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Cashing Out of Business

March 1, 2008

7 Min Read
Cashing Out of Business

Your successful self-storage company is more than just your most valuable capital asset: It represents the realization of a dream. During the startup and growth stages, enhancing your firms productivity was your primary goal.

Now that youve decided to sell your company and retire, your primary goal is to extract maximum value from the business youve worked hard to build. Unfortunately, too many exiting entrepreneurs (as well as their legal, financial and business advisors) leave too much cash behind because they fail to recognize the enormous value hidden within one of their most overlooked and underused business assets.

Competition Stiffens

As baby boomers face retirement age, our economy is at the precipice of the largest business transition in history, with millions of entrepreneurs seeking to monetize business equity. According to recent reports by Deloitte & Touche, a provider of audit, consulting, financial advisory, risk-management and tax services, Seventy-one percent of small and mid-sized enterprise owners plan to exit their businesses within the next 10 years.

Research by the Small Business Administration indicates only 30 percent of family businesses survive to the second generation and just 15 percent survive to the third. Most companies are sold or, if a sale isnt possible, closed. With so many companies up for sale at the same time, the increasing competition to sell demands innovative asset-leveraging strategies to capture optimum value as well as create more cash with which to expedite a sale.

Your Hidden Business Assets

Throughout the business cycle, companies purchase numerous business-life insurance policies for the purposes of risk management, employee benefits and investment. Examples include:

  • Policies funding buy/sell agreements 

  • Key-person policies 

  • Split-dollar policies 

  • Policies securing business loans 

  • Policies funding retirement and employee-benefit plans 

  • Estate-liquidity and equalization policies 

Traditionally considered inflexible assets with little liquidity, these have long been viewed as necessary yet unrecoverable expenses.

When a company is up for sale, some of these life contracts may become obsolete because the reasons for their purchase are no longer relevant. And after a company is sold, additional business-life policies may outlive their usefulness.

Historically, exiting entrepreneurs faced limited disposition options when changing needs rendered their business-life policies unnecessary. This allowed the policies to lapse, thereby forfeiting the value of all premiums paid or surrendering the policies to the original insurance carrier for their cash-surrender value, an amount that doesnt reflect their true value.

Today, theres another option. You can use an innovative asset-optimization techniquea life settlementto convert the hidden value in qualified business-life insurance contracts to significant immediate cash, providing a much higher return on your investment.

A life settlement is the sale of a life-insurance policy to an institutional investor for a cash payment that is greater than the policys cash-surrender value. The platform for the life-settlement industry was created in 1911 by virtue of a court case, Grigsby v. Russell. In this seminal case, the U.S. Supreme Court declared insurance policies to be personal property and freely assignable, thereby granting a policyholder the right to transfer ownership to others.

With a life settlement, when your no longer needed term or cash value, business-life policies are sold for the highest quality institutional offer; you receive a lump-sum cash payment that can be used for any purpose, including facilitating the sale of your company for the desired price and on favorable terms.

An Entrepreneurial Tale

Three business partners, ages 69, 71 and 72, were the principals of a successful self-storage company. To fund a cross-purchase buy/sell agreement, each partner owned two $3 million term policies (no cash-surrender value) on the lives of the other partners.

Seeking to sell their firm, these entrepreneurs received no offers they considered adequate for achieving their retirement and legacy goals. Unfortunately, their legal, financial and business advisors were unaware of the enormous value hidden within these business-term policies, believing they were worthless due to having zero cash-redemption value.

Rather than lapse the policies and receive no return on the premiums they had paid for many years, these three wise men sold their policies to institutional investors in the secondary life-insurance market and received cash windfalls of approximately $600,000 each. By coordinating the sale of their company with the sale of their obsolete buy/sell policies, the owners were able to sell quickly at a reduced all-cash price because the life-settlement proceeds provided the money they needed to fill the gap between their original selling price and the offers from buyers.

The Basics of Life Settlement

Although life-settlement viability is determined on a caseby- case basis, with all transactions subject to relevant legal requirements and underwriting authorization, the general purchasing parameters are as follows:

  • The insured is 65 or older.

  • The policys death benefit is $250,000 or more.

  • The policy has been in force at least two years.

Unlike applying for life insurance, no medical exams or extensive interviews are required. The underwriting process involves only paperwork, such as your life-insurance policy and in-force ledger as well as your medical records, which are necessary to verify the specifics of your insurance and health. Furthermore, there is no appraisal, application or processing fee.

Large portfolios of life policies are purchased by institutional investors seeking predictable non-market correlated returns based on the future value of policy proceeds. In 2006, corporate money managers invested $10 billion to $15 billion in life settlementsmore money than in the previous seven years combined, because they are increasingly interested in purchasing pools of life policies to diversify their portfolios into alternative investments.

End of a Monopsony

Imagine a world where you were only permitted to sell your house back to the builder, your automobile back to the dealer, and stocks back to the issuing corporation. This is what a world without secondary markets would look like, and this is the world life-insurance policyholders have traditionally encountered.

Before the emergence of the secondary life-insurance market in the late 1990s, the originating insurer was the only potential purchaser for your expendable business life-insurance contracts, thereby restricting policy disposition options to receiving an artificially low cash-redemption value. Because the insurance companies set the re-purchase price, policyholders traditionally received little economic value from their superfluous life contractson average, just 4 percent of the policys face value.

Fortunately, the life-settlement industry has replaced this monopsony (an anti-competitive market situation in which a seller is only permitted to sell to one buyer) with a free market alternative wherein companies competitively bid to acquire the rights and obligations in your dispensable business-life policies. This vibrant marketplace enables you to retrieve the fair market value from these otherwise illiquid business assets. With the average life-settlement payout today being 20 percent to 25 percent of the face value, a life settlement can be an effective tool for liberating substantial liquidity hidden within a dormant business asset.

Caveats

Although selling your obsolete business-life policies in the secondary life-insurance market can be profitable, navigating the labyrinthine life-settlement marketplace can be challenging. The industry, in general, lacks ample due diligence and transparency as well as services responsive to the unique needs of retiring entrepreneurs who are selling companies.

Safeguarding your privacy, securing the highest quality institutional offer and coordinating the sale of your unnecessary business life policies with the sale of your company demands specialized advisory skills in business life insurance, exit planning and life settlements. Working with an independent advisor who has expertise in these disciplines is the key to a successful, efficient transaction.

A Done Deal

Every day, retiring business owners, frustrated by inadequate purchasing offers for their firms, unknowingly discard valuable capital assets by cash surrendering and lapsing their no longer needed business-life policies. Selling these hidden business assets can be the answer to easily getting your deal closedsuccessfully. 

Rhona Sacks, an attorney and business coach, is the founder and president of Legal Life Settlements, a mergers-and-acquisitions advisory company specializing in helping retiring business owners extract maximum value from their hidden business assets. For more information or to receive a copy of the article, 10 Tips for Optimizing Your Life, call 650.581.1596; visit www.legallifesettlements.com

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