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Small Bites Podcast: Insurance

October 2, 2023

An understanding of insurance and long-term care insurance policies in relation to midterm and long-term financial goals, retirement planning, risk management, and access to liquidity for emergency, is essential for business owners. These topics are covered in this Small Bites of Business Insight episode.

Dr. Kathy Gosser, YUM! Assistant Professor of Franchise Management and Director of the Yum! Center for Global Franchise Excellence

Rebecca McDade, JD – Attorney

(NOTE: This is an automated transcription and not intended to be used as a substitution for listening to the podcast recording. Simply click on the player above and receive the full benefit of the conversation.)

So welcome to another episode of Small Bites of Business Insights, talking wealth planning. I have Becca with me again. Hello, Becca. Hey, Kathy. It’s good to have you here. We are actually going to talk about the early stage business owner and what kind of plans. That an early stage business owner should actually start to think about.

So what type of planning should they be considering? So there are a number of things that I would want you to get out of this particular session. The most important one is that you want a basic estate plan. So you want a will. For most people, and for the clients that I used to have, it was always a revocable trust too.

So, you do want a basic estate plan because you want to control who gets your assets when and how. Right. And as we said in an earlier one, if you don’t do it, the state will do it for you. And wrapped up in that basic estate plan would also be the power of attorney for healthcare, the power of attorney for property, the advanced directive.

You just want to build the basic house for yourself. To ensure that all of your wealth is protected, um, and that it’s going to the people that you want it to go to. In addition to putting the basic estate plan together, I actually think that people need to be looking at liquidity buckets. And I break them into emergency funds, midterm goals, long term goals, education and retirement.

So the emergency fund, a lot of times what we hear, Is that you should have enough cash on hand to support you and your family for 6 to 12 months. So part of your goal is you’re building your business. Is always putting aside some cash so that it’s available for those reasons for, for those purposes.

Nobody foresaw the pandemic, right? Their businesses, you know, shut down, but you still had to pay your mortgage. You still had to pay the electricity and you still had to feed your family. So the emergency funds, I think, are an important liquidity bucket. And, you know, it’s interesting, you should say six to 12 months because.

If you look at FDDs, which I love to read those franchise disclosure documents, they usually mention three months of working capital. But I think that your suggestion of six to nine, especially considering we just came off the pandemic, makes a lot of sense. And, and I think you’re talking two different things, but you’re, I think you’re, you add something that I hadn’t put in there, which is a business emergency fund and a personal emergency fund.

You need both. Absolutely. Then we’re looking at midterm and long term non business goals. Within the confines of your business, you’re going to know what your financial needs are, but you’re also going to want to create liquidity buckets for non business midterm and long term goals. That could be, you guys are looking at buying a home or a second home.

It could be a private school for your kids. Um, it could be a boat. It could be a wedding. It could be anything, but making sure that as you are growing your business, you’re creating a liquidity bucket for these other goals is important because you’re not going to want to have to pull from the business at an inopportune time.

When that midterm or long term goal materializes. The other thing is retirement planning. I have talked to so many people who say my business is my retirement plan. And for some people, that’s true. You’re going to be able to sell your business for what you’re going to need for your retirement. But for some people, it’s not.

So let’s go back to when the pandemic hit. If you were set to retire in 2020 and your business took a hit, you were no longer able to sell it for what you were planning to sell it for for retirement. So even if your business is your retirement plan, it still makes sense. To create a 4 0 1 K plan or a SEP I r a or just a regular i r a, so that you are building retirement dollars to help supplement what your business may not provide for you when you sell it.

Oh, that makes a lot of sense. And you know, I love that you call these, instead of savings accounts, you call them liquidity buckets. That is a great name. But I think that’s how we sort of have to look at things. Um, And I think that too many people get caught in the non saving mode and, and we just never know there’s so much volatility with the markets and with the economy and what’s going on in the world that we just never know when we’re going to need liquidity.

And, you know, when you look at the statistics that are out there about Americans and how little we save. It is quite frightening. It really is. It really is. And it’s, it makes sense for those of you who haven’t started your, um, your endeavors into being an entrepreneur yet or newer to it. Um, it makes sense to start good habits early.

And pay yourself first, which is what that retirement’s all about. That’s exactly what it is. That’s perfect. So that’s true. So there are a couple of other things that you should plan. Part of it is asset titling. Can you talk about that? Yep. So there are a number of ways to hold assets and the way that first comes to mind is in your individual name.

So I just titled things in my name. If you’ve been through the earlier podcasts. Anything that I own in my individual name is going to have to go through the probate process at my death. So if you’re trying to avoid probate, you don’t want assets titled in your individual name. Another way of holding assets is in joint tenancy.

So, there are two different kinds of joint tenancy. One is joint tenancy with right of survivorship. And you usually see that with spouses. So my husband and I are going to buy a house and we’re going to own it joint tenancy with right of survivorship. And that means that if I predecease my husband, my half of the house will automatically go to my husband.

So we’re avoiding probate. We don’t have to go through any legal rigmarole. He just gets the asset. The other type of joint tenancy is tenants in common. And oftentimes you’ll see this with business partners or with friends or family. That’s where my sister and I go and we buy a house or a building. I own 50 percent and she owns 50%.

If I die before my sister does, I can do whatever I want with my 50 percent share and she still owns her 50 percent share. And my 50 percent share is going to have to go through probate if I own that in my individual name. Another way of owning assets is in trust. So, I can title assets in the name of a trust.

Any assets titled in the name of a revocable trust, avoid probate at my death, which is nice, but assets that are titled in a revocable trust are still considered mine. I can do whatever I want with those assets. I have unfettered access. Um, assets that are titled in an irrevocable trust are no longer mine.

I have gifted them to someone else and they are actually owned by the trustee of the trust. And it is the trustee who manages the assets that are titled in the name of an irrevocable trust. Um, and then the last thing is assets can be titled in the name of a business entity. So, if I create an LLC or a partnership or a C corporation or an S corporation, assets of the business will be titled in the name of the corporation, as opposed to my individual name.

And then I will own an interest in the company. So I may be a partner or I may be a unit holder of an LLC. That makes sense. And then your interest is actually, if you look at estate planning as part of either Revocable Trust, or your own. Correct. Yes. That okay. Absolutely. Gosh, this gets complicated. Then there is, the other component of planning is creditor liability and protection strategies.

Can you tell us about those? So one of the things that I don’t think people think about a lot is risk management. Yeah. So risk management comes in the form of what type of business entity are you creating? For instance, an L L C. Provides creditor protection. If your business is organized as an LLC and somebody sues the LLC, the creditor, the person who’s suing is limited to the assets in the LLC.

That’s all that they would be able to recover. They wouldn’t be able to get any of your other personal assets. So understanding the pros and cons of. The different types of business entities that you can structure your business as make sense from a credit or protection point of view. Insurance makes a lot of sense, property and casualty insurance.

So you’re going to want to make sure that you have the right property and casualty coverage, not just for your business, but for you and your family. So don’t just get Cheap car insurance you want to make sure that it’s actually going to Protect you because every dollar that goes to a creditor is a dollar that’s not going to your beneficiaries And that’s just a waste of the hard earned dollars that you’ve accumulated.

The other thing to consider in the risk management is an umbrella policy. So an umbrella policy is one that overhangs you, and it’s additional insurance. So for instance, if you get into an auto accident. And somebody sues you, they may get the policy proceeds, the coverage under your auto insurance, but their injuries may have been so extensive.

That what they’re due is more than what your auto insurance is willing to pay. The umbrella policy will cover the shortfall and an umbrella policy is actually pretty cheap. Right. So I would say it’s a no brainer, particularly for a business owner. Because a business owner can get an umbrella policy or an individual.

For the business. Right. For they would get a policy for the business and then the umbrella policy would be an individual umbrella policy. Okay. That makes sense. Yeah. And you know, um, you’re right. I think we’ve looked at some umbrella policies and they are pretty inexpensive, shockingly. So it is really surprising how inexpensive they are for the amount of coverage that you can get.

Correct. Correct. So at the early stages, should a business owner be considering more sophisticated planning or what you’ve described is enough? So I would say that the idea, right, is if you’re going into business, it’s going to appreciate in value. No one’s going into business to lose money. So Your business is never going to be at a lower value than it is when you first start out, which is an opportune time for transferring units in the business to a trust for your kids.

So if my startup costs for the business are a million dollars and I want to transfer 10 percent of the business to my kids, like a trust for the kids, that would cost me 100, 000, 10 percent of a million dollars. Over time, my business may grow, in which case it’s worth 10, 000, 000. That 10 percent that I transferred to my kids is now worth 1, 000, 000 and my transfer tax cost was 100, 000.

Oh. So for 100, 000 of transfer tax, I eventually transferred 1, 000, 000 worth of assets to my kids. Oh, so early is better than you grow your early is better. Yeah. Then you grow that and then you’ve already paid that transfer tax. And so as that money accumulates for them, of course they would pay ordinary income tax, et cetera.

If they have dividends, I would imagine. Absolutely. I do want to put in one plug. I am saying that early is better, right? When you’re starting your business, that’s the lowest value that your company theoretically will be at. But I’m also going to say any time is the right time for planning. So if you’ve been in your business for 10 years, 10 years is the right time for planning because your business will continue to grow.

So it’s at the lowest value that it will be going forward. So let’s talk a little bit about these business entities. Cause you touched on them, Becca, about choosing the right business entity. And I think that in the early stages, that’s really critical. Can you explain why and how they would do that? You know, given the nature of your business, um, That’s going to help determine what type of business entity you’re going to form.

And I did mention a couple before. So one is the LLC is the limited liability company. There’s a partnership, a sole proprietorship, a C corporation and S corporation, and I’m sure there are other. Other things out there. General partnership. Um, the one that we see more often than not with small business owners is a limited liability company.

And the reason for that is that It protects your assets that are held outside of the limited liability company. Um, but when I’m looking and I’m trying to decide what’s the best entity for me, things that I’m going to think about are creditor protection. Is this a high risk business that I’m starting?

So franchisee. Where it’s, um, a cleaning service or a fast food restaurant where people are coming in and someone could get injured. That’s a higher risk than it is if I’m doing your taxes. So I want to look at what my risks are with respect to my business. Um, I want to look at what the tax ramifications are.

Kind of income am I getting? Is it. Mostly capital gain. Is it ordinary income? I want to look at who my potential creditors are, not just liability creditors, people who might be suing me. Um, but who are my suppliers? I’m going to look at those kinds of things and the answers to those are going to help me determine which of those entities that I discussed a couple minutes ago would be the best one for me.

The other thing that I’m going to be looking at is, Are there some entities that are better for wealth transfer strategies versus another? A quick example is a C corporation. So, a C corporation is one that’s double taxed. So, the C corporation pays its own income tax, but if I ever want to get assets out of the C corporation, either for myself, or because I transferred some of the C corporation to a trust for my kids, In order to get those assets out, I have to have the C corporation pay a dividend, which is subject to a second tax.

So a C corporation is really not a good entity if I’m wanting to use it for wealth transfer strategies. Okay. Whereas an S corporation or a partnership would be a better vehicle for wealth transfer strategies because there’s no double taxation. There’s a one taxation system. So if I’ve got children and wealth transfer is important to me, then I’m not going to want a C corp.

Also, and lastly, some business entities are better for active businesses versus passive businesses. So an active business would be. Um, a law firm or it might be a fast food restaurants, any kind of franchise versus a passive, which is I’m building a real estate empire where I’m just buying a whole bunch of commercial real estate.

I have a management company that manages it. Um, that’s more of a passive. So some business entities are going to be better for active versus passive businesses. And where would someone go for sound advice on the best type of business entity to form? So you’re going to want a corporate attorney for this.

There are some estate planning attorneys, and I’m going to emphasize it’s only some, that are going to be well versed on both the corporate side and the estate planning side. But mostly you’re going to have an estate planning attorney and you’re going to have a corporate attorney. That sounds very expensive.

And it can be to have two different attorneys. My recommendation would be to have two attorneys from the same law firm. That way you’re not doubling up on work that is being done. They can share the work so that, um, they’re being more cost effective for you. Also, you know, you could argue that it would cost you a lot more down the road if you didn’t set it up correctly the first time.

And that’s an excellent point. Um, and one I need to remember to say all the truth. Yes, it’s worth, it’s worth setting your investment up correctly and to your point, if you leverage two attorneys from the same firm, you can have some synergy there, which would help. And then lastly on this segment, you talked about insurance a little bit, but can you give us a little bit more advice on life insurance and longterm care?

So I think that there are any number of reasons why people might want to get life insurance. Uh, one is cash flow management. So whether the life insurance would provide cash flow for your family if you died prematurely or it provide cash flow for your business or a combination, insurance is a nice way of getting an influx of cash after your death.

When both the business doesn’t have the benefit of your efforts anymore and your family doesn’t have your income anymore. The other thing that life insurance can do is help fund a buyout. So, if the successor to your business is your oldest son, um, your son can use the life insurance proceeds to help buy out your estate to own the franchise or the business after your death.

Life insurance can also provide wealth. You can build wealth with life insurance. So if I have a life insurance policy. Let’s say my son is going to be the successor to my business and my business is my primary asset, but I have a daughter, um, how am I going to equalize her? And I can do that with life insurance proceeds so that my son gets the business and my daughter gets the life insurance proceeds.

So life insurance is a way to build wealth. So I think that life insurance is an important aspect of planning for a business owner. I also think that long term care can play an important role for the business owner and the non business owner. Long term care policies. Will help pay for medical needs, not health care needs.

But if you need long term care, so you’ve got Alzheimer’s and you’re ending up in a long term care facility or something like that, the long term care policies will pay for that, which means that it’s not coming out of your cash flow. And that means that the business is not being drained at perhaps an inopportune time and other assets that your family has to survive off of are not being drained.

For your ongoing long term care needs. Long term care policies used to be when they first came out, these amazing policies, but people started buying them and then using them and it became a drain on the Insurance companies. So the policies are not as robust as they used to be. But I would say that for a lot of people in certain financial situations, they can be a real lifesaver.

So it really is about planning for the future. Planning to ensure your generational wealth remains for your generations behind you. Absolutely. And you said that so eloquently and so much better than I did. Thank you. I don’t know about that, but this has been, this has been a great session to think about early business owners.

And so join us for the next, when we talk about the mid stage business owner.