Key Man for a small business

[James]

A widow may not be able to replace a partner and hold up their end of the bargin. For example a medical practice. Can the widow keep the spouse's skills active in the practice? So maybe in that case, a buy out works best.

A medical practice as an example? You gotta to be kidding me!

How do you actually place a figure on a medical practice? I could not pull out a more bizarre example if I tried, sorry but could you use a more reasonable example, and one with a tad more detail?

Ps, it is kind of funny, but recently or in the last few years I met alot of Dr couples (as in young interns just graduating from UTMC), it seems to be a growing trend. So in your example is the Dr spouse a Dr him or herself?

 

[James]

Plus, you have another problem with Key Man that many don't want to bring to the table. Okay you have a business worth 2 million, you want a mill plus on each owner, say they are in the early 50's or late 40's, I would call that an average age for succesfull business owners. Now they have a mill plus on themselves for their family. Now how much is the take home pay for a partner in a business that is bringing in about 2 mill a year? Likely less then 100 grand a year, maybe a little more but not much. This depends upon the business.

So you call up the superduper Underwriter of Mass, NYL, AIG or name your poison. "Dear Mr Underwriter, I have Mr Jones here, he makes around 100 grand a year and is in his early 50's. Now he has a million or more in place and needs another mill or two". Now what do you expect the underwriter is going to say? My guess, his response is "What!". Okay, now you bring up that this is a Buy/Sell Funding Agreement, wow that makes it okay!

The main point is, there is only a certain amount of insurance available for any one life. On a 50 year old that is likely around 20X factor, maybe more and given the total worth, it is negoitable, but there is a breaking point of what is available. Simple put, there is only so many Rush Limbaugh's and 24 plus million of insurance clients.

 

[LGilmore]

"How do you actually place a figure on a medical practice"

actually it's done quite often. Just as it is done on any business. Remember your college accounting classes and business valuation and irs valuations? Remember estate taxes, James, there are alot of ways to place a value on a business, and alot of folks and government enitities who will do just that.

And it is quite a reasonable example as is ANY business where partners are at.


"So in your example is the Dr spouse a Dr him or herself?"

Should the gender of the partnership matter or the disipline? An internist cannot take the place of an surgeon without addtional training. While at med school in the third and fourth years you sample everything, eventually you focus..specialize.

As I said your role is to lay the cards on the table and let the business partners make the choices. It is not your role to decide fairness to the widow, 3rd cousin or ugly step sister. Your role should be in support of the business partners first, second and third.

Your examples seem to lack the concept of a document of record on how to proceed with the agreement. The "stroke of the pen", "use your money to buy my shares" exactly all set up in advance in a legal enforceable document the partners sign off on and in community property states, I imagine the wives would sign off to. You seem to ignore that in order for a buy/sell to work... everybody has to be in agreement ahead of time. So your arguements are and gawd I hate to use this snobish term " a strawman". If the partners are still in disagreement over who gets what when and how much... no need for you to be sitting there choosing sides.

I too run across family partnerships that have some of the attitudes of the ones you've come across. Guess what? keep moving. You'll have more hair at the end of the day. Buy sells aren't for everyone. Only for those who "want" the business to carry on and the family to be taken care of. Not everybody does....

 

[James]

"How do you actually place a figure on a medical practice"

actually it's done quite often. Just as it is done on any business. Remember your college accounting classes and business valuation and irs valuations? Remember estate taxes, James, there are alot of ways to place a value on a business, and alot of folks and government enitities who will do just that.

And it is quite a reasonable example as is ANY business where partners are at.


"So in your example is the Dr spouse a Dr him or herself?"

Should the gender of the partnership matter or the disipline? An internist cannot take the place of an surgeon without addtional training. While at med school in the third and fourth years you sample everything, eventually you focus..specialize.

As I said your role is to lay the cards on the table and let the business partners make the choices. It is not your role to decide fairness to the widow, 3rd cousin or ugly step sister. Your role should be in support of the business partners first, second and third.

Your examples seem to lack the concept of a document of record on how to proceed with the agreement. The "stroke of the pen", "use your money to buy my shares" exactly all set up in advance in a legal enforceable document the partners sign off on and in community property states, I imagine the wives would sign off to. You seem to ignore that in order for a buy/sell to work... everybody has to be in agreement ahead of time. So your arguements are and gawd I hate to use this snobish term " a strawman". If the partners are still in disagreement over who gets what when and how much... no need for you to be sitting there choosing sides.

I too run across family partnerships that have some of the attitudes of the ones you've come across. Guess what? keep moving. You'll have more hair at the end of the day. Buy sells aren't for everyone. Only for those who "want" the business to carry on and the family to be taken care of. Not everybody does....

Could you use more platitudes if you tried? I don't recall giving any product the snub, I suggested ART simply to keep things simple. Attitudes of the family own business? Now only thing I stated on that, is that is a businesses model most will find that the partnership supersedes the marriage. As in length and commitment to the business outdates the marriage and the partners have separate ties that may be just as powerful as the marriage. It isn't a bad thing, spouses and inlaws, an age old problem.

Now you suggest the pricing of a medical practice is simple and straight forward? Just how many of these deals have you been involved in? In many cases when the Dr dies, his practice dies (or his share of the practice) unless a familiar person/Dr is there that already has a connection with the dead Dr's patients. In many or most cases it would be difficult (if not impossible) for one Dr to take another Dr's clients in with his or her practice even if there is an active partnership. In other words, in a small practice of two, three or more Dr's the partnership is not a typical business partnership.

I'm simply suggest the realities most will find if they go out there and start peddling Life Insurance to Business Owners and Partners. There is more fruit hanging a lot lower then the so call, simple Buy/Sell. Basically what the insurance brochure doesn't mention is that simple idea, aint so simple.

 

[djs]

James -

You seem to have the wrong owner on the buy-sell agreements, which is what is leading to the confusion. For instance, if you and I had a buy-sell agreement, I would own a life policy on you, you would own one on me.

Now, you get into an argument with your family, they knock you off. The life policy that I own on your life pays me, which in turn I use to fund purchasing your business.

There is no stroke of the pen where your family can keep that money and tell me to fund the deal with my own money. I just did, by using the life proceeds I received from your death.

In a key-man policy, it pays directly to the business, not the family. Still no way for the family to change it.

If the family can change either of these, the agent didn't do the job correctly and simply didn't understand how these work. He just sold the policies to make the commission. I know a lot of them are misunderstood, a slightly smaller percentage probably are in place incorrectly.

Dan

 

[James]

James -

You seem to have the wrong owner on the buy-sell agreements, which is what is leading to the confusion. For instance, if you and I had a buy-sell agreement, I would own a life policy on you, you would own one on me.

Now, you get into an argument with your family, they knock you off. The life policy that I own on your life pays me, which in turn I use to fund purchasing your business.

There is no stroke of the pen where your family can keep that money and tell me to fund the deal with my own money. I just did, by using the life proceeds I received from your death.

In a key-man policy, it pays directly to the business, not the family. Still no way for the family to change it.

If the family can change either of these, the agent didn't do the job correctly and simply didn't understand how these work. He just sold the policies to make the commission. I know a lot of them are misunderstood, a slightly smaller percentage probably are in place incorrectly.

Dan

Well yes, the swipe of the pen would have to be before someone dies! Somethings should be clear even though not fully explained, I guess I was wrong on that assumption? Now we are suggesting that the insured has his or her family as the main threat? We're getting pretty extreme here.

Ps, more then likely in BOLI or STOLI at least IMHO you have more to worry about from the owners of the policy not the non owners!

 

[LGilmore]

• business assets, including book value and liquidation value methods
• historical earnings, including debt-paying ability, capitalization of earnings or cash flow, gross income multipliers, and dividend-paying ability methods
• a combination of assets and earnings, namely, the excess earnings method
• the market for similar businesses, including comparable sales, industry rule of thumb, and p/e ratio methods
• future earnings, namely, discounted future cash flow or earnings methods

Here's a few James, knock yourself out.

And yes, it is simple and straight forward. I guess it depends on what you bring to the table too. I do have a strong understanding of accounting methods and valuation so it isn't so greek to me. It is pretty simple. sorry.

 

[James]

• business assets, including book value and liquidation value methods
• historical earnings, including debt-paying ability, capitalization of earnings or cash flow, gross income multipliers, and dividend-paying ability methods
• a combination of assets and earnings, namely, the excess earnings method
• the market for similar businesses, including comparable sales, industry rule of thumb, and p/e ratio methods
• future earnings, namely, discounted future cash flow or earnings methods

Here's a few James, knock yourself out.

And yes, it is simple and straight forward. I guess it depends on what you bring to the table too. I do have a strong understanding of accounting methods and valuation so it isn't so greek to me. It is pretty simple. sorry.

The problem with medical practices is the Dr/Patient Relationship. Just becuase Dr X and Y has a historical earnings and assets of this, that is not really transferable as in other businesses. Many of say Dr. X's patients will seek out a Dr of their liking once Dr X dies or leaves. Now most Dr's are fully aware of this and the idea that Dr X practice can be sold is rather problematic.

Mainly, from what I expierence is that a medical practice needs to cover expenses while a new Dr comes on board and starts to build his/her individual practice (as in NEW). No need for a buy out scenario but a small continuation policy for the practice, enough to last 1-2 years will likely be what is called for. Now of course they may very well have other holdings, but that is another discussion, I'm speaking strictly to the actuall practice.

The actual assets to be found in a small Medical Practice will likely be small amount once you start digging. Most of the cost is not equipment or even supplies but the Dr and Nurses.

 

[djs]

Well yes, the swipe of the pen would have to be before someone dies! Somethings should be clear even though not fully explained, I guess I was wrong on that assumption? Now we are suggesting that the insured has his or her family as the main threat? We're getting pretty extreme here.

Ps, more then likely in BOLI or STOLI at least IMHO you have more to worry about from the owners of the policy not the non owners!

James

I hate to admit it, but I'm really not following your statements. You seem to be all over the map, maybe intentionally. Let's first agree that BOLI's and STOLI's have nothing to do with buy/sell agreements. This is blatently obvious, so if you think they do, we are not having the same conversation.

Your comment:

Yet, others will tell you to go into selling the simple Buy/Sell (term or Ul) where the business or major partner funds the buyout with insurance dollars that could easily to diverted to the family or families with a swipe of the pen. Basically saying to the other owner, if you want my share of the business it has to come from you and your dollars.

Now this comment clearly refers to diverting insurance dollars after death, yet your comment above says it has to happen prior.

I'm not clear if you don't understand buy/sell agreements, don't see the advantage of them, never thought through funding one, or seriously believe life insurance is a bad idea for them, or just trying to be antaginistic, but these are quite common and work well for the parties.

Can you spell out what your arguement is without making so many assumptions, or do it in a timeline format such as:

Joe Drycleaner and Bob Restaurant enter a buy sell agreement. For arguements sake, we'll say the restaurant is worth $1,000,000 and the drycleaners is worth $750,000. Both Joe and Bob are sole owners of the business. (yes, buy/sells are usually either between partners or highly related businesses, I'm just trying to make this clearer by using different things). Joe Drycleaner takes out a $1M policy on Bob Restaurant and funds it himself. Bob takes out a $750K policy on Joe and funds it himself.

Bob has a heartattack from eating his own cooking. Joes life policy on Bob pays out, giving Joe the funds to execute the buy/sell, paying the heirs of Bob, and now Joe owns the restaurant.

What is the problem with this? What family would object?

Dan

 

[padthaiforlunch]

It seems to me the unfairness is the difference in the cost of the policies. If Joe is 55 and Bob, the junior partner, is only 35, then Bob has a higher oop expense. Yes, Bob's pay could be increased to cover the higher premium, but this could throw Bob into AMT (higher taxes).

Now, the company could pay for both policies, but then Joe is getting the short end. Why should Joe suffer lower dividends because of the higher premium on his policy which will ultimately favor Bob?

So let's say they have an agreement in place, where they will buy out the survivor's family over the course of several years. In order for this to happen, the business will need a policy to cover lost revenue and hiring/training costs to stabilize the business.

My question is what is the coverage put in place to stabilize the business after the death of one of the partners?