BUSINESS Exit Strategy Basics Although there’s no such thing as a free lunch, when you’re sufficiently profitable, you can reduce your tax liability and protect your business and loved ones at the same time. Would you rather pay more taxes on your profits or use some of that money to carry insurance? Premiums for key man insurance coverage are a deductible business expense, and the proceeds from such coverage are typically paid to the company upon the demise or incapacitation of the insured. Depending on the structure and ownership of the business (and your beneficiaries), this could be a worthwhile consideration, but consider that such coverage may end prior to your death. Alternatively, you could carry and di- rectly pay for personal life insurance cov- erage, with the proceeds payable to whom- ever you designate, and this coverage could prevail at the time of your death. Either way, life insurance can offer protection for those leſt behind, especially if your departure is unexpected and when you are younger. Of course, discuss this with your accountant, attorney and licensed insurance agent. Sure, having life insur- ance is somewhat obvious, but you would be amazed at how many business owners just never get around to actually doing it. Talking about it is not good enough, and it’s too late when you suddenly wake up on the wrong side of the dirt! Incidentally, life insurance is not gen- erally considered to be a good invest- ment, although there are so many differ- ent types of coverage that you may have access to a policy that offers accumulation of cash values. The policy may even earn interest, which can sometimes partially offset the premiums. Consider life insur- ance primarily as a defensive strategy rather than an investment. Again, seek guidance from your licensed insurance agent, financial planner, accountant and/ or other relevant adviser. 18 KEYNOTES NOVEMBER 2020 Retirement Planning and Investments One common exit strategy is to use the profits from your business to fund your personal retirement investments. This ap- proach is appealing for at least two rea- sons. First, you will possibly reduce your business and personal tax liability, de- pending upon your business structure. You could effectively have the business (directly or indirectly) fund your retire- ment investments such as 401(k)s or IRAs, using profits that would otherwise be used to pay taxes. Look at the aſter-tax impact of various options and avoid or defer tax liabilities until your tax rates may be lower. The second reason this approach is ap- pealing is that you are building your re- tirement fund separately and, thus, insu- lating it from your business. For those who don’t want to have their retirement depen- dent on the ultimate successful sale of their business, this can be a desirable option. In many instances, personal retirement accounts are protected (exempt) from lawsuits, bankruptcy and certain other liability risks. This can be an effective way to protect some of your personal as- sets and retirement savings, but check with your legal adviser for liability issues. Another common approach (if your business has a retail and/or warehouse location) is to buy your building(s) per- sonally and then lease/rent the premises back to your business entity. Under this scenario, the business is indirectly paying the mortgage (which is a tax-deductible expense for the business) for your person- al investment in a building. The expecta- tion is that your building is likely to be worth more when the time comes to sell it, perhaps as part of, or even the founda- tion of, your retirement and exit strategy. Your lease would typically also require the business to pay for maintenance and repairs. Frankly, especially if you own a building over decades, don’t be surprised if your building can be sold more easily and profitably than your business. This reminds me of when I would ask small business owners who sold their business at retirement (and also sold their building) the rhetorical question, “What business were you in?” As expected, they would typically reply, “The XYZ business or industry.” But more oſten than not, the numbers would suggest that their primary business was actually real estate investment, which was funded by their XYZ business! Think about banks, gas stations, fast- food restaurants, drug stores and other businesses that own well-located build- ings. The cash flow from the business pays the mortgage on the building, which increases in value over time. Such build- ings are oſten held by a separate real es- tate holding entity that may be owned or controlled by owner individuals and may be leased back to the operating com- pany. The building owners may be able to avail of the accelerated depreciation of the building (creating a phantom loss for tax purposes) and, thus, offset some or all of their personal income tax liability. Remember, depreciation is a deductible business expense, but nobody ever writes a check to pay for it! Back in the late 1980s, I was execu- tive vice president of a real estate syn- dication firm whose portfolio included thousands of apartments and dozens of shopping centers (in eight states), which were owned by more than 100 limited partnerships. These financial instruments were sophisticated, regulated securities that offered higher-income investors tax shelters of up to as much as a five-to-one write off for every dollar they invested. This was accomplished largely by ap- portioning the accelerated depreciation (which resulted in an on-paper income loss) from the limited partnership’s owned real estate. Thus, a doctor with a WWW.ALOA.ORG
