Most Mid-Size Businesses Owners Needlessly Pay Huge Estate Taxes & Unnecessarily Expose Business & Personal Assets to Creditors.

For Business Owners Preparing for a Sale
The Potential to Materially Reduce or Eliminate
Taxes can be Quite Substantial and Time Sensitive.

The Interview – Asset Protection & Estate Tax
We have interviewed dozens of Business Owners regarding their estate plans. Of those Owners that do have a plan the most frequent set of responses are:

LockeBridge: What kind of trust do you have?
Bus. Owner: I’m not sure.

LockeBridge: There are many different types of trusts. Can you call your lawyer to find out what you have!
Bus. Owner: My lawyer tells me that I have a revocable trust that will protect me.

LockeBridge: Did you know that currently your revocable trust will only shelter $5.45M from federal estate taxes for each of you and your wife and there is a good change that you will have to pay state and federal estate taxes of more than 50% of your net worth.
Bus. Owner: Are you kidding! I expect my Company to grow significantly so the taxes are going to be huge. Why didn’t my lawyer tell me about this?

LockeBridge: Well, did your estate attorney speak with you about the eventual disposition of your Company.
Bus. Owner: No, when I was speaking with him I was not considering the sale of my Company. Now that I have decided to sell it these issues are more tangible to me

LockeBridge: I assume that your also not aware that you can also shelter substantially more of your Company from estate taxes by valuing the Company utilizing an IRS acceptable Lack of Marketability and/or a Minority Interest Discount prior to gifting or selling it to a irrevocable trust. I would be happy to illustrate for you how much you can save by doing this. I would also be happy to refer you to another estate attorney.

If you are contemplating the sale of your business
in the foreseeable future, it is even more important to act now
or you will most likely lose much of the opportunity to reduce estate taxes.

More Than Estate Tax Protection – Protection From Creditors
In addition to estate taxes a proper trust vehicle can keep both the business owner’s personal and business assets safe from creditors such as:

• Divorcees
• Tax Collectors
• Accident victims
• Health-care providers
• Credit card issuers
• Business creditors

Select Client Experience – Estate Planning and Asset Protection

“LockeBridge gained a clear understanding of our objectives which went well beyond the transaction itself. They gave us invaluable guidance on estate planning and wealth management. This was a part of the process we had given very little thought to but turned out to be a very important step in completing the deal and preserving our wealth”

Joe Montesano
President and CEO – Something Sweet, Inc.

“Not only did LockeBridge structure a very favorable deal and manage all the steps to closing, they provided services far beyond the transactional requirements focusing on the personal interests, tax minimization, and wealth creation of the owners. Winning Proposals was actually a subsidiary holding of a pension fund with multiple layers. The objective was to create a transfer that would result in deferring materially all taxes while at the same time meeting the Owners’ post-closing income needs.”

David Claiborne
President -Winning Proposals, Inc.

“LockeBridge gave us invaluable advice on how to both minimize and defer the taxes which resulted from the transaction. Because the buyer was a foreign public company, on the Stockholm exchange, the financial considerations were even more complex. In the end we made a very favorable transaction and protected our assets from creditors which were exposed to certain potentially adverse foreign policies.”

Matthew Nekoroski
President -Surgical Tables, Inc.

* LockeBridge advises its clients on strategies to minimize estate and income taxes. When appropriate LockeBridge refers its clients to attorneys and accountants which are pre-approved via an arduous screening process which seeks both excellence in performance and uncompromising client commitment. LockeBridge does not charge retainers and we do not accept compromising referral fees. Mission Statement / No Conflict of Interest.

Jake Robson
Editor in Chief
AQC Magazine

The LockeBridge Award can be viewed on page 63 in the AQC Global Awards Publication or by clicking here. The Award will also be advertised on CNN and The London Financial Times website.

This article has been specifically written for the small business owner.

Low interest rates have also been one of the principal drivers behind favorable valuation multiples and these low interest rates are soon to rise causing downward pressure on valuations.

# # #

All else being equal, when interest rates go up the value of businesses go down. This includes the value of lower mid-market businesses (generally classified between $5M – $100M in value). How much the value will go down in part depends upon the amount of debt available to the buyer in a potential transaction (i.e. the leverage amount) as well as the the buyer’s required return on equity. Commenting on the increase in the CPI, Todd Hedtke, Vice President for Investment Management at Allianz Investment Management, states, “I think it’s a decent sign for the economy. I don’t think it’s a good sign for capital markets.”

The required return on equity goes up with interest rates because equity investments compete with debt investments. The higher the interest rate on debt, the higher the required return on equity needs to be in order to attract investors. Stated another way, as interest rates rise investors are more attracted to fixed income investments, which in turn reduces the amount of capital available for equity investments. In order for a company to attract equity investment the company’s perceived future prospects must increase and/or perceived risk must decrease. The combined costs of equity and debt, called the Weighted Average Cost of Capital (WACC), are used to discount the company’s future expected cash flow and establish on measure of a company’s value.

When WACC increases 1%, what happens to the value of a small business? A typical company with $30M of Revenue and $3M of Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA) growing at a compound annual growth rate of 5% (the “Model Company”) will lose $945,000 (6.7%) of its value, from $14,038,000 to $13,093,000, with the EBITDA multiple decreasing from 4.91 to 4.5 (refer to below chart).

As illustrated in the chart above, the $30M Model Company will lose $945,000 (6.7%) of its value as a result of a 1% increase in interest rates.

The Federal Reserve has made it clear that they will raise interest rates only when it is confident that the economic recovery is robust and companies have regained the ability to raise prices.

Per our analysis, if the Fed were to raise interest rates by 1%, from the current .13% to 1.13%, in order to maintain the current value of the business, the modeled $30M company will need to increase its operating profit by approximately 7.2% to compensate for a 1% rate increase.

Don’t panic quite yet. Interest rates are not going up overnight. U.S. Federal Reserve Vice Chairman Stanley Fischer said the process of returning to a more normal level of interest rates will take a few years. Last week the Federal Funds Rate closed at .13 percent. Fed economists expect the rate will reach from 3.25 percent to 4 percent in three to four years. Will that mean that our Model Company will go down in value proportionally more? Probably not, for two reasons:

1. Although the interest rate at which businesses borrow moves with the Fed Funds Rate, they do not necessarily move proportionately and
2. As previously stated, the Federal Reserve is expected to raise rates with a growing economy. A growing economy generally translates into an increase in the value of small business.

Take note, there can be and most likely will be a lag between an increase in rates and an increase in valuations. This means that Business Owners who do not have a longer term time horizon, at least five years to outlast a cycle, should consider the impact of a rate hike on the value of their business and the timing of an exit. Keep in mind that even after you decide to start the exit process, between getting valuations, choosing an investment banker and executing the selling process, you are easily looking at 1 to 2 years.