Life insurance as a risk management vehicle to preserve company value

The role of life insurance as a financial protection policy for families is well understood. Life insurance as a risk management tool designed to protect the value of the business, however, might not be as well known.

A company’s value, especially in small and mid-sized companies, can be tied to the owner or a single executive and their ability to manage the business. That makes protecting the business from their sudden demise or inability to work critical; otherwise the company can’t continue to provide for the people who have come to rely on it.

“Small and mid-sized companies need a mechanism that helps them deal with the death or disability of shareholders and key individuals, both of which are foundational to the company’s ability to perform and maintain company value,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank.

Smart Business spoke with Altman about life insurance, and how it can preserve company value in the event of the unexpected loss of a key individual.

Why is life insurance important for companies?

Business owners and key executives are a wealth of information in their organizations. But the size of their organization typically limits the size and depth of the management team, meaning there are fewer people with whom skills and organizational knowledge can be shared. That compartmentalization creates risk in a company. Life insurance, in this scenario, would serve as a safety net, replacing the monetary value of what that key person brings to the company while giving the company time to adjust and replace the person in the event he or she is unexpectedly lost.

Another common protective application of life insurance is in situations involving multiple shareholders. In the event that one shareholder dies, life insurance becomes a funding mechanism for the remaining ownership to purchase the deceased partner’s shares. Without this protection, the existing shareholders or the company may be forced to buy the shares with their own cash, depleting valuable liquidity unnecessarily.

Life insurance is also useful for risk mitigation. In some instances, a bank may require a company to have an insurance policy in place to cover the value of a loan to ensure it gets repaid if a critical member of the business passes away. That requirement is more common in early stage companies that don’t otherwise have the collateral to cover a loan.

In what ways can a corporate life insurance policy benefit larger companies?

The application of life insurance in a larger company is really more about the creation of an alternate funding mechanism. Businesses are looking for tools to attract, retain and reward key executives. One method is to set up nonqualified deferred compensation plans that trade enhanced retirement benefits for an executive’s commitment to the organization for a set number of years. A life insurance policy can be a method of funding that long-term obligation. This approach is appealing because it’s balance-sheet neutral and also offers a tax benefit.

Corporate-owned life insurance can be bought for a set number of people with no medical underwriting. Corporations also like that it doesn’t have any surrender charges.

What is important for companies to consider as they design people-centered risk management strategies?

Companies should work to identify and understand their most significant risks. It’s important that business owners take time to consider what could diminish the value of the business. To that end, it’s critical to determine who are the people driving operations and what is being done to protect the business should they become unavailable for whatever reason.

Organizations that have multiple shareholders should review the financial obligations that would arise in the event of the death of a shareholder, specifically whether any existing insurance is structured in a way that provides the remaining shareholders or the company with the cash to buy those shares.

It can be a hard discussion to have, but the company’s risk position in this regard should at least be reviewed every three to five years or whenever there is a significant change to the business.

Insights Banking & Finance is brought to you by Huntington Bank

A look at the decisions that go into funding large capital purchases

Manufacturers are steadily buying equipment as upgrades, for business extensions, and in some cases, to meet green initiatives.

“These purchases are being made to seize an opportunity,” says Krista J. Dobronos, senior vice president and market leader at Westfield Bank. “Some manufacturers have moved into bigger buildings, which have given them more space that they’re filling with additional machines. Some are making large capital purchases because there are many tax advantages available, so companies are acting now to replace aging equipment.”

With market confidence up, businesses have shown a greater willingness to move on large capital purchases. But how that purchase is funded can be the difference between a good investment and a great one.

Smart Business spoke with Dobronos about the options manufacturers have to fund large capital purchases.

Have lending requests from manufacturers been trending up or down in recent years?

There have been steady requests from manufacturers for lending. Part of that is being driven by the tax law changes. Many service providers, accountants in particular, are reaching out to their customers to help them understand the opportunities that exist, and whether it’s a good time to buy.

Otherwise, companies that are sitting on cash might see an advantage to holding it rather than using it to buy equipment. As interest rates start to rise, companies are beginning to earn a better return on their money, so debt may be the better option when making a large purchase.

What are the more common ways manufacturers fund large capital purchases?

Typically, large capital purchases are made with term loans, but the debt type and terms will be contingent on the useful life of the equipment and whether it’s new or used.

In addition to conventional financing, there are several federal and state programs that can help fund these purchases. At the federal level, there are SBA programs for equipment loans. In Ohio, there are programs such as Ohio GrowNOW, which can be used to fund equipment as long as jobs are added because of the addition or upgrade. Ohio’s Collateral Enhancement Program helps companies that might not otherwise have the collateral to access loans, also with a job growth component. Banks can connect companies to these options.

Another option is to lease the equipment. This can be advantageous, but companies should work with their accountant to understand if it’s really the best choice.

What should manufacturers weigh as they consider making these purchases?

Manufacturers should always weigh the ROI on the purchase they’re making and determine how quickly that return might come back. This data will guide the company to the right term — say five years versus 10 years — for the financing.

Companies should also ask if the equipment they’re buying can be used to support more than one customer. Relying on one customer to make a big purchase could mean the company gets stuck with an unproductive and costly piece of equipment should the customer leave.

Also explore the efficiencies the company stands to gain from the purchase. Will the new equipment mean quicker production times, better quality, less overhead? And then calculate the savings.

The environmental impact of equipment is also part of the consideration. As more companies go green, they’re finding a significant benefit in replacing old machines with more modern equipment.

What should manufacturers prepare before meeting with their banker?

Banks are going to want to see the past three years of the company’s financials as well as projections, including how the equipment will impact the bottom line over the next couple of years. Banks might also like to see the actual quote for the equipment costs, as well as the costs of any other necessary parts for the machine. That will give the bank the full picture of the proposal.

Manufacturers should discuss financing options for large capital purchases with both their banker and accountant. The new tax laws will play a part in the equation, so it’s a good idea to get guidance on the type of structure, whether to lease or own, and how it will depreciate under the new laws before making a purchase.

Insights Banking & Finance is brought to you by Westfield Bank

What to consider when planning for an exit and an ownership transition

As business owners evolve in their life cycle, moving on from the business they built becomes top of mind. But what form that takes, and whether or not the end ultimately serves the owner’s retirement goals, are important questions to answer. Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank, says that’s why owners shouldn’t go through the process alone.

“Build a team,” Altman says. “Involve your tax and wealth planner, your accountant and banker, and figure out how to put the company, yourself and your family, in the best position through the transaction.”

Smart Business spoke with Altman about transition options for owners and how to set up a post-business financial future.

What options are available for business owners looking to exit their company?

The decision on what to do with the business hinges on personal goals. Some business owners are looking to cash out of their company and make as much money on the sale as possible. That typically means selling the company outright to a third party, such as a financial or strategic buyer.

For some owners, price isn’t as important as legacy. While they’ll want to maximize the income from the liquidity event, the priority might be taking care of the company’s employees. In that case, an Employee Stock Ownership Plan might be a good fit.

An ESOP breaks ownership of the company into stock that’s owned by employees. At the time of the sale, the owner doesn’t get everything out in cash at once. Instead, he or she gets a note for part of it and the balance is returned in cash over time. Meanwhile, the owner is able to take advantage of the favorable tax treatment created by an ESOP as well as give the owner the option to remain in an executive leadership role if desired.

Some owners would like to keep the business in the family and do so through a generational transfer. Most companies allow the selling shareholder to continue to draw money from the company as the business is gradually transferred to the next generation. This, like any ownership transfer, takes tax planning to do it right. It also requires having a family member ready, willing and able to take the helm, which might not always be the case.

How should a business owner value his or her company?

Many owners, knowing the sweat equity they’ve poured into the business, believe their company is worth far more than the market will bear. That’s why an independent third party should be engaged to perform a valuation. Accountants who have business valuation practices are one of the best choices for this job, though M&A advisory shops also provide similar quality service.

How does a business owner financially prepare for his or her future after an exit?

The primary question is typically whether the owner will have enough money to fund retirement, or at least life post-business, after a sale. Once that’s satisfied, owners move on to questions regarding the capital and income they’d like to bequeath to family members or to charity. That becomes a balancing act between the needs of family and the owner’s personal goals and objectives.

Preparing for a sound financial future, whatever that might look like, is made easier through the guidance of a wealth planner. The process should start as early as possible. Many business owners wait to seriously plan until a liquidity event is imminent. But a much better strategy, as well as greater peace of mind, can be achieved if planning is completed very early in the company’s existence and then regularly updated.

Coming to terms with letting go of a company built from nothing is difficult. Keep an open mind and evaluate all of the options. With a sound strategy and a trusted team in place, owners can step confidently and securely toward the next stage of their life.

Insights Banking & Finance is brought to you by Huntington Bank

Are you overlooking your foreign currency risks?

Nearly all S&P 500 companies discuss foreign currency risk and hedging activities. However, any business that is competing, buying or selling services and/or products internationally, regardless of its size, faces some form of economic risk attributed to currency movements. Even if companies are transacting internationally in U.S. dollars only, they are still subject to foreign exchange risk.

“One of the biggest challenges companies face is the ability to identify and quantify their foreign exchange risk exposures,” says Jim Altman, middle market Pennsylvania Regional Executive at Huntington Bank. “This is particularly true of economic risk — the competitive advantage or disadvantage resulting from exchange rate fluctuations that impact the value of a firm. Even those that can identify their exposures face the issues of optimizing their hedging strategies or forecasting their future exposures.”

Smart Business spoke with Altman about foreign exchange risk and strategies to hedge against it.

What are the first steps to hedging the impact of foreign currency fluctuations?

An effective strategy is to lock into a forward contract or enter into an option contract. These strategies allow companies to lock in exchange rates today to settle contracts in the future and can mitigate currency exposures currently on the books or expected future exposure. Hedge accounting rules may also play into companies’ hedging policies, if applicable.

What are the more common hedging strategies?

Most companies implement a foreign exchange risk hedging program to reduce earnings or cash-flow volatility. Given this objective, it’s wise to create and implement a formal hedging program, which includes establishing a foreign exchange policy.

For example, the program may seek to hedge 100 percent of foreign currency receivables/payables currently listed on the balance sheet. Additionally, the company may also forecast foreign exchange risk exposure out one year. However, if the company does not wish to hedge all exposure, as many do, the plan may include hedging 75 percent of anticipated exposures less than six months out and 50 percent of anticipated exposures six to 12 months out. This is called a tiered hedging approach.

Often companies ask if it is best to hedge all known exposure at one point in time, called a static approach, or if they should layer on hedges — a dynamic approach — throughout a defined time period while blending the varied rates. It is important to consider the level of confidence in forecasted payables and receivables to decide which strategy is best. When considering an approach, it is important to define what percentage of ‘core’ hedges should be locked-in vs. the percentage that should be ‘tactical’ or market driven hedges.

What should companies know and understand before hedging their foreign currency risk?

Throughout the risk management process, the most challenging step can be exposure identification. Foreign income translation can be challenging to hedge, but it may be the cause for unwanted cash-flow fluctuations. Meanwhile, other foreign exchange risk exposures may go completely unnoticed. For example, a company that sells internationally in USD would be extremely vulnerable on a competitive scale if the U.S. dollar rallies broadly. Conversely, if a U.S. company is sourcing overseas in U.S. dollars, it may be over-paying, prompting price concessions.

It is also important for a company to know and understand their tolerance for foreign exchange risk. It is not always advantageous for a company to hedge all of its exposures. Comfort with a specific earnings-at-risk or cash-flow-at-risk will help prevent over-hedging.

Developments in technology and globalization mean the world is increasingly becoming a single market. Often, companies grow faster than their comfort level in managing associated foreign currency risks. Fortunately, the foreign exchange risk market is extremely accessible to businesses of any size, and banks’ foreign exchange risk advisory teams can help tailor risk management solutions that best fit companies’ ever-changing needs.

Insights Banking & Finance is brought to you by Huntington Bank

How growing companies can effectively give back to the community

Companies that give back through philanthropy and volunteerism strengthen the communities in which their employees and partners live and work.

But for growing companies, fitting community giving into their go-to-market plan means ensuring resources are being allocated to the right organizations, and for the right reasons. 

Smart Business spoke with Jon Park, chairman and CEO of Westfield Bank, about community giving strategies for growing companies. 

How does a company determine where it should devote its philanthropic efforts?

Companies should first look to align their giving with their areas of focus, taking into account their resources and capabilities. 

Aim to address three or four general areas of focus. Develop criteria for support to determine who to support and why their mission fits with the mission of the company.

Companies that are already supporting organizations and causes in their communities should take an inventory of their giving and discuss the efforts internally. Look closely at where money and time are being allocated and whether the organization — employees, management and leadership — all still feel that the causes being supported still align with the company’s values and interests. This will help the company decide how it will move forward with its giving and volunteerism.

How should companies track their giving?

It’s important for companies to track the dollars they spend on community outreach. The bigger the gift, the more the company should dial in on the efficacy and performance of the organizations receiving the money — smaller, one-time donations likely don’t need to be tracked, or at least not as closely. 

Larger gifts should come with definitions of the scope of use for the donation, as well as metrics the organization will use to measure as it allocates those funds. Assign an employee to stay engaged with the organization and monitor its performance. It’s not always exact, but it makes clear that there are expectations for results and should raise the bar of performance. 

As part of its measurements, companies should look at how much of what they give to an organization goes to programming and how much goes to its administration. Companies need to make their own determinations regarding their comfort level with the percentage that goes to each. 

How should companies measure the return on their philanthropic investments?

It’s difficult to measure a direct return on donations. There are, however, compelling intangibles that can be tracked, such as how well the connection between the company and organization is promoting and reinforcing the company’s brand and image with customers and prospects. 

When it’s determined that the company’s donations have been effective, consider giving more. Those organizations that underperform expectations should receive less.

How can companies ensure that giving and growth coexist? 

Set a percentage of income that the company is willing to give. Allocate the money as part of the budgeting process and set it aside. 

At the same time, urge employees to volunteer and actively support civic and social organizations. Encourage them to not just participate, but to take leadership roles within those organizations. 

Consider granting employees paid time off for community volunteer efforts. That has the twofold effect of boosting the company’s engagement with community organizations while also increasing employee morale. It’s especially important in growing companies where employees are often working hard and might not have the free time to participate in a meaningful way. Giving employees time off for volunteerism also sends a strong signal of the company’s commitment to community involvement. 

How should companies talk about their philanthropy?

Companies should share their efforts through social media, taking pictures and posting them as they work in the communities. It builds awareness in the community of a company’s values while also promoting a culture of giving, which can attract employees.

Insights Banking & Finance is brought to you by Westfield Bank.

Align retirement plans with company goals to increase their effectiveness

When it comes to retirement plans, the mistake most plan sponsors make is not taking a comprehensive approach to plan design and management, an approach that incorporates the company’s goals into the goals of its retirement plan.

“Fifteen years ago, a company might have reached out to any financial adviser to set up a retirement plan, concerned mostly with the matching contribution,” says Robert Klug, regional executive at The Huntington Private Bank. “There might have been a general idea of what the company wanted to accomplish with a plan, but it likely didn’t think too deeply about the objectives relative to its participants or the company. That’s changing now.”

Today, it’s important that companies ask from the outset why they want a plan and what they hope they can achieve through it. Plans created without specific intentions will inevitably fall short in key areas. Companies could run into fiduciary governance issues, have a lackluster investment menu, poor participant engagement or have participants who are unable to realize the full benefits of the plan.

Companies could also run into challenges with administration, whether internally or externally with vendors, which can be costly to correct. That’s why it’s so important to put a lot of thought and attention into plan design from the start.

Smart Business spoke with Klug about purpose and design in retirement plans.

What services are available to help companies design the right plan for their organization?

More and more, companies are engaging with advisers who specialize in retirement plan design, even companies that have relatively small plans. That’s because it’s become such a complex proposition. Plan advisers can help guide companies through the myriad services available to sponsors to help them with a plan’s ongoing management.

How often should companies review their retirement plan and what should they look for to understand how well the plan is performing?

Plan sponsors should, at minimum, conduct a comprehensive annual plan review. Through it, companies should look over all of their fiduciary responsibilities to ensure they’ve been covered, and review the investment menu as well as participant engagement rates to make sure they’re getting the full use from the plan.

And while companies conduct their annual reviews, they should always look to see that the plans elements align with its goal. If the goal was adding participants, did that happen? Was the purpose a higher average balance? Good investment performance? A plan that’s easy to administer? What progress, if any, has been made toward those ends?

These reviews are also an opportunity to evaluate the retirement plan services providers. Assuming a company has plan goals that align with its overall corporate goals, it should be easy to see if the service providers are helping the company achieve those goals. If not, take a look at what else is out there.

How should companies go about setting retirement plan goals ahead of designing a plan?

Goals are unique to each company because they’re situational. For example, a manufacturing firm in a tight labor market might be looking for ways to keep the employees it’s trained who might get offers elsewhere. That company’s goals might be to increase enrollment and engagement to make sure employees understand all the benefits it offers.

A small professional services firm, on the other hand, might find it more effective to improve the average balance of its retirement benefits.

There are advisers who have experience designing retirement plans for companies in specific industries. That’s important because retirement plans aren’t just a product to be bought and sold. They’re a benefit that needs a thoughtful approach.

Plan sponsors are responsible for making sure that all facets of the plan get the necessary attention they require. If a plan sponsor isn’t sure they’re getting everything covered, they should engage with an adviser, even if it’s just to get a second look to validate that everything is in order.

Insights Banking & Finance is brought to you by Huntington Bank

You’ve been named executor of your family’s estate. Now what?

Losing a loved one is difficult. Aside from the overwhelming grief that comes with loss, many families are often faced with executing the deceased’s final wishes. To make fulfilling their wishes easier, sometimes people, before their death, will name an estate executor.

While it’s an honor for someone to entrust you with carrying out their final wishes, if you’re a business owner who has been named executor of an estate, you may want to first consider whether you’re up to the task.

“Being an executor is a lot of work,” says Northwest Bank Trust Officer Lisa Arnoczky. “You should understand what it entails before you agree to take on the responsibility because the process of settling an estate can take up to a year. Business owners need to prepare to be in it for the duration before getting involved.”

Smart Business spoke with Arnoczky about what you should expect after you’ve been named the executor of someone’s estate.

What does being named an executor of an estate mean?
Being named executor of an estate means you help carry out the deceased’s wishes laid out in their last will and testament. Family members are usually tasked with this request because they’re closest to the deceased.

If you’re familiar with the decedent’s finances, handling their affairs after their death should be a fairly seamless event. However, if you’re not familiar with them, you could be faced with duties you may not know how to carry out, like untangling their investments, locating family members who may be entitled to an inheritance, finalizing their income taxes, navigating the legal system and paying off their final debts.

You should give these duties some careful consideration, especially as a business owner. Before taking on the role, ask yourself: Do you have the manpower available to step in while you handle your loved one’s final affairs? Will your business suffer if you take on the responsibility of being executor? The answers should give you a sense of whether you’re really able to take on the task.

Are executors personally responsible for outstanding debts of an estate?
If you run your own business, the possibility of taking on more debt can be overwhelming. Under normal circumstances, however, executors aren’t personally responsible for the decedent’s debts. That’s not to say there aren’t some exceptions.

In cases where estate assets won’t cover all of the deceased’s financial obligations, some debts must take priority. Each state specifies which creditors have priority. If you don’t follow these rules, you may end up personally liable for that debt. You may also run the risk of being sued if one of the decedent’s beneficiaries tries to contest the will.

If I’m named executor, do I have to serve or can I decline?
If you’re named as executor and don’t wish to serve, you can decline. Usually, wills appoint an alternate executor if the primary executor is unable or unwilling to serve. If all the named executors wish to decline the responsibility, they can petition the court to name a bank as the executor.

I’m busy running my business but still wish to serve. Can I seek outside help to settle an estate?
Absolutely. In fact, it’s highly recommended. Your loved one doesn’t want you to jeopardize your livelihood or monopolize your time when you have a business to run. To keep your business top of mind while still serving in an executor capacity, you can enlist the help of professionals like the trust department at your bank, an attorney and an accountant to help navigate the financial and legal tasks. The fees for these services are generally paid from the estate.

Serving as executor of an estate can be a demanding and complicated job. Not everyone is suited for the task. You know your business better than anyone else and will ultimately know whether or not taking on the responsibility of being an executor is right for you.

Only Deposit Products Offered by Northwest Bank are Member FDIC. Nothing in this article should be construed as legal or tax advice. You should consult an attorney or tax professional  with any legal or tax questions.

Insights Banking & Finance is brought to you by Northwest Bank

How growing companies can effectively give back to the community

Companies that give back through philanthropy and volunteerism strengthen the communities in which their employees and partners live and work.

But for growing companies, fitting community giving into their go-to-market plan means ensuring resources are being allocated to the right organizations, and for the right reasons.

Smart Business spoke with Jon Park, chairman and CEO of Westfield Bank, about community giving strategies for growing companies.

How does a company determine where it should devote its philanthropic efforts?

Companies should first look to align their giving with their areas of focus, taking into account their resources and capabilities.

Aim to address three or four general areas of focus. Develop criteria for support to determine who to support and why their mission fits with the mission of the company.

Companies that are already supporting organizations and causes in their communities should take an inventory of their giving and discuss the efforts internally. Look closely at where money and time are being allocated and whether the organization — employees, management and leadership — all still feel that the causes being supported still align with the company’s values and interests. This will help the company decide how it will move forward with its giving and volunteerism.

How should companies track their giving?

It’s important for companies to track the dollars they spend on community outreach. The bigger the gift, the more the company should dial in on the efficacy and performance of the organizations receiving the money — smaller, one-time donations likely don’t need to be tracked, or at least not as closely.

Larger gifts should come with definitions of the scope of use for the donation, as well as metrics the organization will use to measure as it allocates those funds. Assign an employee to stay engaged with the organization and monitor its performance. It’s not always exact, but it makes clear that there are expectations for results and should raise the bar of performance.

As part of its measurements, companies should look at how much of what they give to an organization goes to programming and how much goes to its administration. Companies need to make their own determinations regarding their comfort level with the percentage that goes to each.

How should companies measure the return on their philanthropic investments?

It’s difficult to measure a direct return on donations. There are, however, compelling intangibles that can be tracked, such as how well the connection between the company and organization is promoting and reinforcing the company’s brand and image with customers and prospects.

When it’s determined that the company’s donations have been effective, consider giving more. Those organizations that underperform expectations should receive less.

How can companies ensure that giving and growth coexist?

Set a percentage of income that the company is willing to give. Allocate the money as part of the budgeting process and set it aside.
At the same time, urge employees to volunteer and actively support civic and social organizations. Encourage them to not just participate, but to take leadership roles within those organizations.

Consider granting employees paid time off for community volunteer efforts. That has the twofold effect of boosting the company’s engagement with community organizations while also increasing employee morale. It’s especially important in growing companies where employees are often working hard and might not have the free time to participate in a meaningful way. Giving employees time off for volunteerism also sends a strong signal of the company’s commitment to community involvement.

How should companies talk about their philanthropy?

Companies should share their efforts through social media, taking pictures and posting them as they work in the communities. It builds awareness in the community of a company’s values while also promoting a culture of giving, which can attract employees.

Insights Banking & Finance is brought to you by Westfield Bank

Take a holistic approach to wealth management for optimum outcome

When it comes to wealth management, business owners often spend so much time managing their business that their personal affairs get overlooked or become stale.

“They don’t have a personal CFO to nudge them to keep everything up to date and to seek the best returns as they do on the business side,” says Denise M. Penz, executive director of wealth management at Home Savings Bank. “This is where having an advisor who knows both sides of the equation for the individual can be a huge benefit.”

Conversely, she says sometimes owners are very good at working with an advisor to keep their personal funds invested, but they have large balances of business assets not being advised, which means no one is working to ensure those assets are yielding an appropriate return for the business.

“Both sides need to be equal priorities to be well balanced and maximize value,” she says.

Smart Business spoke with Penz about the intersection of personal and business wealth management, and what business owners tend to overlook.

What should business owners do to capitalize on their financial position today to ensure a strong financial future when they exit their business?

Working with an advisor who knows the owner’s goal for the business and how that matches with the owner’s personal goals and time frame is imperative.

In order to maximize the value of the business, and do so within a time frame that enables the owner to pass the business to a successor or sell the business before retirement, goals must be set and business and personal funds must be appropriately invested. If a business owner does not work to keep both invested and in sync with their goals, they can find themselves not prepared for their endgame.

What are some strategies or wealth management products that business owners should consider?

Maximizing wealth is as much about the advisory services as it is the product. Of course, retirement plans are essential, using either individual or qualified plans (or a combination), as well as portfolio management that looks broadly to identify opportunities, risks and returns.

It’s important to give an advisor full view of the investor’s assets and finances. Even those who are using multiple investment professionals are best served when one is the ‘quarterback’ who ensures that the rest of the advisory team is using their strengths to maximize return. So many investors believe that diversification is only about having multiple advisors. However, many times that leads to overlap, with team members buying many of the same securities. True diversification, then, is not being achieved.

In what ways can a bank help a business owner maximize his or her wealth and prepare for a secure financial future?

Banks are able to be holistic in their approach, offering deposit products, loans, investment vehicles and expertise. This enables the advisor to monitor the business and personal balance sheets, and take advantage of the markets when possible.

Having an eye on both balance sheets and income statements is a must, and working with an advisor is the best way to accomplish this. At the same time, an advisor can only be effective if he or she has a full understanding of the business owner’s goals.

Business owners should take a moment to decide who their quarterback is and then empower that person by sharing goals, time horizons, business strategies and needs, as well as their personal risk tolerance. The advisor can then craft the ever-evolving plan that is needed to achieve success in the business owner’s business and personal financial future.

Insights Banking & Finance is brought to you by Home Savings Bank

Why business owners should consider ESOPs when exiting their business

Every privately held company, whether owned by individuals, a family or private equity firm, must go through ownership transition at some point. When the time comes, an owner has several options: create liquidity via a leverage recapitalization using a debt-funded dividend to owners; sell control to a strategic or financial buyer; or sell a minority or majority stake of the company to an Employee Stock Ownership Plan (ESOP).

“An ESOP is a qualified retirement plan designed to give employees an opportunity to own employer stock,” says Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank. “ESOPs are the only retirement plan allowed to borrow money to purchase employer stock. Once purchased, the employer stock is allocated to accounts for individual participants so that, when they retire, they can either receive cash or shares, which are then sold back to the ESOP.”

Altman says an ESOP is considered a Qualified Defined Contribution Retirement Plan that is invested primarily in company stock. It’s a flexible tool for owners to sell all or part of a privately held business.

“In this arrangement, the business owner controls the timing and extent of his or her exit, but may still maintain company control or use the tax advantages to help fund its sale.”

Smart Business spoke with Altman about ESOP viable options and potential benefits the structure provides owners and their companies.

What are the characteristics of companies that are typically found to use ESOPs successfully?

ESOP plans work well for companies with:

  • Strong cash flow.
  • A history of stable sales and profits.
  • Taxable income.
  • A capable management team in place that will remain after the sale.
  • An annual payroll of $1 million or more.
  • An owner who has a significant portion of his or her net worth invested in the value of the business.
  • Valuable employees.

Industries considered suitable for ESOPs include:

  • Manufacturing.
  • Financial Services.
  • Construction.
  • Professional Services.
  • Wholesale Trade and Distribution.

What advantages does transferring ownership to an ESOP offer?

Significant tax advantages come with ESOP ownership as selling to an ESOP is a tax advantaged transfer of ownership. The seller’s proceeds can potentially be tax-free via 1042 rollover. There are income and estate tax savings for sellers, management and the company. If the business is structured as a 100 percent ESOP-owned S-Corp., the company will not pay federal income tax.

Also, an ESOP can deduct the transaction price over time, enhancing cash flow and improving credit metrics.

Among the advantages to a seller when transferring ownership to an ESOP is liquidity — the seller gets more money after tax for the sale of closely held stock than for the sale of assets to a third party. The seller enjoys a rate of return via the seller notes, which is far superior to any return available on an alternative investment with fully understood risk and within the seller’s control to manage.

Selling to an ESOP offers flexibility as an owner may sell between 30 to 100 percent of the shares either all at once or gradually over time to accommodate multiple seller exit scenarios. It also creates the option for the seller to maintain control over his or her company, or allow the previous management team to maintain control and management of the company. Warrants and stock appreciation rights may be used to provide incentives to key managers.

How does the transition to an ESOP affect the employees who remain at the company?

There are indications that transitioning to an ESOP improves employee performance as a result of having an ownership interest in company and the accompanying enhanced retirement benefits.

ESOPs can provide advantages to owners transitioning out of their companies, as well as employees. For the right companies, it can be worthwhile to explore an ESOP option.

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