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1 Prepared for Smith & Jones, Inc. On 05/18/2009 Prepared by Aviva Life and Annuity TABLE OF CONTENTS Needs Analysis Buy-Sell Agreement Four Ways to Pay Action Plan Report Benefit Report Cross Purchase Report No Agreement Scenarios The information and conclusions contained herein are not offered or intended as legal or tax advice. Providing such information does not create a fiduciary relationship. This material should be used in conjunction with competent legal and tax advice in your financial and business planning. May 18, Version:

2 A t the retirement, death or disability of a business owner, their interest in the business can be preserved and passed on, or it can be liquidated for less than its fair value. It can even shrink to almost zero value before going to the owner s heirs. In large part, preservation of the value of the business and orderly passage of control will happen because the owner(s) chose to plan carefully for this transition. A Buy-Sell Plan. While a business interest can be successfully passed by will in some cases, a well thought out and fully funded buysell plan is a much better way to assure the business interest will be passed on, at its full value. A good buy-sell plan will meet these objectives: Preserve the business as a successful concern, for the benefit of its owners, employees, customers, and creditors. Maximize the value to the owner or the owner s heirs at the time of transfer, by assuring that the interest is transferred for a fair price. Minimize transfer taxes; a well planned business continuation plan is a critical element in a good estate plan. Smooth the change of ownership, which often involves family members. An existing plan can reduce emotional stress at the death or retirement of a senior family member from a business. Smooth the change of management; sometimes the disruption at the unplanned sale of a business interest can make employees, customers and creditors uneasy. A well planned and fully funded transfer of ownership can make the change in management more comfortable for the other people involved. This report shows the type of agreement selected for your business continuation plan, the way it works, and an estimate of the funding required to make the agreement work. Implementation of the agreement will require legal documents and the services of your attorney. May 18, Version:

3 Summary A careful plan for business continuation in the event of ownership death begins with an overview of the current situation. Basic Information: Smith & Jones, Inc. Estimated Business Value $7,000,000 Corporate Tax Bracket % Owners John Smith Shares/Percent of Ownership Barry Jones Shares/Percent of Ownership Assumptions: Forced Liquidation Value % Bank Lending Rate % Number of Years Installment Purchase Rate % Number of Years Funding Alternatives (cost per dollar): Liquidate Assets $1.25 Borrow the Money $1.32 Pay Heirs Equal Installments of Principal $1.29 May 18, Version:

4 There are two types of Buy-Sell Agreements: Entity Plan The business is the buyer; it is the owner, premium payer, and beneficiary of life insurance. There is one policy per owner. The remaining owners do not get an increase in cost basis. Works well with larger numbers of owners. Usually not appropriate for family-owned corporations, due to attribution rules. Cross Purchase Plan Each owner owns life insurance on all other owners. The policy owners are the beneficiaries and premium payers. The business may participate in payment of premiums via executive bonus or split dollar arrangements. There is an increase in cost basis for the surviving owners. With larger numbers of owners, there will be many life policies required. Non-Proportional Cross Purchase at the death of John Smith Barry Jones Division of Ownership Shares/Percentage Funding Required $3,150,000 Non-Proportional Cross Purchase at the death of Barry Jones John Smith Division of Ownership Shares/Percentage Funding Required $3,850,000 There are two types of Buy-Sell Agreements: Entity Plan The business is the buyer; it is the owner, premium payer, and beneficiary of life insurance. There is one policy per owner. The remaining owners do not get an increase in cost basis. Works well with larger numbers of owners. Usually not appropriate for family-owned corporations, due to attribution rules. Cross Purchase Plan Each owner owns life insurance on all other owners. The policy owners are the beneficiaries and premium payers. The business may participate in payment of premiums via executive bonus or split dollar arrangements. There is an increase in cost basis for the surviving owners. With larger numbers of owners, there will be many life policies required. May 18, Version:

5 1 Liquidate 2 Borrow 3 Installment 4 Life Assets If you sell business assets to buy out the deceased owner......and in a forced sale the assets' value shrinks to 80.0% of its current value......then each dollar of ownership interest purchased will require the sale of business assets worth $1.25 A forced sale to fund a buy-sell can be very costly the Money You can borrow money from the bank and pay surviving heirs outright... Assumed Interest Rate: 8.0% Number of Loan Years: 10 Business Tax Rate: 34% Each dollar of ownership interest purchased with borrowed money will cost: $ but will you be able to borrow enough? The lender may require a lien on the business which could restrict future borrowing. Assumes level annual payments, interest is deductible and accrues each year on outstanding balance. Purchase You can pay the surviving heirs installments over a period of time... Assumed Interest Rate: 8.0% Number of Annual Payments: 10 Business Tax Rate: 34% Each dollar of ownership interest purchased with installment payment will cost: $ but will you have sufficient cash flow with one of your key owners gone? A lien may be required against business assets. Assumes decreasing annual payments, interest is deductible and accrues each year on outstanding balance. Insurance You can purchase the ownership interest with the death benefit from a life insurance policy which can significantly reduce total outlay. Benefits may be income and estate tax free, and the funds are provided when needed. Pay Premium Before Death Use Death Benefit To Buy Ownership Interest The average cost is $0.40 to $0.60 per dollar. Individual premium amounts may vary depending upon age, sex and health condition of each person insured in the buy/sell agreement. May 18, Version:

6 Take action today to protect Task Assigned to Target Date Establish the value of the business Decide the structure of the agreement (entity vs. cross-purchase) Draft and sign the buy-sell agreement Fund the agreement with life insurance Implement disability buy-sell funding if appropriate Review / revise each owner's estate plan Advantages of Life Insurance A life insurance policy will provide income tax free proceeds to fund the buy-sell agreement upon the death of an owner, exactly when the money is needed. The ownership of the business will be transferred as planned, with most or all of the cost paid promptly, avoiding the need for long-term financing. The risk that the heirs will not be paid if the business fails is minimized. The business suppliers and creditors will be more comfortable continuing the relationship upon learning that there has been a smooth transition of ownership with little or no additional debt. The amount required to fund the buy-sell will be delivered when needed, regardless of whether the policy has been in force for months or years, at a cost of pennies on the dollar. May 18, Version:

7 Benefits of a Buy-Sell Plan to the Surviving Owners The deceased owner's interest will be purchased for cash. The surviving owners will have an increased ownership share. Management will be free of meddling by heirs or outsiders. Doubly-taxed dividends and impairment of expansion capital will be avoided. The business will not be sacrificed by liquidation. Creditor confidence will continue. Conflicts with heirs will be avoided. Benefits of a Buy-Sell Plan to the Deceased Owner's Heirs The plan guarantees a market and a fair price for their ownership interest. It avoids the serious losses that would have accompanied forced liquidation. It facilitates the prompt and efficient administration of the estate. The family is assured cash or income when they need it most. The 'arm's-length' agreement may establish estate tax value of the ownership interest. Relationships built over time can remain untarnished. May 18, Version:

8 Advantages Increased basis for acquiring owners Avoids family attribution rules Avoids state law redemption restrictions Shareholders can lend proceeds back to corporation Under a bonus plan, premiums can be deducted by C corporation No alternative minimum tax problems Issues Administratively complicated as number of shareholders increase More policies needed Owners may not have funds to pay the premiums Personal creditors may have access to policy cash values Higher cost if corporation in lower bracket than individual shareholders May 18, Version:

9 Situation ABC Company was started in 1989 by five experienced managers. It was growing and profitable, with sales last year exceeding $5 million. Larry, the president, was one of the five founders. He was instrumental in the successful growth of the company, and in maintaining a high level of enthusiasm and cooperation among the other four owners. Larry was also the primary marketing and sales representative; his efforts generated over 80% of the company's revenues. May 18, Version:

10 Unforeseen Event About two years ago, Larry began to experience difficulty with his vision. He went for a routine eye exam, and was referred to a specialist. Test revealed an untreatable brain tumor, and Larry died within a few months. He left a wife and three minor children. Larry's wife Karen now owned a 20% interest in ABC Company. Since that interest did not pay dividends, and she did not have the skill and experience to take Larry's place, she needed to convert her interest in ABC Company to an income-producing asset to replace Larry's income. Also, the value of the business declined at Larry's death, as he had been responsible for much of the income. Problem Karen was in need of income to raise her children, and the remaining owners of ABC Company were anxious to buy her interest and regain complete control over the business' future. The business was appraised, and Karen and the four remaining founders agreed on an installment purchase of her interest by the business. The value was lower than during Larry's life, but there was no other choice for Karen. * Any discounts should be VERY well documented. Consult your tax advisor. Unfortunately none of the remaining owners had the contacts and sales experience that Larry had, and sales and income dropped. The company had difficulty making the installment payments to Karen, and eventually a court battle ensued. Solution If there had been a buy-sell agreement funded with adequate life insurance, based on the value of the company prior to Larry's death, these undesirable consequences could have been avoided. Karen would have been able to sell the interest in the company she inherited at Larry's death for its full value, rather than at a "distress" price. Her future financial security would not have been at risk if the company were unable to make future installment payments. The remaining owners would have had the necessary funding exactly when it was needed, rather than having to mortgage their future to buy Karen's interest in the company. And, their cost would have been just pennies on the dollar. May 18, Version: