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THE SOFTER SIDE Powered By Docstoc
					                                                                                               Strategies for advisors from advisors

                                  By Douglas V. Nelson

                                         THE SOFTER SIDE
                                         The technical features of buy-sell agreements only tell
                                         one side of the story.

                                  One of the most important goals for a
                                  financial advisor working on a buy-sell
                                  agreement for his clients is finding just the
                                  right balance between the softer issues and
                                  the technical solutions. More often than not
                                  we, as advisors, are overly focused on the
                                  technical aspects of the planning process
                                  and on specific product recommendations.
                                  Yet, these recommendations are often not
                                  implemented because of other softer issues
                                  that may influence the client’s decision.

                                  The softer side of the business creates
                                  discussion questions much like these:
                                  a. How important is it that the surviving
                                     spouse be financially independent of the
Illustration by Alanna Cavanagh

                                     business if the key shareholder passes
                                     away unexpectedly?
                                  b. Should those family members not active in the day-to-day       the following two examples.
                                     operations of the business be shareholders?                    Example #1: Dad is a partner in a business with another
                                  c. What strategies can be considered to ultimately maximize       non-related family. Mom is not active in the business,
                                     family wealth?                                                 nor are any of their children.
                                     To see just how significant these questions can be, consider                                           Continued on page 17
Continued from page 15                        be involved in the business. The problem      and Mom’s long-term financial security.
   In most situations, 80% or more of         for Mom is the business does not have            The best way to ensure Mom is
Mom and Dad’s wealth is tied up in the        enough free cash flow to pay her a reg-       financially independent of the business
business. If Dad passed away unexpect-        ular income, buy out her shares over time     is to own enough life insurance, both
edly, Dad’s shares would typically be         or have enough cash to pay another            personally and through the business, to
rolled over to Mom tax free. In many sit-     salary to replace Dad’s.                      make sure she has enough capital
uations Mom would not have enough                In this situation, Mom may feel com-       to maintain the income level she is
personal financial resources to maintain      pelled to be more involved in the busi-       accustomed to receiving.
her lifestyle. Her primary source of          ness to appropriately protect her inter-         Now that Mom is financially secure
income would still be the business, except    ests. Unfortunately, this may cause more      from the highs and lows of the busi-
she may not have the skills or interest to    harm than good to both the business                                    Continued on page 19

                                                  SINGULAR FOCUS
                                   Simple buy-sell plans have more chance of being implemented.

   For many family business organiza-         implemented at all.                            out will typically be funded using life
   tions, there is a tremendous sense of        To keep the buy-sell situation simple        insurance.
   urgency to have a funded buy-sell          and effective, a “Buy-Sell Agreement           Think of this agreement as one of
   agreement in place.The challenge, how-     on Death” could be devised. This            several smaller agreements. Other
   ever, is to draft a simple agreement in    agreement could include the following       agreements could be:
   a short period of time to create the       components:                                 • The Buy-Sell Agreement on Disabil-
   immediate security required by the         • The deceased shareholder agrees to           ity, Sickness and Retirement
   family.                                      sell at the fair market value at the      • The Operations Agreement (who
      In many situations, the development       time of death;                               does what, how the money is divided,
   of an agreement can take on a life of      • The surviving shareholders agree to          how holidays are determined, etc.)
   its own if too many additional provi-        buy the shares at the fair market            Make sure plans are implemented.
   sions are built in.The provisions may be     value at the time of death;               By creating simple agreements with a
   important but they may also delay          • The agreement contains a formula          singular focus the agreement is easier
   implementation. In the worst-case sit-       for establishing fair market value;       to understand for all parties and is
   uation, this added complexity may            and                                       much easier to implement.
   result in the agreement never being        • The agreement states that the buy-                                         —D.N.
Continued from page 17                     reinvested in the company to facilitate       on family wealth. Charitable giving
ness, what should be done with the         further growth.                               strategies in Mom and Dad’s estate
shares? Should she own Dad’s shares or                                                   could be structured to minimize tax
sell them to the other active sharehold-                                                 paid to the Canada Revenue Agency,
ers? Should she own Dad’s shares and          The problem for Mom                        maximize a contribution to a charity
sell them to her children one day? In           is the business does                     and maximize the after-tax benefit to
many situations there is an emotional         not have enough free                       the family. Life insurance could also be
attachment to the shares because they          cash flow to pay her                      used to create additional assets in the
represent the business. Since Dad                                                        estate, increase charitable contributions
worked long and hard to help build the
                                                 a regular income,                       or to pay the tax bill with fewer dollars.
business, many surviving spouses feel it     buy out her shares over
is important that the children be given        time or have enough                       Example #2: Dad is the majority
an opportunity to work in the business.         cash to pay another                      shareholder in a business. Mom is
                                             salary to replace Dad’s.                    not active in the business, but two
This raises important questions:                                                         of their three children are.
• Is share ownership a right or a priv-
ilege? Should Mom’s kids be given             Because of the conflicts that can be          The same planning work, as
shares that they never had to work for?    created, the advisor should have a serious    described above, applies. If Mom is
What does this teach the kids? If the      discussion with Mom and Dad regard-           financially independent from the busi-
kids own shares in the future, does this   ing share ownership for non-active fam-       ness and two of the three children are
automatically entitle them to work for     ily members. Many families believe            running the day-to-day operations,
the company?                               strongly that only those individuals active   Mom’s financial security would not be
• If the surviving shareholders con-       in the business should own shares. In         affected if the children ultimately run
tinue to increase the value of the com-    these situations, a funded buy-sell agree-    the business into the ground. This is
pany, is it fair to them to have to buy    ment could be structured to ensure there      really important for both Mom and the
back shares from Mom, at some time in      is cash available to purchase the shares      children. Can you imagine how you
the future, at a higher value, that she    from the non-active shareholders (see         would feel if you not only lost the busi-
had no hand in creating?                   “Singular Focus,” on page 17).                ness your father spent his lifetime build-
• Will conflicts occur between the            Many interesting strategies can be         ing, but you also decimated your
non-active shareholders and the active     implemented by Mom and Dad to                 mother’s long-term financial security
shareholders? Non-active shareholders      maximize family wealth. Depending on          when she needed it most? The children
typically want to see a regular dividend   the family situation, the corporate           running the business have enough
paid from the company. Active share-       structure and buy-sell method used            challenges and responsibilities as it is and
holders typically wish to see dividends    could have a positive or negative impact                               Continued on page 21
Continued from page 19                        the will and the reasons for these           the time of retirement, at the time of
do not need to take on the further            decisions in advance.                        Dad’s death or on the last death
responsibility of Mom’s financial secu-                                                    between Mom and Dad?
rity. Many families elect to ensure Mom’s                                                     Many family enterprises take a long-
financial security is independent of the
                                                   In many situations                      term view to the evolution of their busi-
business in the event of Dad’s death.                Mom and Dad                           ness. In these situations, so long as Mom
   It can be extremely difficult for a par-      decide that the best                      and Dad have created appropriate wealth
ent to choose one child over another to           strategy is to leave                     outside of the business and Mom, in the
lead the family business. In many situ-          the business to each                      event of Dad’s death, is financially inde-
ations Mom and Dad decide that the                                                         pendent from the business, it may be
                                                of the children equally.
best strategy is to leave the business to                                                  effective to leave the final share buyout
each of the children equally. Unfortu-
                                                     Unfortunately                         using the last-to-die scenario. There are
nately this creates several problems.             this creates several                     several benefits to this approach, includ-
   First, the natural conflict between                 problems.                           ing the possibility of creating substan-
active and non-active shareholders will                                                    tial long-term wealth for the family.
arise. If the non-active child receives          Second, in many situations, when             As you can see, the softer issues will
shares, perhaps this is a message from        Mom and Dad leave issues unresolved          influence how technical solutions are
Mom and Dad that they want all three          in their estate, conflicts arise among the   implemented for a family business.
children to work in the business. When        siblings. Since Dad created the business,    Advisors need to be aware of these
situations like this occur through the        it is his responsibility to clean up his     issues so their planning recommenda-
estate, the message it sends to each fam-     affairs and deal with these challenging      tions are not in conflict with the needs
ily member may be very different, and         issues. For the sake of family harmony,      and values of the family, the business or
will typically result in conflict. It is      encourage the family to discuss these        any of the key stakeholders.
amazing how easily conflicts are created      issues before Dad’s death.
among surviving family members when              Assuming Mom is financially inde-         Douglas V. Nelson, CFP, CLU, is a partner
the deceased family member is not there       pendent from the business, another           of Nelson Financial Consultants based in
to explain his decisions. This is why it      question to consider is the timing of the    Winnipeg and author of Advising Family
is so important to communicate to all         final sale of shares from one generation     Businesses (The Knowledge Bureau).
family members the decisions made in          to another. Should the sale happen at

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