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Why “Deferred Sales Trusts” Can Be A Risky Way To Defer Taxes On A Business Sale

May 29, 2024 07:02 am 0 Comments CATEGORY: Taxes

Small business owners often treat their businesses not only as their source of income during their working years, but also as an asset that can be sold to fund their retirement. And while many businesses can build up substantial value over the years, the downside is that, when that value is realized upon the sale of the business, a large amount of it is treated as taxable income. And for many business sales that create capital gains of more than $500,000, the one-time spike in taxable income created by selling a business can bump the seller into a higher income tax bracket, requiring them to forfeit a significant chunk of their funds needed for retirement to pay their own tax bill on the sale.

One way to reduce the tax impact of selling a small business is by using an installment sale. Under IRC Sec. 453, capital gains on the sale of assets, such as privately held businesses where the payments are spread out over a period of 2 or more years, are deferred until the years when the payments are actually received. Which not only defers the taxes owed on the sale to future years, but can also reduce the absolute amount of tax on the sale by spreading out the tax impact over multiple years and keeping the seller within the lower capital gains tax brackets.

The downside to installment sales, however, is that, being essentially a loan from the seller to the buyer of the business, the seller takes on the risk that the buyer may ultimately be unable to make their payments as required by the installment note. Additionally, it can sometimes be difficult for a business seller to even find a buyer who is willing to agree with them on the terms of an installment note. And furthermore, because an installment sale involves one or more payments being deferred until future years, the seller can't use or invest any of the sales proceeds until they're actually received.

One purported solution to the issues with installment sales that has been promoted by a group of accountants, attorneys, and financial advisors is known as a Deferred Sales Trust (DST), which works by using a third-party (the trust itself) to buy a business or other asset from the seller under an installment agreement, rather than selling directly to the ultimate buyer. The trust then sells the asset to the buyer in a lump-sum transaction and invests the proceeds to pay back the seller under the terms of the installment agreement. As the sales pitch goes, this allows the seller to benefit from installment sale treatment, while eliminating the credit risk of selling to a buyer and giving them at least some ability to choose how the proceeds are invested even before they actually receive them.

However, closer scrutiny of the DST strategy raises significant red flags that aren't included in the sales pitch. For one thing, details of the strategy are kept closely under wraps by the group that promotes and sells DSTs, limiting advisors' ability to vet the DST's legitimacy. Additionally, although DST promoters tout the strategy's ability to eliminate the credit risk of entering an installment agreement directly with a buyer, in reality, the risk is simply shifted to the trust itself: Because the seller cannot be the owner, trustee, or beneficiary of the DST (because doing so would cause the transaction to lose its installment treatment), they are wholly reliant on the trust to be able to make its required installment payments. Meaning that, for example, if the DST trustee mismanaged the sales proceeds and caused them to default on the installment loan, the seller would have no recourse to recover those funds. (While at the same time, any extra funds that are left over after the note is fully paid off go to the DST trustee, not the business seller – a true 'heads I win, tails you lose' proposition.)

In other words, the characteristic that is needed to make DSTs work from a tax perspective – the ceding of all control over the sales proceeds to a third-party trustee – can make them even more risky than a traditional 2-party installment sale. Which is why instead, sellers of small businesses may want to consider other strategies such as structured installment sales (in which the installment note is funded by a large insurance company that has significantly more assets with which to pay off the loan), entering into the installment agreement directly with the buyer, or even simply selling as a lump-sum and taking the entire tax hit in 1 year – which, while being possibly less favorable from a tax perspective, at least ensures that the seller receives all of the sales proceeds to begin with!

#FASuccess Ep 387: Merging A Fast-Growth Firm Into A Much Larger One To Get The Operations Monkeys Off Your Back, With Jenny Martella

May 28, 2024 07:04 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Jenny Martella Podcast Featured Image FAS

Welcome everyone! Welcome to the 387th episode of the Financial Advisor Success Podcast!

My guest on today's podcast is Jenny Martella. Jenny is a Principal and Wealth Manager at Modera Wealth Management, an RIA based in Westwood, New Jersey, that oversees $12.5 billion in assets under management for approximately 4,700 client households.

What's unique about Jenny, though, is how she and her previous business partner were so successful in the early years of growing their advisory firm, that they decided not to hire up the operations staff they would need to keep up, and instead chose to merge into Modera Wealth, and become smaller partners in the much-larger enterprise, so that they could re-focus on their own strengths of serving clients rather than spending more and more time on firm operations.

In this episode, we talk in-depth about how Jenny and her partner grew their firm from $19 million to $250 million of assets under management in just 7 years, thanks in large part to investing in a professionally designed website that highlighted their status as a women-run fee-only financial planning firm, how Jenny felt an increasing burden of operational responsibilities, from hiring to compliance, as the firm grew and there were more clients to serve, and how Jenny's desire to get these operational monkeys off of her back, as well as a lack of a viable internal successor, led Jenny and her partner to look to merge with a larger firm that would reduce these operational burdens and ensure her clients would be served well no matter her own future career choices.

We also talk about how Jenny and her partner managed the merger process itself, including how Jenny first tried to merge with firms their own size and found that many of them wanted Jenny's firm to be their succession plan, the 'courtship process' that led Jenny and her partner to decide to merge into a much-larger RIA like Modera Wealth Management instead, and how Jenny and her partner used the consulting firm FP Transitions to advise them both on their partnership agreement and on the terms of the sale of their firm.

And be certain to listen to the end, where Jenny shares the challenges she experienced going through a merger into a larger firm, including transitioning clients, learning new technology systems, and the loss of the brand identity and client acquisition pipelines from their previous firm, how Jenny carved out a new role for herself within Modera that not only ensured her clients would continue to be well-served, but also allowed her the impact she wanted to help shape Modera as a whole, and how Jenny maintains a running list of quotes and scripts for herself that helps her find the right words at the right time (or occasionally just some personal inspiration) when communicating with clients.

So, whether you're interested in learning about merging with a larger firm to achieve operational efficiencies, how to overcome the technical and emotional challenges of selling a firm, or how to develop better client communication skills, then we hope you enjoy this episode of the Financial Advisor Success podcast, with Jenny Martella.

How Advisory Firm Owners Can Overcome The Marketing “Capacity Crossroads” And Options For Continuing (Sustainable) Growth

May 27, 2024 07:02 am 0 Comments CATEGORY: Marketing

The first few years of building an advisory firm from scratch are typically the most demanding for solo advisors since this often means putting oneself 'out there' as much as possible – working through lead generation services, trying to network with Centers Of Influence (COIs) and the community at large, and battling through all of the "no" s needed to get a "yes" (and therefore a client). Next comes the challenge of establishing patterns and processes to onboard and retain clients, getting referrals, hiring and training staff, and doing the (very rewarding) work to turn a fledgling firm into a sustainable practice.

However, as the firm matures, many advisors find themselves at the "capacity crossroads", which marks the point when the ongoing demands of running a firm and caring for clients begins to completely fill an advisor's day-to-day schedule and their capacity to continue to find and onboard prospects becomes severely diminished… at least, if the advisor wants to avoid burnout.

There are certainly many aspects to this capacity crossroads, but perhaps an under-discussed factor is that the marketing tactics often used by new business owners to build their advisory firm – COIs, cold-calling, networking, and online referral services – are, in fact, creating blocking points in an advisor's ability to continue to scale their firm's growth. This is because the tactics generally used tend to be time-based marketing tactics, and as the firm's client base and revenue grows, the advisor's time becomes increasingly valuable and in short supply. Furthermore, even though these soft-dollar marketing tactics don't have an associated bottom-line expense that requires payment with hard dollars, they can still be 'expensive' because of how much of the advisor's time they need.

To alleviate this time capacity shortage, advisors have 3 options to reduce time-based expenses and increase money-based expenses, allowing them to regain their (more valuable) time that they can invest into the continued growth of their business. The first is to automate certain tasks/tactics, such as scheduling social media content, project management for recurring tasks, or sending reminder emails for webinars. The second option is to delegate tasks/tactics by handing off certain tasks/tactics to an employee or contractor, often decreasing the soft dollar cost (when the other person's time is less expensive than their own). The third option is to eliminate certain tactics entirely, thus reducing both the hard- and soft-dollar costs.

Ultimately, the key point is that marketing, when limited by an advisor's own time and energy, can only take a firm so far. To get to the next level, advisors can position their firms for success and protect themselves from burnout and overwork by using marketing tactics with decreased dependency on their own time… while still continuing to grow!Read More...

Weekend Reading For Financial Planners (May 25-26)

May 24, 2024 01:45 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "Weekend Reading For Financial Planners" - this week's edition kicks off with the news that amidst growing cybersecurity threats targeted at the finance industry, the SEC adopted final amendments to Regulation S-P that will require SEC-registered RIAs and other financial firms to develop, implement, and maintain written policies and procedures for an incident response program to detect, respond to, and recover from unauthorized access to or use of customer information. Further, firms will be required to include procedures to notify clients whose sensitive information was or is "reasonably likely" to have been accessed or subject to unauthorized use. And while firms will have between 18 and 24 months to comply with the amendments, adopting strong cyber hygiene practices could help firms proactively mitigate cyber risks, better protecting client data and maintaining the trust of their clients in the process.

Also in industry news this week:

Why the Federal government is proposing new rules targeting the use of donor-advised funds that could impact financial advisors who work closely with them
A recent report indicates that while financial advisory firms prioritize their client experience, they often make such decisions without consulting their clients first

From there, we have several articles on investment planning:

Why the current moment could be an attractive environment for investors considering an allocation to intermediate-term bonds
How fiscal pressures could keep bond yields' higher for longer' and make certain fixed-income investments less attractive
Why market forecasts are often incorrect, even when they are based on seemingly sensible fundamental analyses

We also have a number of articles on practice management:

Financial advisory industry veteran Joe Duran offers a 4-part framework for advisors to achieve greater organic growth in the years ahead
How "embracing discomfort" can help an advisory firm break out of its normal routine and boost its growth trajectory
5 shifts transforming growth for advisory firms, from using technology as a growth driver and capacity builder to leveraging the remote work environment to attract clients regardless of geography

We wrap up with 3 final articles, all about compensation:

Strategies to negotiate a higher salary, from finding senior advocates to lobby on one's behalf to obtaining a competing job offer as leverage during raise discussions with one's current employer
Why autonomy is a key factor in determining job satisfaction and overall wellbeing and what this means for financial advisors
Why one company publishes every employee's salary online and how doing so has helped it and its staff thrive

Enjoy the 'light' reading!

Navigating The FTC’s Ban On (Most) Non-Competes: The New World Of Partnerships And Non-Solicits

May 22, 2024 07:01 am 0 Comments CATEGORY: Regulation & Compliance

Non-compete clauses are common features of employment agreements around the business world and are often used to dissuade companies from 'poaching' another's employees, and/or to prevent employees (at least for a certain time period) from taking the knowledge gained from working at one company to a competitor. Which can allow companies to protect the 'investments' they have made in their employees and maintain continuity amongst their staff.

However, these agreements can also be unduly restrictive towards employees, limiting their ability to advance within their chosen industry, which is especially problematic in skilled professions that might have required years of education and training just to enter in the first place. Further, critics of non-compete agreements argue that they restrict dynamism in the overall economy by making it harder for businesses to hire (as the pool of applicants will be smaller in industries where non-competes are prevalent), and for employees subject to non-competes to start new companies.

With these factors in mind, the Federal Trade Commission (FTC) in April of 2024 announced a final rule banning most non-competes nationwide that is expected to take effect (pending legal challenges) on September 4, 2024. To comply with the rule, employers are required to provide written notice to relevant workers (which include employees and independent contractors, among other categories), letting them know that their non-compete agreements are unenforceable and will not be enforced.

Notably, the ban includes exemptions for "senior executives" who previously had signed a non-compete (new non-competes are banned for all employees, including senior executives) and in the case of a "bona fide sale of a business entity, of the person's ownership interest in a business entity, or of all or substantially all of a business entity's operating assets". This latter exemption means that financial advisors with an ownership interest in their company (even a very small one) could still be subject to a non-compete as a term of the sale of their stake (which could impact how they value receiving an ownership interest in their firm).

Furthermore, the regulation does not prohibit non-solicit agreements (which restrict a departing employee from soliciting the clients of their former employer for a specified time period), which are more common than non-competes in the financial advice industry, meaning that non-solicit agreements can remain in place, and might even become more prevalent amongst firms that are no longer able to enforce non-competes. But because enforcing non-solicits can be less clear-cut than enforcing non-competes (given that it is more difficult to tell whether an individual is actively soliciting their former employer's clients compared to obtaining a job at a competitor or starting their own business), the number of legal battles over non-solicits could increase as their use rises. Which could make it more advantageous for firms and advisors alike to consider a more equitable, cooperative approach than strict on-competes or non-solicits to deciding which clients an advisor can solicit if they do eventually leave the firm.

Ultimately, the key point is that the FTC's ban on non-competes may provide advisors with increased flexibility to move amongst firms within the financial advice industry, while also offering the opportunity for both financial advisory firms and their advisors to revisit their employment agreements… not only to ensure that they comply with the FTC's final rule, but also so that they better meet the needs advisors and their firms!

#FA Success Ep 386: Turning Impostor Syndrome Anxiety Into A Strength That Drives Client Referrals, With Dann Ryan

May 21, 2024 07:04 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Welcome everyone! Welcome to the 386th episode of the Financial Advisor Success Podcast!

My guest on today's podcast is Dann Ryan. Dann is a Managing Partner of Sincerus Advisory, an RIA based in New York City, that oversees approximately $165 million in assets under management for nearly 150 client households.

What's unique about Dann, though, is how he has channeled the anxiety of having imposter syndrome, which still causes him to be nervous before every client meeting (despite having 17 years of experience in the financial advisory business), as a means to hold himself accountable to always be doing the best he can for his clients, which has allowed Dann to build a thriving financial planning business that generates a steady flow of client referrals.

In this episode, we talk in-depth about how Dann and his partner have 5Xed their AUM in the past 5 years thanks to their firm's commitment to quality client service (which has spurred so many referrals that Dann's firm has implemented a waitlist), why Dann has found that referred clients are willing to remain on the waitlist (because they don't mind as much when Dann explains it's because they're already working so hard for their existing clients!), and the reason that Dann's firm has continued to stick with an AUM fee model despite an increasingly financial-planning-centric service offering.

We also talk about how Dann started his career at a fee-only financial advisory firm in the mid-2000s, when such a path wasn't nearly as common as it is today, why Dann believes that the long hours he put in building financial plans as an employee advisor earlier in his career were a positive career investment that gave Dann the skills needed to be an effective lead advisor today, and why Dann, after not getting an opportunity to become a partner at his previous firm, decided to take the leap and break off to start his own firm.

And be certain to listen to the end, where Dann shares his agile approach to the planning process, proactively analyzing planning issues according to a structured quarterly client service calendar while making himself available when issues arise in the interim, why Dann takes a hands-on approach to the investment planning process and is even open to helping clients implement investment ideas they bring to the table instead of talking them out of it, and how Dann's interest in working with a wide range of client types, rather than focusing on a single niche, coupled with his desire to build long-lasting relationships with these clients, has been crucial to managing his imposter syndrome and building a successful career in financial planning.

So, whether you're interested in learning about how to build a career entirely at fee-only firms, the unexpected upsides of impostor syndrome, or how to handle situations where clients bring their own investment ideas to the table, then we hope you enjoy this episode of the Financial Advisor Success podcast, with Dann Ryan.