable position. So again, this decision might cost Jen tens or hundreds of thousand of dollars.

A third option would be for Jen and Joe’s wife to come to terms of a buy out agreement. Then Jen might be able to borrow the money to pay her new partner off. But again, it’s a long a complicated process to properly evaluate a business and complete the sales process. This process costs thousands of dollars and takes time. What would happen to the profitability of the business while Jen and Joe’s wife and fighting over that? Would there be much left to run? Furthermore, the cost of borrowing the money for the buy out would be substantial. Tens of thousands in interest. And even after that happened, Jen would not be in a position to hire a kitchen manager. She would have the additional overhead of the loan to service. She would have to run the whole show herself for some time afterward.

Jen had no good options. None that weren’t very costly either.

I didn’t go into the “why didn’t you” mode with her. It was water over the dam. But I was thinking it. A business continuity plan, and life insurance on each partner, would have been by far the cheapest and most effective solution, had Jen and Joe done it when they started the partnership and the business.

Here’s how it could have worked. Jen and Joe start the business, and each buys a life policy on the other, in the amount that represents their share of the value of the business. Say the business is worth $750.000. Jen would buy a life policy on Joe for $382,500. Joe would buy one on Jen for $367,500. That way, if the other dies, the survivor would buy out the survivor’s beneficiaries with the proceeds. Of course, this would have to have what’s called a “Buy-Sell” agreement in place too. The other thing is that both Jen and Joe would need to re-evaluate the value of their business regularly to keep the agreed to purchase price current.

The cost for all this? When I ran illustrations for a “What If” scenario, I came up with $529.00 for Jen and $1604.00 for Joe at the age they were when they started the business. That’s a little over $2100.00 a year.

Clearly, life insurance to fund business continuity plans is always the least expensive option financially. And, as we can see from this case, it is also the least expensive emotionally.

Planning For Your Business to Survive

Business owners pour their lives into their businesses. The business becomes more than just a way to earn a living. It is a way of living itself. It is often an extension of the person and their life.

If it were easy being in business, everyone would do it. However, small business is the backbone of our economy. I’ve read statistics from the US Department of Labor that more people are employed in small businesses than all the Fortune 500 businesses combined. I’ve also read that small businesses contribute more to the GDP than all the Fortune 500 companies.

So small business isn’t so small. Not for the business owner. Not for our economy.

It’s a puzzle, then, why so many small business owners don’t plan for their businesses to out live them. In an informal survey, I asked 50 business owners what their business continuity plans were. A full 45 didn’t even know what that was. The other five thought I was talking about disaster planning.

The survivors, which would include partners if there were any, of a business owner only have 3 basic choices when there is a lack of business continuity planning.

1. Liquidate the business. This is probably the most expensive option, literally costing hundreds of thousands if not millions of dollars. Those who have a financial stake in the operations loose all the future income from the business. They are also giving up much of the business’s present value.
2. Take over the business operations. One of the problems with this is that if the survivors were suited to be in the business, they would have been the business owner and not sitting on the sidelines. I’ve seen several family owned businesses run into the ground this way. This is a costly option, not only in losss of future income, and reduction in present value, but also in terms of emotional stress. If the survivors hire someone to take over the functionality of the business owner, there is the cost of that person’s salary. They probably won’t work for the same salary as the business owner. Cash flow can be a big problem here. Often times, borrowing funds is necessary, if they can be found. This adds to the expense of taking over the business.
3. Sell the business. The problem here is that it can take a long time to sell a business at full price. So to affect a quick sale, the business and its assets are often sold at a discount. Again, this is very costly, in the hundreds of thousand to even millions of dollars.

The least expensive method—by far-- of ensuring business continuity is to provide insurance on the life of the business owner(s). It comes out to less than a penny on the dollar to the other options.