Podcast: How to Utilize Tax Benefits in a Successful Exit, an Interview with Bill Smith

By Ryan Tansom
Published: February 28, 2019 | Last updated: March 21, 2024
Key Takeaways

Learn the leveraged funded program and how it works for just about everyone when it comes to getting the deal you want.



About the Host

Ryan is an entrepreneur, podcast host of the show Life After Business and the co-owner of Solidity Financial. Having personally experienced the hazards of selling a business, he joined up with his friend Brandon Wood to educate others on the process. Through their business (Solidity Financial), they provide a platform for entrepreneurs called Growth and Exit Planning that helps in exit planning, value building and financial management.

About the Guest

Bill Smith is a principal consultant for Navigate Group, a strategic business solution provider. Navigate works with business owners and high-level executives to find ways to save the company money through tax benefits and expense evaluation. It is a win-win situation that provides leverage to your company and takes a lot of the stress out of the equation.


If you listen, you will learn:

  • How Navigate got started and why they exist.
  • Why you want Navigate involved in your end-game.
  • The 3 silos of service Navigate provides its customers.
  • How Navigate is different from other loan services.
  • Navigate partners with CPA firms.
  • How Navigate’s deferred compensation contract works.
  • How the system works for the client.
  • How the system works for the banks.
  • The 3 events that will end a contract and what happens next.
  • The pros and cons of release mechanisms in your deals.
  • A typical Navigate policy.
  • Why Navigate prefers a narrowed focus of services.
  • Who should use Navigate’s service?
  • The changes to and 4 components of the RND Tax Credit.

Full Transcript

Announcer: Welcome to Life After Business, the podcast where your host, Ryan Tansom, brings you all the information you need to exit your company and explore what life can be like on the other side.

Ryan Tansom: Hey everybody and welcome back to the Life After Business podcast. This is episode 134 and today I had a blast on this episode. I learned a lot and one of the reasons I really enjoyed this episode is because one of the big challenges that I know that we had in a lot of entrepreneurs and business owners have is if I sell my business will I have enough money in passive income and how do I make sure that I sell my business for enough money? Well, there's a lot of different things that you can do to actually make sure that you hit that equation. You could focus on increasing the value of your company, the multiple and the EBITDA, which Ken Sanginario was just on the podcast recently to share how you do that. So if you're interested on in that he is episode 131 you can do a bunch of different things on the deal structure, so whether you're doing a 330 at age 10 and a stock sale, you could do a 10-31 exchange with your building to hit your income so that way you could reduce the amount of needs that you had for the proceeds of the business.


Ryan Tansom: My point is there's a lot of different things you can do to maximize those proceeds and get the annual income that you need, but what if you can't hit your financial targets with what you currently have? You're either going to have to keep the business longer, save more money, it's going to be the long game or you reduce your income needs. My point is you're going to run into this wall of, okay, I have what I have here. How do I deal with this? Well, it's so interesting because Bill Smith is on the show today. He is a strategic consultant for the navigate group and Navigate Group and Bill have a very unique set of skills because they have a bunch of engineers and very, very intelligent people that are specializing in tax strategy and cost segregation, R&D tax credits. Also this program that bill's gonna be talking about called the leverage funded platform.

Ryan Tansom: They're also a PEO, so they are filled with a very, very solid bench full of technical intelligent people that are about maximizing the money for the business owner and for the business. Bill has brought up a couple of different technical strategies using what's called a leverage funded program that is essentially a type of deferred comp and it can be used specifically to fund the value gap and increase your income post sale or it can be used as a type of deferred comp, your key executives and it's a little bit different than the typical insurance programs and products that are used for deferred comp. And it is crazy interesting and I just absolutely think it's a must listen to because anybody that wants more income after they sell the company and wants to tie their executives right to the business to eventual outcomes in the business and the transaction… it's an absolute must listen to because it's very actionable and it's very specific and I use my curiosity to dive into it with Bill. So there's a couple of other gold nuggets that bill shares from some of the other skill sets him and his company deal with. We talk about the R&D tax credit and a couple of other very interesting things. So I really hope you enjoy this episode. Without further ado, here's Bill Smith.


Announcer: This episode of Life After Business is sponsored by GEXP Collaborative. Their proven process gives you clarity on all of your exit options and how those options impact your financial success, timing and future happiness. Sell your company on your time frame to the buyer of your choice at the price you want.

Ryan Tansom: Bill, how you doing?

Bill Smith: I'm great, Ryan, how are you?

Ryan Tansom: I'm doing good. I'm excited to have you on the show. We have a mutual friend of ours, Ken Sanginario, who was just on the show recently that introduced us because, uh, and you know, maybe even to your horn before we get into it, as I was like, you know what, I've got a lot of experience designing comp plans for my previous business and I've also worked on executive comp and you know, there's a lot of different ways to do it between Phantom stock and insurance and all these different things. And I was like, you know, I just haven't really met anybody that can design this stuff as creatively as what I think could be done. And then mechanically put in a lot of the different creative technical solutions and products and services as such. And then your name came up. So hopefully that gives you a little bit of a, a nice little warm introduction. But for the people that don't know your background, Bill, give us like, you know, how did you get into this space? Maybe a little bit of an overview of the business and the business model that you're in and then we can kind of jump into it.

Bill Smith: Sure, absolutely. Navigate is basically a I call it a strategic business solution provider. Even though we're consultants, we're usually going into a situation where we're trying to provide a solution which could be a product in some cases to fulfill, um, whether it be attacks or deficiency in a business owner's valuation or in a certain benefit packages that he's trying to offer…. He or she had tried to offer their key executive. So we come from a pension background. It's been 30 plus years designing, understanding pensions and working in that world. And from that, we've obviously gotten to know a lot of business owners and understood where they're coming from when it comes to the ultimate succession of their, their company. Especially when they're probably about five to 10 years away from what I would call the end game, where they're going to sell the business or transition it to a family member or a group of family members or their siblings or children or whatever. So we want to get involved probably Ryan within at least 10 years of that end game or a couple reasons. Um, one is in something that we've talked about before. It's a lot of business owners, they're not only ill prepared for selling their companies are, or even planning for succession in near a lot of professionals out there that can help. But at the end of the day, are they really helping them? Are they just trying to get paid a fee]? We don't sell product so we're not insurance guys, but we understand the insurance world. So we'll actually bring certain kinds of solution to the business owner. So for example, we have a um, leveraged concept that basically we'll take the business owner, take a look at the company. So say we get Ken Sanginario's company to come in and do a business valuation guy. I originally thought it was worth 22 million to $20 million. It comes to find out it's only worth between 12 and 15 million.

Bill Smith: How's he going to fulfill that short? Well, oftentimes he's going to try to Super Fund this foreign k plan. Which you can't because it's capitated on highly compensation testing that they do the non highly compensated versus highly compensated employees. So there's a lot of restrictions in the traditional sense, traditional pension or foreign case scenario. So what we'll cut come in as analyze a specific subset. And that's to use a a bank loan to lend the business money to super fund what they call an IUL contract, which is a no load insurance contract. Again, we're not insurance people so we're not going to get paid this huge commissions, we're just basically going to get paid a finder's fee for bringing the right contract in and we're gonna set up the, the financial structure.

Ryan Tansom: To kind of clear up for the listeners, what are the services that you guys do and then kind of how does that lend it? And there was a merger recently. So there's, and I think your model, like you said about the fee based and it's just an interesting approach to this. So just before as you kind of dive into the, they'll leverage platform I think is interesting. And how does that compare it to like when you, you had mentioned previously, a lot of people are typically exposed to like no insurance products that, you know, but they're very kind of basic and they're not tied to the overall outcome. So yeah, I don't want go back too far, but I think it's an interesting kind of concept and background.

Bill Smith: Absolutely. There are three silos for the company. Uh, farming, uh, analogy, but I grew up on a farm. The first silo is a professional employer organization. What a peo is, is basically a chassis where the business owner can have us take care of everything, uh, HR compliance, payroll benefits and fortune 500 kind of, um, benefit kind of criteria. And then what that does is it releases the business owner from the responsibility, liability and compliance, quite frankly, of running the employees. It's allows them then to focus on their primary objective, which is to improve top line results and profitability and EBIDA. As a business owner yourself, you know that if, if you're distracted and not focusing on those primary suspects and you're tied down and bogged down by employees, employee benefits and every, all the minutia that goes along with that, that's going to and put a great strain on your ability to actually be profitable or to focus on the things that make your company profitable. The PEO model is basically a release mechanism to give the business owner the ability to get rid of all that problematic employee management and functionality that a lot of business owners get tied down to. And so that's the peo side of it. Then we have our tax incentive, well, we'll go into manufacturing firms for an example and we'll provide R&D tax credits. We'll do property tax mitigation, segregation studies as well as um, a group [unclear] will provide a cost reduction in certain areas, whether it be shipping, freight, cellular and that type of a, a scenario. And then the third segway or silo, is really our executive benefit of what I call the business owner group, which is where that succession planning and the tools that we use in the succession planning environment come from.

Ryan Tansom: Well I think it's helpful for the background too because it's, you know, you've got a lot of analysts and people that are strategically behind the scenes. It lends itself to that. You're not just, you know, slinging a product like you said. So I think it's just important to know that. And then I'm curious, how did that business owner group come around and what was, what was the origination and that and how did … cause as we go into the leverage, a plat leverage funded platform, these different things out of those kinds of mechanisms tie into like the ultimate outcome and the goal of the group?

Bill Smith: Sure. The PEO is a more recent um, merger if you will, wasn't an acquisition. It was actually a merger. We took our tax incentive group, all right, is this on our broken and merged them into PEO so that the peo would actually have tools. And, um, other sort of benefits for the business owner other than just the PEO model. Cause it not, not to make the PEO or the professional employer organization seem like it's a smaller facet in the, in the world that we deal in, but it is a benefit sort of a payroll solution. And there were a lot of different payroll solutions out there. Ours just happens to be a little bit more unique because it's actually built more for the business owner than it is for the of the old ADP or Paychex sorta mentality, which is really just to sell payroll.

Ryan Tansom: Mhm.

Bill Smith: From that perspective. So my background being in pensions and foreign k, I was always dealing with the business owners and that's when we started finding solutions for them, which is for instance, R&D tax. But it's, it's not unusual for us with a certain company, whether it be biotech or technology or even manufacturing firms to find 500 to $1 million of tax credit. Well if can find that kind of monetary benefit for the business owner, it allows the business owner then to have capital to do certain things for himself or his partners or his key executives in. That sort of lends it leads into having the money to all of a sudden be able to fried those benefits that come from that. The business owner group.

Ryan Tansom: Yeah. Super Cool. I'm curious what your experience is because there's a lot of questions that I get from clients and people on the show or it's like, why doesn't my CPA do this kind of stuff? Cause you know, you're talking tax and finance related stuff. I think, you know, one of the things that I've had as I've had different accountants and CPAs on the, on the show is it, it just depends on what the, what the skill sets are from those people. I don't know if you've got any kind of 2 cents on, you know, how that relates to their current CPA or their current accounting?

Bill Smith: Sure. You're going to find maybe the top six to eight of the largest M&A national CPA firms will provide tax incentives like R and d tax credit work, meaning that they have the engineers and they have the legal background and whatnot to be able to improve those. Um, okay. The rest, the vast majority of CPA firms, whether they're even large regionals all the way to the traditional no shop that maybe has plenty CPAs in it, they don't have the capacity or the ability to provide those tax credits or proof them out, I should say for the business owner. So that's where we become partners with CPA firms and we'd deal with a lot of them across the country to actually help them, whether it be a Chinese wall situation where they're sort of offering it to their clients and we're doing it behind the scenes or oftentimes we're just referred to it.

Ryan Tansom: Got It.

Bill Smith: To do that kind of work, again, when you, when you find tax money for somebody or credits, in this case, it gives you the ability start really working with the business owner to find other solutions at the same time, now you're a hero, right?

Ryan Tansom: What are we doing with this money?

Bill Smith: We're working on one now, 900 employee company that the credits could be as much as 2.5 to $3 million. That goes a long way in making some decisions on hiring a Ken Sanginario is an example to do a true business valuation because it costs money. Right?

Ryan Tansom: Right. Yup. Let's Kinda dive into the, you know, when we think about when a lot of a lot of owners are thinking, okay, well, and I literally got it, I was in a, I have a client of mine yesterday, it talked to a gentleman this morning is like how do we tie these key executives not only for like how do we recruit them, tie them potentially to a transaction or transition to the right KPIs and no, we're, everybody's out. There's this interesting dynamic where you get someone that's a ass and they always want equity or they want, because they know that they're worth it. So there's this whole, I think dance that so many people do have like what do we do with these key executives? How do we, you know, if I've got a value gap, like you're talking about it, I can't give away any more. So like there's this whole like if you want to call it, um, in, in between no man's land of how do you handle this stuff. And I think a lot of people get, you know, they, they get pitched, you know, just normal insurance, but that doesn't necessarily tie it to the overall structure. So what are the different mechanisms that you use inside of that to actually accomplish the goal?

Bill Smith: Sure, absolutely. You're right. The traditional deferred compensation plan or Phantom stock, which is dangerous in it of itself because it can create a tax liability even though there's no asset to offset the taxation you've got to have the money is what it comes down to. The traditional deferred comp, it's usually funded with an insurance contract, but it's also usually funded with an insurance contract that seems to be more on the side benefit of the insurance broker, not on the side of the business owner or the key executives from that perspective. So we, hello design, we didn't actually design it by ourselves but with a group that we um, used to do our back rest ground work and to create and design these products, create a no load version of a deferred compensation funding vehicle, which is an index universal life contract. Now I know there's a dirty word I just said insurance, but in reality, yeah, when it really comes down to is we're going to provide leverage, meaning funding, fund the contract or the 10 year period, which is not unusual.

Bill Smith: That's a normal, um, funding period. Where we're going to lend a business x amount of dollars per year to fund the country with an ultimate benefit on the backside of that which will included benefit but also will include projection of tax free income for that key executive or business owner in 10 years, 15 years or 20 years down the road whenever they pull the trigger and have their event, whether that be retirement or sale of the business. Our group. Well Len, um, I mean in some cases a couple millions and millions of dollars in some instances where if funding larger group, hmm. And um, providing the leverage. So it, the business now has the capital to buy the contracts for the key executive or the business owner or the partner and they're only going to be liable for paying the interest expense on the vehicle. So the business then in this case gets a tax reduction. And again, we're not taxed or CPA by any measure, but traditional tax code says that you can write off the interest liability on the loan because it's a corporate loan. The other thing, Ryan, is those loans do not impact any covenants which traditional loans from the bank do.

Ryan Tansom: I was just going to ask you that.

Bill Smith: Yeah, they did. They don't impact that because they collateralize 100%. So an easy example did one for a business owner, $330,000. Okay. The loan will be $330,000 for 10 years or three point $3 million over that 10 year period. And because the cash value of the contract being no load is exactly what loan is to the bank is fully collateralized with the bank has no issue with trying to subordinate other assets.

Ryan Tansom: So crazy. And that's why I was excited to dive through this. If you, if you're okay with that, let to kind of go through maybe an example. I think if you were to take like the typical mid market companies, let's say yeah, at a million, million, million or two and even in of yacht, you know, three or four key executives, I'll make an 125 grand or something like that and we know that the business is going to be worth 10 or 15 million bucks and we got a ways to go because we have to like almost reengineer, almost do the VOP can send you an reo stuff where I have to read engineer how that EBITDA is built because of the different value drivers stuff. But the executives all want, you know, as you kind of okay, you know, level up your executive team, whether you're recruiting, you're bringing them on. No. So many people, it's like, okay, equity or phantom equity because we're trying to drive them in you know, x amount of years too, the transaction. So how, how are you, I like what would be the steps and kind of the process of determining how this works, how much to what executives and how do the contracts work if there's KPIs, I don't know if I'm overloading with the question, but…

Bill Smith: You're not at all, Ryan, in fact you have to do it that way. Yes. A business seminar or his or her partners, those are easy numbers to, of put together because you could do a, uh, uh, Vlp business valuation come to find that the company's worth. Yes, 15 million dollars or three partners 5 million dollars each, but they all need $500,000 a year in retirement income when you retire and obviously $5 million not going to do that for them. So that's, that's it. And that's an easy way to back into the numbers. And then when, once we backed into it, then we know what kind of depth. I don't know if it happens. Be Part of it. Yeah. How much would we have to learn the company and then we also will know what the projection, mmm. It will be for the various ages of the partners in that case. So say you might have the five year old 40 year olds, well obviously the funding for the 40 year old is going to be less than the 55 year old as an example. That's a business owner scenario. If you using key executives sort of works the same way. And a key executive wants to your point want two things. One is I want job stability. The other is, they think they want a piece of the company but they're afraid to have 100% endorsement that because now they're on the hook. If that company goes from, you use a $15 million example again and now it's worth $12 million in 10 years because you were are horrible sales manager, even though you're the key executive, well your valuation went down. So they also want some guarantees. These vehicles, we'll give them the guarantee and provide that sort of resource that give us a death benefit for their family. Obviously there's a death benefit portion of that that pays the loan back, but whatever the amount above and beyond the loan. Okay. Hey, that goes to the estate of that secular he executives family. The cash value that builds up in those contracts obviously can come out tax free.

Bill Smith: If they get to that end game where they say age 70 and now they want to retire, they'll get tax free income for 25 years and then there's obviously an isn't it outcome that event, which is usually desk. Okay, and the whatever the residual value is in the contract, we'll go to the estate or the families, right? Now, to really drive this home companies that has built most of these flat forms for us in conjunction with our sort of consulting work. Yes. The total premiums, Ryan get to 1.5 to $2 million range then yeah. The banks will actually arbitrage the debt. They won't even charge interest on the loan. What they will do in that case is they will take a piece of the death benefit in lieu of the loan interest you normally paid on the loan. So now I've just taken a large case situation where I might have a let even a law firm that might have 20 partners and now they all borrow $100,000 from the lending group. Which is 2 million dollars. I'm not even going to pay loan interest on that, but the bank is going to do, is it basically arbitraging, assuming one of those guys partners and that law firm is going to die. They're going to get paid their loan back.

Ryan Tansom: Is that at any point whether they're employed or they're not employed there or is that?

Bill Smith: Certainly, yeah, there's a partner. If you'd leave the practice, you get them, you're going to have to take your contract with you or get bought out.

Ryan Tansom: Yup. Okay. So, well if you, if you don't mind kind of going back and actually kind of walking step by such that, so let's say whether it's the business owner or the key executives and you know what are the typical numbers and like maybe, I don't know if you've got like a typical example, you usually give it like okay, we're going to borrow this much money and this is the premiums and how does the cash balance grow usually? And what are some typical numbers that you see like start to finish on the benefits of these things?

Bill Smith: Sure. Um, I'll, I'll use it when I would call a typical 55 year old business owner that would normally, let's say that that business owner wants $200,000 additional tax free income at retirement. And let's, yes, peg that the retirement date is going to be age 70. that loan would probably be in around the $200,000 $250,000 a year range. So full funding over the 10 year period would be between two and four. Two point $5 million. Cash value is going to be worth significantly more than the two point $5 million. Cause I don't know if you know about index contracts and basically you can't lose principal, um, you, you, the worst case scenario is just the stock market goes down 20%. You got a zero return percent return that year. Stock Market goes up 20%. They have a cap on it of 12%. You're always going to get at least 12 percent on the high side and it doesn't run the low side. You're going to get zero or whatever number is in between. So those contracts don't lose it. Oh. And they don't lose 'em value because they're always growing in some form or fashion. Even if you look at the cycle, Ryan and the markets where we're basically crap, oh, from 2007 to say 2012 mmm. Those contracts still made money a lot. You know, maybe two or 3% they still made money. So it was no last year. That's why, that's why they call him index because their index performance, but nevertheless zero. So is that that gives the business owner or the key executives some um, guarantees, for lack of a better word and you know, peace of mind, if you will, that they never going to have to worry about market performance in cycles and everything else that goes on in the world of investing. And that's why they, yeah, that's why this company, we'll only use an index universal life contract because it's the only one that gives those guarantees where other contractors don't.

Ryan Tansom: Yeah. So then in that situation you're, no, you're borrowing 200 to 250 a year. So this is the bank lend it to you. So does it, does it lend it to you in annual like no installments and then you just go back and pay the insurance company then and essentially it's just all a wash, right? I mean, I know there's a lot of, I enter, but I'm saying like as far as how the, the cash flow's flowing and then that's just getting funded on an annual basis. And I mean, and then the owners essentially give, you're getting that tax free income of 200 a year. I mean that's essentially like saving up another 5 million bucks after tax.

Bill Smith: That's correct. That's correct. Normal a traditional mortality tables. Yeah a 70-year-old man is probably going to live on average till 84 85 so there's at least 15 in years distributions that will come out of that. And that case it'd be $3 million if it was 15 years. But like social security, every, everybody wants to beat the odds so they want to live longer than that just to get their money back.

Ryan Tansom: Yeah. When you say what are some of the other assumptions in that? So if you're 55 years old and let's say we do this, so it is it a 10 year term, so then you want to keep the business for at least 10 years and let's kind of go the what ifs. Like what if the owner, like what kind of thing, what is the balance sheet have to look like for that one? First of all, like what, you know, to get financing for borrowing 200 250 grand a year, what does the typical EBITDA or revenue or profits have to look like? And then what happens if things happen between when they do that and then they actually… The term that the contract is complete?

Bill Smith: You, you'll find most companies, Ryan without using EBITDA, and then it makes it a little easier. A general revenue companies between probably 10 million plus if they're profitable and without a lot of them cooking the books and whatnot. You'll find that they're all pretty eligible for the lending part of it. There's very few cases in that range that we find any issues, unless again, it's just not a credit-worthy customers. Oh, there, there is that right. There's still always that issue. You gotta be a credit worthy customer.

Ryan Tansom: What happens? Okay, so which makes sense because again, like if it doesn't happen much to do with cash flow of the bank's giving the loan, you're just paying the insurance company and the banks already collaterized so like every, it's just a mechanism for the banks to sell product and the insurance or sell product on the benefit of the owner, which sounds fantastic.

Bill Smith: Yeah. The banks love the loans because they're going to be a little bit higher then say that, say the traditional commercial loan is 4%. Right now you're going to probably pay in five and a half percent of the bank for that kind of loan. So they're actually making a better return on their investment. Okay. Holy collateralized. So they have no risk. They don't own real estate, so they don't have to worry about markets going up and down on that standpoint, basically cash, there's covering the uh, the, the, the debt. But as a business, uh, owner continues to make the interest payments in a traditional sense. $2 million example I gave you earlier then, is there going to be a, no issue with the bank, but business owners say has a bad business cycle, a two or three years and years? Six, seven and eight can't afford to pay the loan interest. At the worst case, the business owner, the cash to contract and pay the loan off and maybe come up with a a hundred thousand dollar profit as an example?

Ryan Tansom: So yeah, that's what would be the typical on that $250,000 annual payment? What would be the insurance?

Bill Smith: In the first year. Yeah. All right. Well 5% easy math and $250,000 basically 50. Yeah. Oh, so it's not like a corporate, ordinary, they can't, the other thing that they're allowed to do, and I don't want to make this more complex than it is, is in a 10 year period, if a company has um, growing profitability and growing cash flow, they would probably want to start with the interest only on the smaller amount, basically in this case would be $250,000. If it's a company that has stable cashflow and once two divide the interest payments into a 10 year period. So let's say that that's $70,000 a year for the loan, over 10 years is the same number as if you started year one at 15,000 year two at 32,000 dollars a year. Three yet, no $58,000 type of thing. Thanks. That's an escalating kind of an interest payment based on the fact that every year there's another traunch of $250,000.

Ryan Tansom: Right.

Bill Smith: So they can streamline it in equal payments. [Ryan interjects: It's deductible.] Yes, deductible anyway, but if they want to streamline it and accelerate it in the early years by paying higher amounts on the interest side, the banks are happy to do that.

Ryan Tansom: So what happens, something happens between along the scenario that's run, if the business is sold or you know, like if there are missing payment, like how did, like what are, I mean I'm sure that you, you answered the questions all about what about all the would've said when life actually happens outside of the financial projections?

Bill Smith: Well there's this three events, one would be death, and if a business owner dies or the key executive guys, then the loan will be paid out by the death benefit or the intrinsic cash value. Either way. But there's an event that happened. So obviously it triggers both the death benefit and cash value in there. So in that case, the intrinsic value would go to the family of the business owner above and beyond them on after the loan I mean to the a family or to the case executive. The same. Thanks. Yes. Business owner as a, an event, meaning he sells the company. He can make decisions. He or she can make decisions based on, okay, I've got this contract, I've only funded it for seven years. I planned on funding it for 10 years. Do I take some of my sale proceeds from selling the business and put it into the contract? Cause obviously I'm not credit-worthy anymore cause I sold the business so the banks aren't going to give me any more money. So he can make a decision on, I liked the value where it is right now. That's fine. Seven years. Instead of getting $200,000 a year, I'm only going to get $170,000 a year in tax free income. That's fine. I sold the business sooner than I thought. Um, and obviously the third event is if they have financial difficulties, they can just back out of the loan and back out of the contract.

Ryan Tansom: So we're, because yeah, because the, you might have some cash value there and then the insurance company, I mean everything just kind of nets itself out. Yeah.

Bill Smith: It, well use that example. Right? So, so in five years, $250,000 a year is 1.2 $5 million money that the bank has given that business. And you know, he runs into trouble. He's got it at least 1.2 5 million in value. He'll definitely have more based on what I explained with the index side of it. Contract's worth one point $4 million. He cancels it takes us $150,000. Um, which by the way, we'd be a taxable event because he didn't take it as tax redistribution, but at least he's got $150,000 that he's going to, he or she is going to get out of the contract. So that's at least he knows they're going to be okay from that standpoint. It just didn't work out to the projections and that happens. Business happens. Yeah.

Ryan Tansom: So what, what are the, what are the things that people need to know about the banks that are doing the loans and the insurance companies? I mean, obviously there's people like you and I that are helping the clients facilitate this entire situation, but no, as far as the institutions that are, you know, behind the scenes of both of those people that, you know, are there institutions that are set up for success for this or ones that are not? And what are the questions that people can be asking should someone present something like this?

Bill Smith: I think that that's a great question on your part because well, pretty easy with, with the firm that designed all our, our, um, portfolios for this particular company, it says Zurich Life. So we'll just say that it's one of the largest in the world. You're not going to have any financial concerns from the integrity standpoint of that company and all the banks that are doing the lending are big companies. Companies and banks like bank one, Harvard, Eh, uh, however, which, yeah, regional Midwestern bank is, there is a grouping of them. And what they do is oftentimes they'll, no the, if they're going all in together as a team or they're going to just do a one off depends on six situations and circles.

Ryan Tansom: Okay. Okay. Okay. Yeah. As far as like, honestly I can't think of any reason why a business owner that owns a company that is five years out or more or, or wouldn't do. But yeah. The other question I was, I was, is that, you know, just like you know, any of the phantom stock or deferred comp, the traditional deferred comp is the, the way that the compensation structure is actually built around for the executive. Right. Cause you can give this stuff, but it's more about, I'll just kind of maybe tea, you know, prime to get the conversation is like, I always suggest that. Okay. Tie, like put the contract in place to tie the benefits of this stuff to the outcomes that the owner wants. Right. So if one of the lists and said, okay, I want this eva, you also $2 million Ebitda on a $10 million valuation, I've got three executives are going to help me get there.

Ryan Tansom: Instead of giving them part of my proceeds or something like that. Give you this leverage, leverage funded platform for the owner and a few of the executives. But you're going to receive certain benefits when certain things happen. So when we get to a certain valuation when we, and then, so I like to suggest that people tie in a a stay bonus. So whether it's, you know, at closing they get it. Yeah. And then also, oh you're 18 so that way it's locking them in. So I dunno if you've got any kind of 2 cents on, like how would this is tied in or some of the creative things you've seen people do on that end.

Bill Smith: He's actually set up a vesting schedule. Oh. Where the vesting schedule would be tied to performance. So if they're not hitting those criteria, whether it be from your perspective and even a number or revenue, a number or projected sales or revenue, you know, type of number on the top line, and then they can have a graded vesting schedule if you will, that if you don't hit those targeted numbers, you're not going to be vested in that portion of whatever the benefit is. So, um, if they make in a 10 year period and they only come up with 75% of goal, they're only gonna get 75% of the benefits of residual or the remaining value would stay in the company.

Ryan Tansom: Got It. And then I was just going to, I was even thinking as like, as executives decided to leave there vesting or cause he had an offer or something like that, it goes back to the company. And then would that inherently then be the owner's benefit?

Bill Smith: Well, yeah, the insured in that case would be the key executives. Okay. Executive leaves, The contract basically is, and let's say a key executive wants to take it, contract with him or her. Yeah. Basically that nothing's going to happen. They're just going to leave it behind and cash value would go to the business owner and that would probably be the end game on that.

Ryan Tansom: Essentially the cash value and the benefit would then go to the owner though so they can pull that…

Bill Smith: Cause I pay the loan off, pay the loan off, take whatever the residual is for their own benefit.

Ryan Tansom: Because of what I was also thinking Tuesday. I mean I'm assuming you can put stipulations in there that you're not allowed to take it even though technically you probably couldn't. Yeah. I'm assuming you could put into contract cause I mean I could foresee someone's stealing someone else's executive and saying, well yeah, that's great. I'll just continue to pay for your, to me, if your comp plan so that you want to make sure…

Bill Smith: Well, unfortunately for them they could do that. I presume unless there's a covenant from the company standpoint that doesn't allow that.

Ryan Tansom: That's what I'm saying like….

Bill Smith: If the business owner said okay go take it, I don't care but I'm not responsible for it anymore. There's got to be all release mechanism. Somehow built into that.

Ryan Tansom: Got It. But it's up to the discretion of just small, stupid examples. I had a key executive that I sent to college and all this stuff, and then if he left within a certain period, he was in a have to pay for it and three days after he got it, after he graduated, he found another job where that company paid for everything. So I still was totally screwed. Got to love people. Right.

Bill Smith: It's not funny, but …

Ryan Tansom: But you're laughing.

Bill Smith: Well I'm laughing it's idiocracy right.

Ryan Tansom: And so that's why like a, you know, for the listeners it's like yeah, you can technically do that, but essentially you put all the hooks in so that way that person is stuck in your business helping you unless you, but then you can like, like you said, you can have release mechanisms where if you decide to, you can, but you know, just being cautious of that stuff.

Bill Smith: Yeah. Yeah. Obviously the business owner's going to try it and we're going to recommend they protect themselves as best as possible. You don't want to be held hostage by an employee no matter how good they are or what integral part they are of the business.

Ryan Tansom: Yeah. What are some typical like maxed out, I mean cause like if someone had a profitable business and this is all ends up kind of being free money, especially as you look at the tax write offs and stuff. So it's, it's a significant Roi for an owne. What? What are the typical policy side and so if I were to take a one for one for one for me and all three of my executives, I mean like is there like a top, a cap on all this stuff?

Bill Smith: No, there's no cap as long as there is insurable interest, which in this case it would be again, because it is a collateralized loan. It's not unusual… I rarely have we seen anything under $5 million in debt. I bet. Yeah. Obviously that happens where I am because of the various, yeah. Ages. No. He might have somebody in your age bracket. You might have somebody in their late forties and fifties and whatnot. Oh the pen is on that. But the bed benefit part of it would probably be at least $5 million or more and you'll usually see funding, um, small contracts, maybe 150. It is a $200,000 annually.

Ryan Tansom: Okay.

Bill Smith: Cause you're usually talking about people that want to have tax free income in six figure denominations. Obviously you're going to have the funding source being no signs kind of denominations as well.

Ryan Tansom: Well and when I sent what I find so intriguing about all of this, which is why like in our five principles, the whole goal and I don't know how far you want go down this rabbit hole, but it's like no what you want, what does the financial targets and trying to hit, what are the exit options, how do you maximize the value of the company and then how your team and then all the, the mechanisms that are suggested then overlap because everybody's working together on the estate plan, the financial plan, the business like the exit accident, all that stuff is like a big jigsaw puzzle. When I find intriguing about different tools like this is like, okay, let's say there's a family, you know, a family business that's listening that's out there and the, you know, the parents want 250 grand a year in income. Well they might not have to sell the business and they could then gift wrap the business in an estate plan to the kids or someone because they don't need the proceeds and then there's still a death benefit that shores up an estate to give it to the kids. So like you just kind of like solve different mechanisms that I a technique we allow you to increase your options because of some of the things you're selling, right?

Bill Smith: Yeah. You hit it right on the head. Very common to see. Um, dad and mom who, you know, bootstrap the business 30 years ago, their children to take over the business and they're looking for a way to get out. They lived a pretty good lifestyle and paid for college, paid for all this kind of stuff and now they don't have enough money to retire on and they need that. They need the cash flow either from the business or they can super fund one of those contracts that we were just talking about. And then the children can take over the business without that financial burden on their shoulders and mom and dad are going to go off into the sunset with their tax free income for the rest of their lives.

Ryan Tansom: Well, and they can reduce the price of the business for tax purposes. Correct?

Bill Smith: Same. Same exact thing. Yes. A planning standpoint. Exactly.

Ryan Tansom: So then the parents, what happens to that income stream? Does that income stream just go away and then there's the death benefit?

Bill Smith: Yes.

Ryan Tansom: You can't transfer it?

Bill Smith: Well the husband in this case in the contract was on his, it's particular life and let's say that he's 70 years old and the kids now take over the business and the cash value that's built up in there is $10 million and he starts taking you annual distributions and he dies at 85 years old. The death benefit would kick in at that time and remember it was, and it was $5 million universal number and that number will waffle during the early distribution years. Right towards the end of it, we'll actually go back to the $5 million numbers and now as a state's going to get it or a spouse if she still alive, $5 million down. Okay.

Ryan Tansom: Got It. Okay. Super intriguing. I mean the timing has a lot to do with this cause I mean when you say that like, you know, you're trying to get to the 200 grand or whatever in the end, tax free income, it's because the cash value of that policy that was being funded super is way above and beyond that. The loan payoff. Right. Because I mean, you have to get, you have to, I close across before you can actually get the benefit that you're looking for.

Bill Smith: Yes, exactly. Those are all actuarial studies done by the companies that we use to do the best. Yeah. Presentations and proposals.

Ryan Tansom: Well, how does, how does this tie into or as a replacement of, or how have you seen it used with, I guess in traditional deferred comp or traditional phantom stock or any of that other stuff? I mean is, or just interesting genetic makeups of these things that you've seen that have been really interesting and creative?

Bill Smith: You can call this deferred comp, only it could be a free standing version of comp if you will. Yeah, that's more semantics in that case. Ryan, I think at this it is something that's sort of a better version of traditional deferred comp more than I think of this as something just totally unique.

Ryan Tansom: Well, cause if you like, I'm just thinking if you were to pay for like if I'm a, if I'm running the business and I got to pay for, you know, call it the 15 of, you know, 50 grand of interest, it would visit, be going to a premium anyways. So it's like, you know, I, there's, there's, yeah.

Bill Smith: Yeah, exactly. I mean if you're funding it traditional insurance contract, you're paying probably a lot more yes. And premium. Then you would be in loan interest. It could be an alternative to the traditional different comp or an enhanced version of it.

Ryan Tansom: Yeah. Super intriguing. So are there any other, I mean, is this kind of like the, the horse that wins all the time, or is there other things in that business owner, um, group that you guys, other tools and other, um, utilities that you're bringing to the table?

Bill Smith: in that particular world? No, we're pretty and narrow in our focus and we want it to stay narrow in our focus. We don't want to be all things to all people, number one, yes, we are pension consultants, but that's a different world, although not unto itself. We went to have a very specific engagement with a business owner or their key executives if they're trying to do something for their key executives and be very specific with what we're trying to offer them without convoluting it and coming up with 14 different versions and variations and concepts and whatnot. Because all that does is confuse. So we went out. We want to stay on the straight and narrow. Quite frankly, I. Dot. I've been doing this for too long. I think the more you start opening up options, I think that the more confusion comes in usually leads to no decision. And we want proactive yeses. Not emotional, you know, 12 months, 18 months decisions where they're still confused and don't know which direction they're going.

Ryan Tansom: Why wouldn't someone do this?

Bill Smith: Sometimes the phrase too good to be true comes up, but in reality if you look at an actual illustration or contract, it is, it's straight out. It is what it is. There are no deviations, no magic pill. It's a basic, straight contract with a loan from the bank. And it works exactly the way it says it's going to work.

Ryan Tansom: Do you have pushback from other advisors, you know, that get their hands into the different solutions that disagree with this?

Bill Smith: And if for insurance agents get involved, brokers usually CPA's are pretty cool. They actually liked the concept. Yeah. All right. And um, but other business advisors who are trying to sell something will have a big problem with us.

Ryan Tansom: Because what, what are the things that the listeners should be aware of like that they would be selling instead of offering this up?

Bill Smith: Well, it's traditional deferred comp plan really is normally funded with an insurance contract, and the broker is going to make it handsome commission on that transaction. Ours is a fee-based platform, so we just get paid our basic fee and that's it.

Ryan Tansom: You said 10 million in revenue in the top. So is this something where anybody underneath 10 million in revenue should be looking at more like, you know, traditional like then other insurance products or phantom stock or something like that?

Bill Smith: Okay. Well I always have a dialogue Ryan. Um, no matter what size the company is, right. Um, the dialogue or conversation is going to be very short with a smaller company or a smaller, right.

Ryan Tansom: So, I mean is there any 2 cents that you want to leave with the listeners or is there something that, I mean it's so, it's so straight forward, Bill, it's like it's hard to,

Bill Smith: it's exactly what I want it to be.

Ryan Tansom: Well, it's interesting. I was gal on who had a, who does cost segregation and it's like, yeah, that just makes a ton of sense. Whether it's cost seg or its R&D tax credit, you find more money, you'd take it from the government and then you buy yourself a policy like this.

Bill Smith: Well and knowing cost seg and understanding that world, it's amazing how many business owners with commercial property. Won't do it because they're afraid of the IRS is going to come challenge their tax return.

Ryan Tansom: But it's crazy. Like this Gal, her name is Jody Neilson for the listeners. I don't remember what podcast number it was, but um, and we can have it in the show notes is they've done too. 20,000 of these studies and never been challenged. So it's like, okay, well that's uh, that's a pretty good run. Run away. Pretty crazy.

Bill Smith: Yeah it is. But sometimes even when we do R&D task, our clients, yeah. Oftentimes comes up as it is one of their fears. If I am I going to have an IRS audit because I'm doing this? Well because like she does with cost seg, we sometimes get some push back on r and d for the same thing.

Ryan Tansom: Well, I was just going to say, because we have some time, I don't know if you want to give a little bit of an overview of the R&D tax credit cause I know some things changed recently. I believe so, um, and actually have a couple of clients that are specifically interested in this. Uh, right now as you're looking at last year. So I don't know if you want to maybe just give a kind of a give… if there's enough time to kind of give an overview.

Bill Smith: Yeah, absolutely. Well it won't take long, either. In 2006 in Congress, permanentized, the R&D tax credit. Yep. Previous years. It was a year in, year out. The decision whether or not congress was going to allow it to go. So that was, that was number one. Number two is the path act. Yes. Part of the provisions of the new tax act, which allows, um, startups now to participate in the R&D tax, but it's where historically you had to be a profitable company because they didn't have profit. What are you going to do with the tax credits? You can't use them basically. So now startups can actually participate and use it against offset payroll taxes in the first five years of their existence change that they made, which is why R&D, while it was important to a lot of business owners, they, a lot of business owners would get trapped with alternative minimum tax. When the AMT kicks. Yeah. They couldn't use the credit. Well the tax act in 2016. Now you can use the credits and it doesn't create AMT. So now they can fully use all the credits against a tax liability.

Ryan Tansom: So then what is, for the listeners that might not be overly familiar with R&D tax credit, can you kind of give like a one on one overview of like what is it and what are the certain things that qualify?

Bill Smith: Sure. There, there are basically four components as to be technological in nature. Change a process, a definition or, or creating something new. Yep. Proof. Uncertainty in, in a, in a process if you will. And it has to be. a Technology that does something like a patent or, or even in a manufacturing firm that they might be creating this yes. This widget and now they created another cad cam system and I'm a whatever else with an tool and died. Great. Different version of it. Just any of those kinds of processes that a company does change process period basically is what it comes down to is usually eligible R&D tax credit. And R&D tax credits. Ryan are usually right predicated in benchmark payroll. So for every million dollars of payroll that a company has, there'll be above 35 to $70,000 or credits vailable for that, for every million dollars that we processed through the system. So obviously if you have a, um, a company with $10 million payroll, you'd be looking at some significant credits that are available to the business from that perspective. And hmm. Similar to the, well my new mentioned down to cost seg, our firm has never lost or been challenged on any of the work we do because when we poof out the R&D to begin with, when we do the initial study and proposal, we know that they're going to be eligible for them. Otherwise we won't advance project.

Ryan Tansom: So the kind of the, the layer underneath it as far as the definition of what people are doing it is it, is it their payroll is doing the literally the development and R&D or does it, cause I got clients where, you know, they spent a quarter million dollars, some internal payroll, you know, a couple of people get paid a hundred grand a year that are devoted to this, but also outside vendors of the pay to cut, you know, a lot of money to too as well. So how does the internal versus external?

Bill Smith: Any anybody that works on the, okay. No, it's called technology for lack of a better word. That works in a technology, whether they're outsourced or in house, a staff. Okay. Payment or payroll component is part of the R&D credit including the including the president and the owners of the business as well cause they, oh they will always in some form or fashion detaching a project even if it's from the, from a distance.

Ryan Tansom: Bill. Like you know, I'm just thinking of like give him personally back when, right before we sold the business for probably about a year prior, we spend about 300 grand on a new ERP system and then I hired a gal that was 90 grand to help implement it. And then like it touched every single facet of our business from the people. So like all of that. Would that be qualified or is it more just, hey this is stuff that you're developing a new system that will have IP and that could be resold to other people?

Bill Smith: If you're developing a technology, which it sounds like you were from an Ip standpoint, then we would proof out credits from that. Now that that person, the example with the 90,000, the outdoors, maybe only 50% oh his or her, um, income might be eligible. That's our job to find those numbers and we don't, Ryan, start a project unless we know we're going to find the credit, we'll tell, tell a business owner not to bother. It's an if, if we think it's not worth it their time because it takes a little bit of time.

Ryan Tansom: Well, I think, you know, as we're kind of wrapping up a minute, it's, it's trying to find the money that you can, you know, additional cash flow today to reinvest in the business to increase the value of your business or your cash flow post exit. I mean, then that's the whole point of having a comeback.

Bill Smith: Well, I, I look at it, the way we help companies obviously with what we offer is if, if I'm doing an R&D task project, business owner and now I find them a half million dollars, now I've got an opportunity to discuss leveraging his retirement program. Okay. Planning. And so now I can bring in the, or like yourself or Ken who we spoke about earlier. Or maybe they do own a commercial property and then we want to have somebody come do a cost segregation on it. So we want to bring those resources from our tool belts and be able to help those business owners to find more money. So the end of the day and it goes through the business succession part of it. Things that may sell the company, we can have a dialogue with their attorneys and the people about what's the best way for them to sell the business. They just tell it or did he try to go into an important sure. Right. Monetized installment sale or they just want to pay the taxes and be done with it. But at least we're part of that conversation throughout the, the transition.

Ryan Tansom: And I don't know if you want to do the installment sale thing that you're talking about. Wholeness threatened. I keep forgetting. Uh, there, there was a couple other things. I mean I don't know if you want to go down that or maybe we do a different episode on it.

Bill Smith: That could be better use of our time. I think we're talking about tax strategies. Actually they're the end game for the business owner. It's, it's most people know what a 10-31 exchanges. So this is sort of taken a 10-31 exchange concept. Yeah. To the next level because it's not just transfer property to another property, it's actually a actual sale, but that's a lot different than converting it, um, farm land to a commercial.

Ryan Tansom: Well, we'll put a little pin in that for the listeners as we're, as we tee that up for a follow up conversation with you, bill, because it's so much actionable stuff, which is the whole point, right? Listeners want to get in touch with you, want to learn more about you and the business, what's the best way?

Bill Smith: Direct contact. 617-FIVE-298Y-57TY-7. I prefer to have a conversation with people, oftentimes emails, right. And whatnot. And they can always check my profile and I'm link. Hmm. Okay. Okay. Yup.

Ryan Tansom: Bill, thank you so much for coming on. The show is a blast.

Bill Smith: Thank you Ryan. Take care.


Ryan Tansom: I really hope you enjoyed that episode. If you have some takeaways, I think the biggest takeaway should be checked this out. Reach out to me, reach out to bill, talk to anybody that can help you determine whether this program is right for you or it's right for your executives. Because I can't believe that this is something that is not being more optimized and utilize out in the marketplace because it makes so much sense. If you can afford to pay the interest payments, why not take a look at this because there's not a whole lot of downside. And if there is, let's get on the horn and actually dive in to figure out why wouldn't it be for you. So if you have any questions, reach out to me, [email protected] reach out to Bill Smith, let's chat. Otherwise check out the show notes, we'll have all the links in it and if you have time, please reach out on iTunes. Give me a rating. I would appreciate it so much. And then if you have anybody that you think would be a good guest for the podcast because they're an owner who have sold, or it's another piece of technical information, like what bill did today, reach out. Let me have him on the show because I want to give you more content as much as I possibly can. So with that, I will see you next week.

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Written by Ryan Tansom

Ryan Tansom

Ryan runs industry-specific podcasts on his website which pertain to mergers and acquisitions, and all the life lessons he wish he had known then. He strives to bring this knowledge to his listeners in a way that is effective and engaging by providing new material each week from industry experts.

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