Selling A Business. Designing Your Life Post Transaction. October 7, 2010 Web Seminar. When You Think TRUSTS & ESTATES. Think Fulbright.

Transcription

1 Selling A Business Designing Your Life Post Transaction October 7, 2010 Web Seminar When You Think TRUSTS & ESTATES. Think Fulbright. TM

2 Today s Presenters Joe Sleeth Trusts & Estates Partner, Fulbright & Jaworski L.L.P. L Houston Brian Wodar Director, Bernstein s Wealth Management Group Glen Eichelberger Trusts & Estates Partner, Fulbright & Jaworski L.L.P. Houston Timothy Naumann Vice President Bernstein s Global Wealth Management 2

3 A Holistic Approach to Pre-Transaction Planning Determining when (and how) to sell the business Impact of the deal structure t on the owner s ability to meet lifetime financial goals and objectives Explore advantages of wealth transfer planning pre-transaction Bernstein.com 3

4 Teamwork Among Client s Advisors Is Critical Client Bernstein Bernstein.com 4

5 Case Study: The Commander Family in 2007 In early 2007, Mr. and Mrs. Commander determined that their grown children would not be taking over the family business They considered selling their business They showed 2006 EBITDA of $7.5 million They wanted to sell for 8 EBITDA or $60 million Initial professional estimates suggested 6.5 EBITDA was more likely only $48 million They passed, with the plan to continue growing their business Bernstein.com 5

6 M&A Trends Since 2007 Liquidity and Lending Commerce Earnings Consumer Confidence Quantity of M&A Deals Dollar Value of M&A Deals Sense of Panic Source: AllianceBernstein Bernstein.com 6

7 The Commander Family in 2010 Mr. and Mrs. Commander, now age 65, are considering selling their business again EBITDA plummeted during the manufacturing trough, bouncing back to $6 million in 2009 New professional estimates t currently suggest 4.5x EBITDA or $27 million in an all-cash deal Bernstein.com 7

8 The Commanders: Snapshot Mr. and Mrs. Commander have kept most of their wealth in their business, and they have $1 million in IRAs Net of taxes and fees, liquid wealth totaling $23 million if they accept EBITDA They want to purchase a second home valued at $3 million with the sale proceeds Will this nest egg support their annual spending need of $500,000?* What is the tax risk of putting off the sale again? Should they consider alternative deal terms? *Assumed to grow with inflation Bernstein.com 8

9 Quantifying the Opportunity: The Wealth Forecasting System Family Profile Data Financial Goals Assets Income Requirements Risk Tolerance Tax Rates Time Horizon Scenarios Deal Terms Asset Allocation Based upon the current state of the capital markets Prospective returns Wealth Forecasting Model Simulated observations based on Bernstein s proprietary stribution of 10,0 000 Outcom mes Probability Distribution 5% capital-markets research 90 Forecasts returns for 30+ asset classes and 16 different planning vehicles Tracks wealth of G1, G2, G3, and charity after income and transfer taxes See Notes on Wealth Forecasting System at the end of this presentation. Source: AllianceBernstein Bernstein.com 9 Di 95

10 Evaluating What You Need and What You Want Lifestyle Spending Personal Reserve Core Capital Amount to ensure spending needs are met Often calculated at 90% level of confidence How much do you spend? What is your age? What is your risk tolerance? Extra Spending Capital for Next Venture Children & Grandchildren Charity Excess Capital Amount for expanded opportunities How much? To whom? How quickly? How allocated? What strategies? Source: AllianceBernstein Commander Core Capital Required (allocated 40/60): $16.6 Mil. Bernstein.com 10

11 Why 40/60?: Projected Returns of Various Allocations Range of Annual Pretax Returns* (%) (3.0) (2.3) (3.7) (6.0) (8.7) (11.6) Range of Returns 10% (Superior Markets) 50% (Median Markets) 90% (Poor Markets) 0/100 20/80 40/60 60/40 80/20 100/0 Allocation (Stocks/Bonds) Asset allocations assume globally diversified stocks (35% US Value, 35% US Growth, 25% developed foreign markets, 5% emerging markets) and diversified intermediate-term municipal bonds in the proportions noted. * First-year volatility of the portfolios: 0/100 = 4.0%, 20/80 = 5.1%, 40/60 = 8.0%, 60/40 = 11.2%, 80/20 = 14.5%, 100/0 = 17.9%. The annual equivalent volatility of the portfolios over the entire 30-year analysis: 0/100 = 7.5%, 20/80 = 6.9%, 40/60 = 7.7%, 7% 60/40 = 9.3%, 80/20 = 11.5%, 100/0 = 13.9%. Annual equivalent volatility differs from the first-year volatility because the expectation and distribution of asset-class returns change over time. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 30 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 11

12 Why 40/60?: Projected Volatility of Various Allocations Probability of Peak-to-Trough Losses* (%) 10% Loss 20% Loss 30% Loss /100 20/80 40/60 60/40 80/20 100/0 Allocation (Stocks/Bonds) Asset allocations assume globally diversified stocks (35% US Value, 35% US Growth, 25% developed foreign markets, 5% emerging markets) and diversified intermediate-term municipal bonds in the proportions noted. *Data indicate the probability of a peak-to-trough decline in pretax, pre-cash-flow cumulative returns of 10%, 20% or 30% over the next 30 years. Because the Wealth Forecasting System uses annual capital- markets returns, the probability of peak-to-trough trough losses measured on a more frequent basis (such as daily or monthly), may be understated. The probabilities depicted above include an upward adjustment intended to account for the incidence of peak-to-trough losses that do not last an exact number of years. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 30 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 12

13 Trade-Offs: The Impact of Taxes Nominal Wealth Values, Business Sold for $27 Million* Year 30; After Taxes, $500K Spending and $3 Million Vacation-Home Purchase; 40% Stocks/60% Bonds $ Millions $85.2 $74.8 $63.8 $ $39.4 $33.2 $27.6 $21.4 $13.2 $8.8 $4.9 0 $0.6 Fed Capital-Gains Tax Rate Assumed 15% 20% 23.8% 28% Level of Confidence 5% *Basis in business assumed to be zero. Spending assumed to grow with inflation each year. In 15% tax case, federal capital gains tax on the transaction and the liquid portfolio is 15% in Year 1 and 20% thereafter, consistent with current tax law. In 20%, 23.8%, and 28% tax cases, federal capital-gains tax on the transaction and the liquid portfolio is at those rates in Year 1 and in each year thereafter. In all scenarios we assume a 5% state t capital-gains i tax. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 30 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 13

14 Should the Commanders Consider Other Options?* The Commanders can t help but think about that $48 million offer from 2007 *All values above are pretax. Bernstein.com 14

15 Should the Commanders Consider Other Options?* The Commanders can t help but think about that $48 million offer from 2007 Another offer from a second interested party would provide more cash and an earn-out, totaling $33 million An Earn-Out structure t $19 million cash up front with annual consulting income of $400,000 for five years $2.4 million cash annual earn-out over five years *All values above are pretax. Consulting income is taxed as wages. Earn-out: Cash up front and earn-out payments taxed as long-term capital gain with zero basis. Bernstein.com 15

16 What Are the Major Differences in the Specific Deals Offered to the Commanders?* The Earn-Out More cash up front nearly enough to fund core capital after taxes and home purchase The seller will give up control of the business Less upside to the seller in the event of earnings or multiple recovery Earn-out may fluctuate subject to continued profitability of the business *All deals are privately, individually negotiated. Issues of core capital, control, risk, debt, equity and cash proceeds will differ. Consult your M&A attorney, investment banker, corporate counsel and other deal-team members for advice in these areas. Bernstein.com 16

17 $ Mill lions Structure as an Earn-Out? Commander Nominal Wealth Values, Year 30* After Taxes, $500K Spending, $3 Mil. Vacation-Home Purchase 40% Stocks/60% Bonds $85.2 $39.4 $13.2 $41.8 $14.2 $0.00 $78.4 $36.0 $11.4 $104.8 $51.4 $22.0 Probability of Meeting Spending 97% 82% 96% >98% $27 Mil. Initial Cash 20% Decline 5% Decline All Cash Deal Earn-Out Level of Confidence 5% *Basis in business assumed to be zero. Spending assumed to grow with inflation each year..all sales proceeds are assumed to be taxed at capital-gains rates in effect upon distribution. The client expects first earn-out payment of $2.4 million, but receives either no earn-out, $1.92 million, or $2.28 million in the first year. Decline scenarios assume pretax earn-out proceeds will decline annually by referenced amounts over the five-year period. The earn-out scenarios include five years of consulting income at $400,000, pretax, annually. All scenarios include $1 million total in husband and wife s IRAs. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 30 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 17

18 The Government Can Become a Big Beneficiary Distribution of Family Wealth $27 Mil. Cash Deal After Spending and Taxes in Typical Markets Projected 30th Year Wealth: $39.4 Million* To Government $20.6 Mil. Left for Heirs $18.8 Mil. *Median results. Assumes that the spouses die in same year, and that $1 million per person is exempt from estate taxes. The remaining estate is taxed using a 55% estate-tax rate. Based on Bernstein s estimates t of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. This analysis assumes that the senior generation s remaining assets after estate taxes pass to their children. Source: AllianceBernstein Bernstein.com 18

19 Importance of Planning The sale of a business offers many estate and gift tax opportunities for leveraged wealth transfer. Taking advantage of pre-transaction valuations is critical to the success of leveraged wealth transfer. Anticipating and understanding available strategies, as well as potential obstacles, is critical to success. Process should be started well in advance of the transaction. ti 19

20 Impact of Transfer Taxes The impact of transfer taxes must be considered with developing a leveraged wealth transfer plan. The Federal transfer tax system consists of three separate taxes which impact wealth transfer planning (the Estate Tax, the Gift Tax and the Generation- Skipping Transfer Tax). Because of the lack of action by Congress in 2009, 2010 is a historic and unprecedented year for the Federal transfer tax system. 20

21 Current Transfer Tax System Estate Tax (but not during 2010!) Gift Tax Generation-Skipping Transfer Tax (but not during 2010!) 21

22 Estate Tax (applies to transfers at death) Estate Tax Free Amount Top Marginal Tax Rate 2009 $3,500, % 2010 No Estate Tax N/A 2011 $1,000,000 55% and thereafter?????? 22

23 Gift Tax $1,000,000 = Exempt Amount Year Top Marginal Tax Rate % % % NOTE: The 2001 Tax Act did not repeal the gift tax. The Act de-coupled the estate tax from the gift tax beginning in

24 Generation-Skipping Transfer Tax Exemption Rate of Tax (on all amounts in excess of exemption) 2009 $3,500,000 45% 2010 No GST Tax N/A ogs 2011 $1,000,000 (indexed for inflation) 55% and thereafter?????? 24

25 What Does the Future Hold? Permanent repeal of the estate tax is generally not longer considered a realistic expectation. General consensus was that Congress would act to prevent 2010 repeal from taking place - wrong! Congress may not act to retroactively re-instate a permanent estate and GST Tax during 2010, so uncertainty may continue to abound until Without Congress acting during 2010, 2011 will be a Back to the Future or Bobby Ewing s dream in Dallas because the rates and exemptions will reset to 2002 levels (55% top marginal estate tax rate and $1,000,000 individual lifetime or death time exemption amount). 25

26 Planning in 2010 Uncertainties in the transfer tax rules pose challenges in 2010, but not insurmountable obstacles. Consideration of potential strategies that make sense in light of the current planning environment is essential. The primary goal of pre-transaction planning is to take advantage of strategies which freeze the value of business interests at their pre-transaction values. Freezing the value of business interests and pre-transaction values creates opportunity to transfer upside to descendants (or to trusts for their benefit) at lower transfer tax values. 26

27 Planning Opportunities in presents unique opportunities for the following reasons: Current ability to use short-term GRATs (GRATs with a term of less than 10 years) Current availability of valuation discounts for the transfers of certain business interests Historically low IRS interest rates which apply to certain wealth transfer transactions Lower valuations on many assets Potential for certain generation-skipping transfers at a time in which the GST tax does not apply 27

28 Wealth Transfer Strategies for 2010 Grantor Retained Annuity Trusts (GRATs), particularly short-term GRAT s Sales to Grantor Trusts Charitable Lead Trusts Taxable Sales for Estate Planning Dividends 28

29 Basics of a GRAT Transfer of assets into GRAT Husband/Wife 3-Year GRAT Trustee of GRAT agrees to pay Grantor an annual annuity - for a 3 year period Total Trust Proceeds at end of term passing to beneficiaries 29

30 Millions $ What a Difference a Discount Makes $6 Million Three-Year GRAT Nominal GRAT Remainder Values, Year 3* After Taxes, 100% Bonds Post-Transaction $3.4 $2.8 $2.4 $4.8 $4.4 $3.8 $7.4 $6.6 $5.8 0 Discount 30% 40% 50% Level of Confidence 5% *Basis in business assumed to be zero. Bonds are 100% intermediate-term diversified municipals. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next three years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 30

31 What a Difference a Discount Makes over Time $ Millions Nominal $6 Million GRAT Remainder Values, Year 30* After Taxes, 100% Bonds Post-Transaction in GRAT 80% Stocks/20% Bonds Thereafter $32.22 $15.6 $7.8 $49.8 $24.2 $12.0 $74.8 $36.4 $18.0 Level of Confidence 5% Discount 30% 40% 50% *Basis in business assumed to be zero. Assumes GRAT remainder is transferred to an irrevocable trust that pays its own taxes (i.e., a non-grantor trust). Bonds are 100% intermediate-term diversified ifi d municipals i for the first three years. Thereafter, the allocation is 80% globally ll diversified ifi d stocks and 20% intermediate-term t t diversified ifi d municipal i bonds. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 30 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this paper. Source: AllianceBernstein Bernstein.com 31

32 To Gov t. $20.6 Mil. More for Children, Less for Uncle Sam $27 Million Sale Distribution of 30th-Year Family Wealth* After Spending and Taxes in Typical Markets No Planning $6 Million Pre-Sale GRAT (30% Discount) To Gov t. $14.9 Mil. Left for Heirs $18.8 Mil. Left for Heirs $29.8 Mil. Projected Year 30 Wealth $39.4 Mil. $44.7 Mil. *Median results. Assumes that the spouses die in same year, and that $1 million per person is exempt from estate taxes. The remaining estate is taxed using a 55% estate-tax rate. In the GRAT case, median senior-generation wealth before estate taxes is $29.1 million and median remaining trust assets are $15.6 million. The analysis on the left assumes that with no lifetime wealth transfer the remaining assets after estate taxes pass to the children. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. This analysis assumes that, in the scenario in which the senior generation engages in no lifetime wealth transfer, their remaining assets after estate taxes pass to their children. Source: AllianceBernstein Bernstein.com 32

33 Basics of Sale to Grantor Trust (IDGT) Sale to Grantor Trust (IDGT) Sale of assets To IDGT Husband/Wife Grantor Trust (IDGT)* *IDGT should be funded with seed capital prior to sale Trustee of IDGT buys assets from Husband/Wife on a installment note requiring annual interest-only payments until the end of the note term, at which time all remaining accrued and unpaid interest is due and payable together with principal. Total Trust Proceeds at end of promissory note, after payment of interest and principal is owned by trust. 33

34 Installment Sale to Intentionally Defective Grantor Trust 9th Year Remainder Values* After Re-Paying Note 80% Stocks/20% Bonds Discount 0% 30% 40% 50% 45 $ Millions $13.6 $6.0 $1.5 $22.3 $11.4 $4.9 $27.2 $14.4 $6.8 $34.0 $18.5 $9.4 Probability of Remainder > $600,000 95% >98% >98% >98% Level of Confidence 5% *Assumes $6 million of discounted assets, net of 30%, 40% and 50% discounts. A $600,000 seed gift is made to the grantor trust, which uses a portion of the grantor s lifetime exclusion amount. The remaining $5.4 million is sold for a 9-year promissory note which bears interest at 1.73%, which is the mid-term Applicable Federal Rate for October The trust makes interest only payments to the grantor in years 1-8, followed by a year 9 balloon payment of interest and principal. All taxes assumed to be paid from assets outside of this analysis. Based on Bernstein's estimates of the range of long-term returns for the applicable capital markets. Data does not represent past performance and is not a promise of actual or range of future results. See Assumptions and Notes on Wealth Forecasting System in Appendix for further details. Bernstein.com 34

35 Basics of a CLAT Charitable Lead Annuity Trust Transfer $5M of asset into CLAT Husband/Wife 10-Year CLAT Trustee of CLAT agrees to pay a charity an annual annuity for designated period. Total Trust Proceeds at end of term passing to individual beneficiaries. 35

36 Non-Grantor Charitable Lead Annuity Trust 10th Year Remainder Values* 80% Stocks/20% Bonds Discount 0% 30% 40% 50% 45 Level of Confidence 5% $ Millions $8.88 $2.6 $0.0 $16.3 $7.6 $2.2 $20.4 $10.2 $3.9 $26.1 $13.9 $ Probability of Remainder > $0 80% >98% >98% >98% *Assumes $6 million of discounted assets, net of 30%, 40% and 50% discounts. Cost basis of assets contributed to CLAT is zero. Assumes 10-year, zeroed-out non-grantor CLAT established at the October 2010 Section 7520 of 2.0%. Annuity payments increase by 20% each year. Based on Bernstein's estimates of the range of long-term returns for the applicable capital markets. Data does not represent past performance and is not a promise of actual or range of future results. See Assumptions and Notes on Wealth Forecasting System in Appendix for further details. Bernstein.com 36

37 Grantor Charitable Lead Annuity Trust 10th Year Remainder Values* 80% Stocks/20% Bonds Discount 0% 30% 40% 50% 45 $ Millions $11.8 $4.5 $0.3 $21.5 $10.4 $4.1 $26.8 $13.6 $6.1 $34.33 $18.2 $8.9 Probability of Remainder > $0 92% >98% >98% >98% Level of Confidence 5% *Assumes $6 million of discounted assets, net of 30%, 40% and 50% discounts. Cost basis of assets contributed to CLAT is zero. All taxes assumed to be paid from assets outside this analysis. Assumes 10- year, zeroed-out grantor CLAT established at the October 2010 Section 7520 of 2.0%. Annuity payments increase by 20% each year. Based on Bernstein's estimates of the range of long-term returns for the applicable capital markets. Data does not represent past performance and is not a promise of actual or range of future results. See Assumptions and Notes on Wealth Forecasting System in Appendix for further details. Bernstein.com 37

38 Taxable Sales for Estate Planning Same concept as sale to IDGT but target is purchaser is a taxable trust. Strategy is to take advantage of favorable LT Capital Gains rates in 2010: % 20% 23.8%** **Includes 3.8% surtax stet includes LTCGs per I.R.C. Section 1411, as amended by the Heath Care & Education Reconciliation Act of 2010 (P.L ) 38

39 DIVIDENDS Strategy is to take advantage of favorable dividend rates: % 39.6% 43.4% **Includes 3.8% surtax stet includes LTCGs per I.R.C. Section 1411, as amended by the Heath Care & Education Reconciliation Act of 2010 (P.L ) 39

40 Potential Obstacles to Planning Becoming paralyzed by the uncertainties in the transfer tax environment. Allowing the deal to get too far along. It is common for the business founder/key employees to be more focused on the business than on the impact that the business sale will have on them personally Becoming paralyzed by complicated considerations: What if the sale falls through and I have done this planning? How much to leave for children/grandchildren? Outright or in trust? If in trust, who is the trustee, what are the terms of the trust? What if I transfer too much depending on how the deal turns out can I take some back? What about charity? 40

41 Appendix 41

42 GRATs Concept: A method of gifting g property p with reduced or eliminated gift tax. Transfer an asset to a trust (GRAT) in exchange for an annuity payment from the trust for a term of years (the taxable gift, if any, is equal to the value of the property transferred to the trust less the present value of the annuity payments). py If the grantor survives the term of years, the remaining trust principal passes to the beneficiaries free of transfer taxes and the donor s interest in the trust terminates. If the grantor dies prior to expiration of the term, the trust property is included in his estate. Congress is considering 10-year minimum terms for GRATs. 42

43 Sale to Grantor Trust Concept: A method of freezing the value of one s estate by transferring in trust to descendants tax free certain assets expected to appreciate in exchange for either cash, a note, or private annuity. Clients form a defective grantor trust for the benefit of their children (i.e., the trust is not recognized for federal income tax purposes, but considered a valid trust for estate tax purposes). Clients sell assets that are expected to appreciate in value to the grantor trust in exchange for cash, a note, or a private annuity. The use of a promissory note with a favorable AFR interest rate as consideration can help solve liquidity problems and reduce the present value cost of the transaction. 43

44 Charitable Lead Trusts Concept: Irrevocable trust which pays an annuity stream to charity for a stated period of years. Remainder of trust passes to designated beneficiaries or back to grantor at termination. Excellent tools to combine wealth transfer with charitable planning. Charitable deduction d can either be available to the grantor or to the trust, t depending on goals and income tax profile of the grantor. Grantors who retain a reversionary right receive assets back at the end of the trust term. Generally used by clients to shelter unusually high income in given year. Non-reversionary CLATs provide that their assets pass to designated beneficiaries (usually the children of the grantor or to trusts for their benefit). Clients sell assets that are expected to appreciate in value to the grantor trust in exchange for cash, a note, or a private annuity. 44

45 Beware Applicability of Certain Tax Rules A method of gifting property with reduced or eliminated gift tax. Charitable lead trusts are not tax exempt entities. Depending on the structure of the trust, the trust s income and the charitable payments are either taxable to the grantor or to the trust. Even though a CLT is not a tax-exempt entity, they are subject to certain of the Private Foundation Excise tax rules. Specifically, a CLT is always subject to Section 4941 (taxes on self-dealing) and Section 4945 (taxes on taxable expenditures) If the charitable portion of the transfer at the inception of the CLT is greater than 60% (which is often the case to avoid a taxable gift), a CLT is then also subject to Section 4943 (taxes on excess business holdings) and Section 4944 (taxes on jeopardy investments) A power to substitute assets held by the grantor to make the CLT a grantor trust violates Section 4941; as would a buy-back from the CLT Bottom line: these rules are complex making advice of your attorney essential 45

46 IRS Circular 230 Disclosure To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any yattachments) ac is not intended dedor written to obe used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter[s]. 46

47 Should the Commanders Consider Other Options?* The Commanders can t help but think about that $48 million offer from 2007 A second interested party might be willing to structure a $49.5 million deal A L Leveraged drecapitalization ti $13.5 million cash up front with annual salary of $400,000 for five years 80% retained equity in the business Second transaction in five years to sell remaining ownership interests *All values above are pretax. Salary and consulting income are taxed as wages. Leveraged Recapitalization: Cash up front and proceeds from second transaction taxed as longterm capital gain with zero basis. $49.50 million proceeds assume EBITDA grows by 5% annually for the five years between the leveraged recap and the final sale. Bernstein.com 47

48 What Are the Major Differences in the Specific Deals Offered to the Commanders?* The Leveraged Recapitalization The up-front cash component is not enough to fund the seller s core capital The seller will retain control of the business and the business risks More upside to the seller if the earnings or multiples recover when the remaining i interest tis sold ldin the future The seller will take on debt, and cash flows will primarily service that debt *All deals are privately, individually negotiated. Issues of core capital, control, risk, debt, equity and cash proceeds will differ. Consult your M&A attorney, investment banker, corporate counsel and other deal-team members for advice in these areas. Bernstein.com 48

49 $ Millio ons Structure as Leveraged Recapitalization? Commander Nominal Wealth Values, Year 30* After Taxes, $500K Spending, $3 Mil. Vacation-Home Purchase 40% Stocks/60% Bonds $ $85.2 $94.8 $ $39.4 $30.4 $50.0 $13.2 $9.8 $8.2 0 $0.00 $0.0 Probability of Meeting Spending 97% 29% 95% >98% $27 Mil. Initial Cash 10% Decline 5% Growth All-Cash Deal Leveraged Recapitalization Level of Confidence 5% 10 *Basis in business assumed to be zero. Spending assumed to grow with inflation each year. Growth and Decline scenarios assume EBITDA in business will grow or decline annually by referenced amounts over the five-year period. All sales proceeds are assumed to be taxed at capital-gains rates in effect upon distribution. The leveraged recapitalization scenarios include five years of salary income at $400,000, pretax, annually. The 10% Decline and 5% Growth cases assume pretax proceeds from the second 80% sale of $12,484,000 and $34,030,000, respectively. All scenarios include $1 million total in husband and wife s IRAs. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 30 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com

50 A Multigenerational Asset Allocation Single Generation Allocation Multigenerational Allocation G1 Core* G1 40/60 Core* 40/60 G1 Excess 40/60 G1 Excess 80/20 Overall Asset Allocation Stocks 40% Bonds 60% Stocks 45% Bonds 55% Total Wealth (Year 30 in Typical Markets):** $39.4 Million $45.4 Million *Core portfolio is $16.6 million. ** Typical markets represent results at the 50% level of confidence in our Wealth Forecasting model. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the periods analyzed. Data do not represent past performance and are not a promise of actual future results or a range of results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 50

51 Gift/Estate Strategies Benefit from a Discount Capitalize on the Valuation Discount Due to Illiquidity and Lack of Control Grantor Discount Heirs (Post-Sale, Pretax) 0% $1.0 Million 30% $1 Million Pre- Transaction 40% Gift $1.4 Million $1.7 Million 50% $2.0 Million Assuming transfer of a minority interest. Bernstein does not advise on the value of any discounts; information on discounts was provided by clients tax and legal team. Bernstein.com 51

52 What a Difference a Discount Makes $1 Million Outright Gift $ Millions Nominal Wealth Values, Year 20* After Taxes, 80% Stocks/20% Bonds $6.4 $3.5 $2.0 $7.5 $4.0 $2.2 $8.7 $4.7 $2.6 Discount 0% 30% 40% 50% $10.4 $5.6 $3.1 Level of Confidence 5% *Gift of non-discounted assets (0% discount) assumed to be made in cash with $1 million cost basis. Gifts of discounted assets assumed to be made with shares in business with $0 cost tbasis. Assumes gift iftis made to an irrevocable trust tthat tpays its own taxes (i.e., a non-grantor trust). t) Trust pays tax on unrealized gains upon sale of business. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 20 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 52

53 1. Irrevocable Contribution of Shares in Business Pre-Transaction Three-Year GRAT Grantor 2. Pays Income Taxes Annuity Payments to Grantor How It Works 1. Contribute shares in business to grantorti annuity trust retained t 2. Grantor pays taxes on the trust s income (including any capital gains) GRAT* How to Succeed 3. Remainder of Assets After GRAT Term 3. If GRAT assets grow faster than IRS Section 7520 rate, wealth is transferred free of gift tax** Trust for Children *The assets of a GRAT are generally invested as directed by the trustee. **Assuming the GRAT is zeroed out so that the present value of the annuity stream, discounted by the Section 7520 rate, equals the original contribution, and assuming that the grantor survives the term of the GRAT. The 7520 rate used in this analysis is 3.0%. Bernstein.com 53

54 Conclusions Comprehensive pre-transaction planning is critical Start by solving for core capital; plan at a high level of confidence Excess capital is important number to know: Transactions offer a unique opportunity for tax-efficient multigenerational wealth transfers Structured gifting program may confer additional benefits over direct gifts An experienced team is needed to integrate transaction, investment, trust and estate, and tax planning Bernstein.com 54

55 How Bernstein Can Help Give clients comfort and confidence to proceed with the transaction Simplify and ease implementation Help clients choose between competing offers with different deal terms Unique ability to model deal terms, personal wealth planning and wealth- transfer strategies in an integrated and customized analysis Bernstein.com 55

56 Estimated Spending Rates and Core Capital Amounts: Based on Age and Spending Sustainable Spending Rate* Allocation 0/100 20/80 40/60 60/40 80/20 100/0 Age % 1.8% 2.1% 2.3% 2.3% 2.3% Age Age Example: 65-Year-Old Couple (Invested 60/40) Spending Needs: $500K Spending Rate: 3.1% = Core Capital: $16.1 Mil. Estimated Core Capital Spending $500,000 Age 20/80 60/40 50 $27.8 Mil. $21.7 Mil *These spending rates are for couples and assume an allocation of globally diversified stocks (35% US Value, 35% US Growth, 25% developed foreign markets, 5% emerging markets) and diversified intermediate term municipal bonds in the proportions noted. Spending is a percentage of initial value of portfolio and is grown with inflation; spending rates assume maintaining spending with a 90% level of confidence. Based on Bernstein estimates t of the range of returns for the applicable capital markets over the periods analyzed. Data do not represent past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. All information on longevity and mortality-adjusted investment analyses in this study are based on mortality tables compiled in In our mortality adjusted analyses, the lifespan of an individual varies in each of our 10,000 trials in accordance with mortality tables. Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein Bernstein.com 56

57 The Commanders Other Goals Make large current impact on charity Involve children in charitable vision Integrate philanthropic goals with sale of business Bernstein.com 57

58 Private Foundations: The Ledger Large up-front tax deduction Personal/ Family Wealth But more restrictive deduction limitations than other gifting g alternatives Virtually tax-free growth and diversification of assets Dollars to Charity Minimum payout of 5% each year But can be costly to run, and A A1 2% excise tax on net investment t income is levied Full control over assets and grant-making Emotional Satisfaction May last for decades, potentially into perpetuity Establishes multigenerational philanthropic legacy But donor must file detailed public reports and satisfy other complex administrative requirements Bernstein.com 58

59 Millions $ Foundation s Impact on Charitable Legacy Nominal Values, $4 Million Contribution to Foundation* Year 30, Distribute 5% Annually 65% Stocks/25% Bonds/10% REITs $14.6 $9.0 $6.0 $22.0 $10.0 $4.6 Level of Confidence 5% Accumulated Distributions to Charities Assets Remaining in Family Foundation *Annual foundation expenses assumed to be 50 basis points. Contribution to foundation of $4 million in cash is assumed to occur in the same year as the business sale. Based on Bernstein s estimates t of the range of returns for the applicable capital markets over the next 30 years. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. Source: AllianceBernstein Bernstein.com 59

60 Less for Children, but Family Achieves Philanthropic Goals $27 Million Business Sale Distribution of 30th-Year Family Wealth (Nominal) After Spending and Taxes in Typical Markets* To Gov t. $20.6 Mil. No Planning Left for Heirs $ Mil. Fund $4 Million Foundation Foundation $ Mil. To Gov t. $11.8 Mil. Left for Heirs $11.6 Mil. $33.4 Million Projected 9.0 (Distributed to Charities) Year 30 Wealth: $39.4 Million $42.4 Million *Median results. Contribution to foundation of $4 million in cash is assumed to occur in the same year as the business sale. In the foundation case, median senior generation wealth before estate taxes is $23.4 million and median remaining foundation assets are $ million. Assumes that the spouses die in same year, and that $1 million per person is exempt from estate taxes. The remaining estate is taxed using a 55% estate tax rate. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the duration of the analysis. Data do not represent any past performance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this presentation for further details. This analysis assumes that the senior generation s remaining assets after estate taxes pass to their children. Source: AllianceBernstein Bernstein.com 60

61 Notes on Wealth Forecasting System 1. Purpose and Description of Wealth Forecasting Analysis Bernstein s Wealth Forecasting Analysis SM is designed to assist investors in making long-term investment decisions regarding their allocation of investments among categories of financial assets. Our new planning tool consists of a four-step process: (1) Client Profile Input: the client s asset allocation, income, expenses, cash withdrawals, tax rate, risk-tolerance level, goals and other factors; (2) Client Scenarios: in effect, questions the client would like our guidance on, which may touch on issues such as when to retire, what his/her cash-flow stream is likely to be, whether his/her portfolio can beat inflation long term and how different asset allocations might impact his/her long-term security; (3) The Capital Markets Engine: Our proprietary model, which uses our research and historical data to create a vast range of market returns and takes into account the linkages within and among the capital markets, as well as their unpredictability; and finally (4) A Probability Distribution of Outcomes: Based on the assets invested pursuant to the stated asset allocation, 90% of the estimated ranges of returns and asset values the client could expect to experience are represented within the range established by the 5th and 95th percentiles on box and whiskers graphs. However, outcomes outside this range are expected to occur 10% of the time; thus, the range does not establish the boundaries for all outcomes. Expected market returns on bonds are derived taking into account yield and other criteria. An important assumption is that stocks will, over time, outperform long bonds by a reasonable amount, although this is in no way a certainty. Moreover, actual future results may not meet Bernstein ss estimates of the range of market returns, as these results are subject to a variety of economic, market and other variables. Accordingly, the analysis should not be construed as a promise of actual future results, the actual range of future results or the actual probability that these results will be realized. 2. Retirement Vehicles Each retirement plan is modeled as one of the following vehicles: IRA, 401(k), 403(b) or Keogh. One of the significant differences among these vehicle types is the date at which mandatory distributions commence. For IRA vehicles, mandatory distributions are assumed to commence during the year in which the investor reaches the age of 70½. For 401(k), 403(b) and Keogh vehicles, mandatory distributions are assumed to commence at the later of (i) the year in which the investor reaches the age of 70½ or (ii) the year in which the investor retires. In the case of a married couple, these dates are based on the date of birth of the older spouse. The minimum mandatory withdrawal is estimated using the Minimum Distribution Incidental Benefit tables as published on 3. Rebalancing Another important t planning assumption is how the asset allocation varies over time. We attempt t to model how the portfolio would actually be managed. Cash flows and cash generated from portfolio turnover are used to maintain the selected asset allocation between cash, bonds, stocks, REITs and hedge funds over the period of the analysis. Where this is not sufficient, an optimization program is run to trade off the mismatch between the actual allocation and targets against the cost of trading to rebalance. In general, the portfolio allocation will be maintained reasonably close to its target. In addition, in later years, there may be contention between the total relationship s allocation and those of the separate portfolios. For example, suppose an investor (in the top marginal federal tax bracket) begins with an asset mix consisting entirely of municipal bonds in his/her personal portfolio and entirely of stocks in his/her retirement portfolio. If personal assets are spent, the mix between stocks and bonds will be pulled away from targets. We put primary weight on maintaining the overall allocation near target, which may result in an allocation to taxable bonds in the retirement portfolio as the personal assets decrease in value relative to the retirement portfolio s value. Bernstein.com 61

62 Notes on Wealth Forecasting System 4. Expenses and Spending Plans (Withdrawals) All results are generally shown after applicable taxes and after anticipated withdrawals and/or additions, unless otherwise noted. Liquidations may result in realized gains or losses, which will have capital gains tax implications. 5. Modeled Asset Classes The following assets or indexes were used in this analysis to represent the various model classes: Asset Class Modeled As Annual Turnover Rate Intermediate-Term Diversified Municipals AA-rated diversified municipal bonds of 7-year maturity Intermediate-Term Taxables Taxable bonds with maturity of 7 30% years US Value S&P/Barra Value Index 15% US Growth S&P/Barra Growth Index 15% Developed International MSCI EAFE Unhedged 15% Emerging Markets MSCI Emerging Markets Index 20% 6. Volatility Volatility is a measure of dispersion of expected returns around the average. The greater the volatility, the more likely it is that returns in any one period will be substantially above or below the expected result. The volatility for each asset class used in this analysis is listed on the Capital Markets Projections page at the end of these Notes. In general, two-thirds of the returns will be within one standard deviation. For example, assuming that stocks are expected to return 8.0% on a compounded basis and the volatility of returns on stocks is 17.0%, in any one year it is likely that two-thirds of the projected returns will be between (8.9)% and 28.8%. With intermediate government bonds, if the expected compound return is assumed to be 5.0% and the volatility is assumed to be 6.0%, two-thirds of the outcomes will typically be between (1.1)% and 11.5%. Bernstein s forecast of volatility is based on historical data and incorporates Bernstein s judgment that the volatility of fixed income assets is different for different time periods. 7. Mortality Mortality is modeled using our proprietary simulation model, which creates a range of death ages for a given age. The outcomes of the mortality simulation model are then combined with the outcomes of the Capital Markets Engine on a trial-by-trial basis to produce summarized mortalityadjusted results. Mortality simulations are based on the Society of Actuaries Retirement Plan Experience Committee Mortality Tables RP Bernstein.com 62 30%

63 Notes on Wealth Forecasting System 8. Technical Assumptions Bernstein s Wealth Forecasting Analysis is based on a number of technical assumptions regarding the future behavior of financial markets. Bernstein s Capital Markets Engine is the module responsible for creating simulations of returns in the capital markets. These simulations are based on inputs that summarize the condition of the capital markets as of December 31, Therefore, the first 12-month period of simulated returns represents the period from December 31, 2009, through December 31, 2010, and not necessarily the calendar year of A description of these technical assumptions is available on request. 9. Tax Implications Before making any asset allocation decisions, an investor should review with his/her tax advisor the tax liabilities incurred by the different investment alternatives presented herein, including any capital gains that would be incurred as a result of liquidating all or part of his/her portfolio, retirement-plan distributions, investments in municipal or taxable bonds, etc. Bernstein does not provide tax, legal or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. 10. Tax Rates Bernstein s Wealth Forecasting Analysis has used the following tax rates for this analysis unless otherwise noted on individual displays: Federal tax rates are blended with applicable state tax rates by including, among other things, federal deductions for state income and capital gains taxes. Start Year End Year Federal Income Tax Rate Federal Capital Gains Tax Rate Qualified Dividend Rate State Income Tax Rate State Capital Gains Tax Rate % 15% 15% 5% 5% % 20% 39.6% 5% 5% Bernstein.com 63

64 Notes on Wealth Forecasting System 11. Taxable Trust The Taxable Trust is modeled as an irrevocable tax-planning or estate-planning vehicle with one or more current beneficiaries and one or more remainder beneficiaries. Annual distributions to the current beneficiary may be structured in a number of different ways, including 1) an amount or a percentage of fiduciary accounting income (FAI) (which may be defined to include part or all of realized capital gains); 2) FAI plus some amount of principal, expressed as a percentage of trust assets or as an amount; 3) an annuity, or fixed dollar amount, which may be increased annually by inflation or by a fixed percentage; 4) a unitrust, or annual payment of a percentage of trust assets, based on the trust s value at the beginning of the year or averaged over multiple years; or 5) any combination of the above four payout methods. The trust will pay income taxes on retained income and will receive an income distribution deduction for income paid to the current beneficiaries. Capital gains may be taxed in one of three ways, as directed: 1) taxed entirely to the trust; 2) taxed to the current beneficiaries to the extent the distributions exceed traditional income; or 3) taxed to the current beneficiaries on a pro rata basis with traditional income. 12. Grantor Retained Annuity Trusts The Grantor Retained Annuity Trust (GRAT) is a wealth transfer vehicle that receives its initial funding from the grantor and transfers annuity payments to the grantor s personal portfolio each year. The annuity amounts, which are determined in advance, may be fixed (the same amount each year) or increasing (growing each year by no more than 20% of the previous year s amount). The annuity payment is made first from available cash, and then from other portfolio assets in kind. Because the GRAT is modeled as a grantor trust, the system calculates all taxes on income and realized capital gains that occur in the GRAT portfolio each year, based on the grantor s tax rates and other income, and pays them from the grantor s personal portfolio. When the GRAT term ends, the remainder, if any, may be transferred in cash or in kind (as the user specifies) to (1) a non-modeled recipient, (2) a continuing grantor trust, or (3) a taxable trust. If the remainder is transferred in kind, the assets will have carryover basis. 13. Private Foundations The private foundation is modeled d as a charitable trust t or not-for-profit fit corporation, which h can be either a private operating foundation or a private non-operating foundation. The foundation may receive an initial donation and periodic funding from either the personal portfolio modeled in the system or an external source. Annual distributions from the foundation may be structured in a number of different ways, so long as the foundation distributes the minimum amount required under federal regulations, including 1) only the minimum amount; 2) an annuity or fixed dollar amount, which may be increased annually by inflation or by a fixed percentage; 3) a unitrust, or annual payout percentage of foundation assets, based on a single year or averaged over multiple years; 4) a linear distribution of foundation assets, determined each year by dividing the foundation assets by the remaining number of years; or 5) the greater of the previous year s distributions or any of the above methods. These distribution policies can be varied in any given year. For non-operating foundations, the system calculates the excise tax on net investment income. Bernstein.com 64

65 Notes on Wealth Forecasting System 14. Capital Markets Projections Median 30-Year Mean Mean Growth Rate Annual Return Annual Income 1-Year 30-Year Annual Volatility Equivalent Volatility Intermediate-Term Diversified Municipals 3.4% 3.7% 3.6% 4.0% 7.5% Intermediate-Term Diversified Taxables US Value Stocks US Growth Stocks Developed International Stocks Emerging Markets Stocks Inflation N/A Does not represent any past performance and is not a guarantee of any future specific risk levels or returns, or any specific range of risk levels or returns. Based on 10,000 simulated trials, each consisting of 30-year periods. Reflects Bernstein s estimates and the capital-markets conditions as of December 31, Bernstein.com 65