A Prenuptial for Business Owners Buy-Sell Planning A Prenuptial for Business Owners Purpose and Scope of this Presentation. This presentation is intended to provide individuals with a general understanding of the Buy-Sell Planning concept. Any figures, costs, fees, or other numerical representations are for example purposes only. Any individual interested in this concept should consider his or her particular circumstances, and should seek advice and guidance from his or her own professional counsel. You may not use this presentation to solicit new or existing clients. Failure to comply with this request is a violation of securities laws. If you are not a registered representative or if your broker/dealer does not have a selling agreement with Manulife Financial Securities LLC, please contact your nearest Manulife Financial sales office to receive information on becoming licensed and/or obtaining a selling agreement with Manulife Financial Securities LLC. This material is for informational purposes only. Although many of the topics presented may also involve tax, legal, accounting, or other issues, neither The Manufacturers Life Insurance Company (U.S.A.), Manulife Financial Securities LLC nor any of its agents, employees, or registered representatives, are in the business of offering such advice. Individuals interested in these topics should consult with their own professional advisors to examine tax, legal, accounting, or financial planning aspects of these topics. Manulife Financial and the block design are registered service marks and trademarks of The Manufacturers Life Insurance Company and are used by it and its affiliates including Manulife Financial Corporation. Copyright 2002. The Manufacturers Life Insurance Company (U.S.A.). All rights reserved. MLI1012011090. Expires 12/31/2002. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. THIS MATERIAL MAY NOT BE COPIED OR USED WITH THE PUBLIC.

Why do you need a buy-sell arrangement? To plan for changes in business ownership, retirement, death, or disability. Sometimes businesses, like marriages, do not pass the test of time and a disagreement between owners may result in the end of a business. A buy-sell arrangement can prevent the loss of business that owners worked so hard to create. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

Best Type of Arrangement The best type of buy-sell arrangement depends on the situation Several factors: Type of business Number of owners FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Two Arrangements The most common types of buy-sell arrangements are: Entity Purchase Cross-Purchase FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Entity Purchase AKA “stock redemption.” Agreement among the owners and the entity. The entity agrees to purchase (or redeem) the business interest of the departing owner. The owners agree to offer their interest to the entity upon death, retirement, or disability. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. The Tax Perspective An entity arrangement with a C-Corporation will not increase the basis of remaining shareholders’ stock. Redemption can be taxed as a sale rather than a dividend. Taxation as a sale is beneficial because only the gain is subject to tax at the capital gains rate. At death the beneficiaries likely will not report a gain – because the deceased shareholder’s estate receives a step-up in basis. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. The Disadvantages The remaining owners will not receive a step-up in basis in their remaining shares when the entity redeems the interest. Life insurance will be subject to the claims of corporate creditors. State law may prohibit the sale if the business is insolvent or lacks capital. Premium payments are not deductible. Life Insurance received by a C-Corporation can cause a 15% Alternative Minimum Tax (AMT). FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Cross-Purchase The owners are obligated to sell their interest to each other. The business is not part of the arrangement. The purchase of the interest will increase the purchasing owner’s basis. No potential AMT taxes. Likely no capital gains taxes at the death of the owner because the stock receives a step-up in basis to reflect the fair market value. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Trusteed Arrangement Cross-Purchase plan for more than three owners. Trustee purchases life insurance on each of the owners. At death the trustee collects the insurance proceeds and purchases the business interest from the estate of the deceased shareholder. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. The Dilemma Transfer for value It is uncertain whether this type of cross-purchase avoids the transfer for value problem. The death of the shareholder could be construed as causing a transfer of the deceased shareholder’s beneficial interest. IRS has not ruled on this. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

Partnership Arrangements Similar to trusteed cross-purchase plans Shareholders form partnership instead of creating a trust. Partnership purchases a policy on each owner. Should avoid transfer for value problem. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

Buy-Sell Funding Methods Life insurance. Borrowing funds. Sinking fund. Installment purchase. Remember, a triggering event will often be something other than death. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Life Insurance Most common method. Cost effective. Predictable amount of cash available upon death. Policy’s cash value may be enough to fund a buy-out prior to death. Sometimes done on a split dollar basis. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

Borrowing, Installment or Sinking Funds Borrowing or installment May cause a strain on cash flow. Sinking Fund May result in taxes on investments. Retained earnings. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Valuation of Business Important and often overlooked – how to value the business. Common ways Fixing the purchase price Book value Capitalization of Earnings Cut-throat Combinations of above FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Fixed Price Periodically fix by arrangement Pros Simple Cons Often fail to adjust price for changes in value. If not adjusted, unfair to selling shareholder. IRS may disregard the actual selling price and attribute a higher value. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Book Value Determined on date of death or close of last fiscal year. Pros Simple Cons Seldom an accurate reflection of value Reflects depreciated historic values Ignores earnings potential FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

Capitalization of Earnings Value determined by multiplying earnings by capitalization factor. Pros Most effective if business value remains constant. Cons Earnings can be manipulated. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Cut Throat Determined by the shareholders at the time of the sale. Pros Used in lifetime sales. Cons Often favors the shareholder with the deepest pockets. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Combination Formula method. Usual sale is based upon book value and capitalization of earnings. Pros Mitigates the disadvantages of the other techniques. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

The IRS’s View on Valuation In order for the valuation to be binding, there must be a bona fide business arrangement. The agreement must fix a way to determine the price. The terms must be comparable to an arms length transaction. The arrangement must not be a device to transfer assets to family members at a discount. The agreement must meet the requirements of IRC Section 2703 (listed above) in order for the valuation to be binding for estate tax purposes. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. MLI SolutionsSM Buy Sell Module Complete valuation module Computes all the common valuation techniques. Contains over 400 SIC codes for common industries. One of the only systems available today. Illustrates Cross-purchase Entity Partnerships FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Summary “A well-drafted and adequately funded buy-sell arrangement is an important piece of a business owner’s succession and estate plan. Without a buy-sell arrangement a business owner can lose much of the equity he worked a lifetime to create…with appropriate buy-sell planning, happy endings can be achieved.” -Randy Zipse FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. For more information on Buy-Sell Arrangements, please contact your local Manulife Financial Representative or call the Advanced Markets Group at (888) 266-7498, option 3. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.

FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Buy-Sell Planning A Prenuptial for Business Owners The End The End Manulife Financial and the block design are registered service marks and trademarks of The Manufacturers Life Insurance Company and are used by it and its affiliates including Manulife Financial Corporation. This material is for informational purposes only. For more detailed information please contact your advisor. Manulife Financial or any of its agents, employees, or registered representatives do not give legal, tax, investment, or accounting advice. The information given here is merely a summary of our understanding of the current laws and regulations. Prospective purchasers should consult their tax advisor. FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.