For most owners, the business is both the largest asset and the least liquid one. The planning work is moving value from the business to the household on terms you control: through the entity, the protection around partners and key people, the benefits the business can pay for, and an exit planned years before the sale. Those decisions are easiest to get right when they are made together.
The business that produced the wealth is not necessarily the right place to hold it.
What questions should a business owner answer?
Six questions decide most of the plan. Each one has its own page.
Value moves from the business to you four ways: salary, pass-through distributions, dividends and fringe benefits. Each is taxed differently, and the entity decides which ones are open to you and what each costs. Most businesses start as LLCs, which is usually right in year one. The structure that fit at formation is rarely the one that fits at scale.
It depends on how many people you employ and how close you are to retirement. A SEP-IRA or a basic 401(k) is simple and works well for a very small business. With a larger staff, a 401(k) combined with profit sharing and a cash balance plan can let an owner put away far more each year, often at a lower cost per dollar than a SEP.
Without a buy-sell agreement, your partner’s share usually passes to their estate, often to a spouse or children. You want to keep running the company. The family wants cash. A funded buy-sell agreement settles in advance who buys the share, at what price, and where the money comes from.
An unfunded buy-sell is a document, not a plan. When a partner dies or becomes disabled, the survivors have to find the purchase price under time pressure. Life and disability insurance owned for the agreement puts the money in place before it is needed, at a known cost.
A raise is a cost the business pays without buying commitment. Deferred compensation and similar structures make leaving expensive and staying profitable. The key person is not the one with the biggest title. It is the one whose loss would hit revenue the day it happens.
A higher price is one goal. How much of it you keep after tax is another. Many of the decisions that set your after-tax proceeds are made three to five years before a buyer arrives, not at the closing table. Installment sales, charitable trusts, a 1031 exchange and a deferred sales trust change when the gain is taxed, not whether it is.
Why do these decisions need to be made together?
Because each one connects to the next. The salary decision shapes the retirement plan. The retirement plan shapes the exit. The exit shapes the estate. Your CPA, your attorney, your plan administrator and your insurance professional can each be very good at their own piece, and none of them is paid to manage where the pieces meet.
Plans assembled one decision at a time, over twenty years, can look sensible piece by piece and still leave money on the table.
How much difference can a coordinated plan make?
Hypothetical examples from Financial Fortress for Business Owners.
Donald and Gil could fund their buyout with $2.7 million in premiums instead of self-funding $4.1 million, putting an asset behind the agreement rather than a hope.
Lewis could move $2.7 million more to his heirs, 8.5% more value, from the same estate and the same business, by moving $900,000 of his profit sharing plan into a survivorship policy held outside his estate, instead of leaving it in the plan to be taxed twice.
Solomon’s partner Jack owns one cash-value policy on Solomon’s life, placed when Solomon was 48. Over 34 years the same policy could fund the buy-sell, lend Jack expansion capital in place of a bank loan, pass tax-free to Solomon when he retired, pay the tax on his Roth conversion, and leave $5.8 million of estate liquidity outside his taxable estate. One policy, five functions.
These are hypothetical examples written for the book, which is published by Triathlon Partners Media LLC. They are not clients, and no result is guaranteed. Actual results will differ.
Which business decisions are hardest to undo?
- The entity before a sale. Some of the best tax treatment at a sale depends on how the business was organized years earlier. Qualified small business stock, for example, needs a C corporation and a holding period: the full exclusion takes five years, with partial relief from three. By the time a buyer arrives, it is usually too late to start the clock.
- Insurance on a partner or key person. It is bought while the person is healthy. After a diagnosis, the coverage may cost far more or not be available at all.
- Moving business interests out of your estate. A gift uses up your exemption at today’s value. A $5 million interest given away today uses $5 million of exemption, and all its growth after that happens outside your estate. Wait until it is worth $15 million and the same gift costs three times as much.
Investment choices can be changed next year. These usually cannot.
What can go wrong in a business owner’s plan?
- A partner dies. Within days the estate can own part of the company, and the family and the surviving partners want different things. See what happens if your partner dies.
- A stale buy-sell. The agreement values the company on a formula negotiated when revenue was a fraction of what it is now, and the insurance behind it was sized to that old number.
- A key person is gone on Monday. Not because they quit, but because they died or had a stroke over the weekend. Revenue, clients and operations take the hit the same day.
- Business risk reaches the household. A personal guarantee signed at a refinance years ago can still be in place, exposing family assets to a business event.
- The exit is planned the year of the sale. By then most of the structures that reduce the tax are no longer available. See tax-efficient exit strategies.
- The estate tax comes due in cash. Federal estate tax is due within nine months of death. When the wealth is in the business, real estate or retirement accounts, finding that cash can force a bad sale.
Frequently asked questions
When should I start planning to sell my business?
Three to five years before you expect a buyer. Many of the decisions that set how much you keep after tax are made in those years, not at the closing table. Planning for a sale is not committing to one.
What is a buy-sell agreement?
A contract between co-owners that sets the price and terms when ownership changes, at death, disability, divorce, retirement or bankruptcy. A funded agreement has the money behind it. An unfunded one leaves the survivors looking for capital under time pressure.
Who should coordinate my CPA, attorney and insurance advisor?
One person whose job is how the pieces fit together, not any single product. That person is defined less by a credential than by what they ask about before they recommend anything.
Questions to ask your advisor
- If I am planning an exit in the next five to ten years, does my current structure give me the best after-tax outcome on a sale?
- Is my buy-sell agreement funded for each trigger event: death, disability, divorce, retirement and personal bankruptcy? When was the valuation last updated, and does the insurance match it?
- Am I capped at the 401(k) default, and what would a profit sharing or cash balance layer add?
- If we are three to five years from a sale, what should we be doing now that we cannot do later?
- What is my estate tax exposure, and where does the cash come from within nine months?
Related questions
Find out which of these decisions your plan has not made yet.
In a first call you get a diagnostic, not a presentation. You leave knowing:
- at least one specific gap in your entity, buy-sell, benefits or exit plan
- every way Triathlon Partners would be paid
- how Triathlon Partners would work with your CPA and attorney
Book a call with Ira or read Chapter 1 of Financial Fortress for Business Owners.
30 minutes · Zoom or phone · nothing to prepare · no obligation
This page is general education, not advice for your situation. Triathlon Partners LLC is a registered investment adviser in Connecticut and New York. Registration does not imply a certain level of skill or training. Triathlon Partners LLC is also a licensed insurance agent and is paid commissions by the insurance companies whose policies it sells.