The 2008 financial crisis and subsequent tepid recovery produced flat or declining sales for many businesses. This has affected balance sheets, but more profoundly, it has altered business valuations and has had a far-reaching impact on the lives and plans of local business owners.
Businesses are typically valued by some multiple of past revenue. As a result of the crisis and slow recovery, the market values of many formerly thriving local businesses have declined or—at best—risen modestly over the past five years. Many business owners who survived the Great Recession have been forced to delay plans to sell or otherwise transition the ownership of their businesses.
We continue to see clients grapple with the lingering effects of the economic crisis. One-third of small business owners
are over age 55, so as the sale of their businesses and their subsequent retirements are deferred, that affects their planning processes.
If a small business owner dies, it makes estate planning even more complex for families, who may face difficult decisions in the absence of a clear succession plan. Many business owners have a majority of their net worth tied up in the company. With federal estate taxes at 40 percent beyond the $5.34 million allowed under the federal exclusion, the family or other beneficiaries must find the cash for the estate tax bill without liquidating the company.
Being forced to liquidate when valuations are artificially low can exacerbate the issue, which is why it’s vitally important that prospective sellers seek the guidance of professionals who can help them sort through the myriad options that may be available, and help them avoid a liquidity trap.
Here are some of the trends we’ve seen in our work with business owners and the potential strategies that have emerged:
• For some business owners, life insurance can be one way to provide liquidity for estate taxes. However, paying the premiums may be challenging for those who have most of their net worth in their business and little liquidity. We are seeing increased interest in premium-finance loans, so that Kansas City business owners aren’t obliged to sell assets or drain precious cash to cover premiums.
• With short-term interest rates still near historic lows and the fact that lenders typically view these loans as very secure, this type of leverage may be an efficient approach to help cover a large estate tax liability.
Another trend we have observed among business owners, particularly ones who have recently sold their businesses, is the desire for a different approach to investing. While they are growing their business, many business owners invest in mutual funds for
simplicity, expert management and efficient diversification.
Mutual funds are generally an appropriate tool for nearly every portfolio. However, we have observed some larger investors are seeking alternatives to mutual funds and Exchange Traded Funds. Here is what we’re seeing:
• As investors grow to a certain scale, more efficient and customizable options may be cost-effective and accessible.
• Specifically, larger investors (with assets of $5 million and beyond) find that mutual funds do not give them the kind of capital-gains control that they need.
• Larger investors do not want to be subjected to the frenetic inflows and outflows in mutual funds that may affect the mass investor, often with the worst possible market timing.
It’s important for investors to work with investment managers who can construct portfolios that give clients more control over tax consequences. But beyond that, investors should seek access to an array of strategies, including private equity, pri-vate debt, hedging strategies, commodities, real estate, and traditional stocks and bonds.
Demand continues to be strong among business owners seeking guidance through planning the transitioning of their business, managing the proceeds and preparing the family for life after the business. Managing a business and surviving the Great Recession was challenging enough; finding an expert to help you transition through the sale, by comparison, should be easy.