Transcript

Michael Palumbos (00:47.138)

Welcome everybody to the Family Biz Show. I'm your host, Michael Palumbos with Family Wealth and Legacy in Rochester, New York. And we have a very interesting show for you today. We're gonna be talking about the Popeye Plan for family business succession and business owner transition planning with Gary Shepherd. Gary, welcome. 

Gary Shepherd (01:11.586)

Thank you, Michael. Appreciate your time. 

Michael Palumbos (01:14.296)

So Gary, we have a little bit of a tradition here where we just ask people, you know, what was your journey? How did you get to where you are today? And then we'll dive into this topic. just, I find it interesting, you know, that most people's paths as we're going through life, it usually isn't a straight line from one place to another. I do find them and I find those people interesting too, but I know mine was a pretty crooked path to get here, know, twists and turns. How about yourself? 

Gary Shepherd (01:45.326)

Yeah, you know, I think we all share that in common. You know, how far back do you me to go? 

Michael Palumbos (01:52.334)

Whatever, whatever works for you. 

Gary Shepherd (01:55.526)

All right. Let's just start. When I got out of college, I was, I have a degree in education and I was going to teach school. I had a double major when I was in college, so I could have taught a whole plethora of stuff. The problem was I also enjoyed school a lot and ended up graduating in December. And if you're a school teacher and you graduate in December, then all the jobs are done. I 

Gary Shepherd (02:23.822)

I had to find something to do before the next school year. And so I went to a recruiter and the person said, well, you I've got this job for you. And it was selling a property and casualty insurance. And I had never sold anything in my life. I didn't see myself as a salesman. And so I said, sure, what the heck. Did that for, you know, the period of time where I thought it was going to take before I went back to school and found it, actually enjoyed it and kept at it for a little bit. 

Gary Shepherd (02:54.766)

until such time as I realized property and casualty wasn't really wanted to be, ran into somebody who was in the insurance business, the life insurance business. I joined him and we did that for a while. and then, ran across, Connecticut general life insurance company and, and one of the first people that impacted my life. He brought me over to the company. that was, you know, a long time ago, pushing. 

Gary Shepherd (03:23.756)

you know, almost 50 years now. And so I, you know, I struggled early on in my career, but they recognized apparently something, they saw something that I didn't see and decided to stash me out on management back then. Because I had those teaching genes, apparently. And so I was on in management for a while. And then the assistant manager or the manager said, okay, 

Gary Shepherd (03:52.75)

You're going to have to be able to produce to certain levels in order to stay on there. And that was the motivation I needed. And one thing led to another. And fast forward many, many years after that, I became the regional chief executive officer for Lincoln Sagemark here in basically Richmond to the ocean. Because I was in Washington, there was an opportunity there. And I did that for a while. 

Gary Shepherd (04:22.296)

Frankly, the company was going through a lot of transition back then and they were taking away control at the organizational level back to the home office. So I went back into personal production in 2010 or so, had a partner for a little while. And then, you know, that was not obviously something that was gonna work over time. You had another transition to go through. 

Gary Shepherd (04:51.936)

I started Shepherd Financial Group as a result of the ending of that partnership, and then effectively decided that with all of the things that were going on in the wealth world these days, you needed to have something that was more or less protected from commoditization. And we'd always had 

Gary Shepherd (05:16.558)

a terrific opportunity and some success working in what I defined as the emerging mid-market space, which for us down here is professional businesses between half a million on a really low side and 5 million. And then operational businesses, again, between 2 million and 20 million. And in the Hampton Road area where I'm at, there's a ton of those folks. We can talk about the characteristics and why I did that. 

Gary Shepherd (05:46.19)

But then I decided that we were going to specialize in succession and transition because that's the kind of thing that you really can't commoditize like you can a wealth management program or something of that nature. They need us and our specific expertise. And so that's how we transitioned or how I transitioned the firm. have a number of folks that work with us in terms of strategic partners and a number of folks on staff that help us to 

Gary Shepherd (06:15.288)

to deal with it, but that's where we're focusing now. And that's how we got to the Popeye plan, which I'm sure we'll talk about here shortly, but that's my journey. 

Michael Palumbos (06:24.878)

Michael Palumbos (06:25.238)

Love it. Thank you for sharing. Appreciate that. You're going through and doing succession planning and transition planning for these business owners. And you and I are part of the Lincoln's BII Business Intelligence Institute and working with John Leonetti at Pinnacle Equity Group, right? Pinnacle Equity Strategies. Yep. 

Michael Palumbos (06:52.364)

And they introduced us to this whole world of making sure that we understood everything from gifting a business to your family, to an ESOP and private equity groups and everything in between. so management buyouts and whatnot. And so in one of these sessions, 

Michael Palumbos (07:18.242)

And I heard this conversation, but you've done something pretty phenomenal with this topic. And this is the topic of the Popeye plan, which is a business transition plan that works really well. because this is the family business show, I know it works great for family businesses, but it also works in other arenas as well. But it's that emerging market, know, that emerging middle market space. 

Michael Palumbos (07:46.146)

you have found it works kind of the best in. 

Gary Shepherd (07:49.122)

Yeah, and there's a number of reasons for that. You know, the vast majority of the businesses that we work with, know, stuff that's under $20 million in terms of business value, not sales and that kind of stuff, but business value. you know, sales can be all over the place. It's the value number that we're talking about here in that marketplace. There's a number of characteristics that seem to populate almost all of those businesses. And the first order of business is 

Gary Shepherd (08:18.798)

almost all of them transition through some form of internal transaction or could because of the financing requirements that were otherwise imposed on them through some kind of traditional sale, such as, you know, earn outs or personal guarantees and those kinds of things. Secondly, there's there's almost a 

Gary Shepherd (08:47.362)

dearth of substantial middle management. you know, the distance between the top C-suite, if you will, and the shop floor is relatively short. And if there's any substantive layers in there, it's very few people in them. And most of these business owners, particularly on the lower end of things, tend to spend more time working in the business than they do on the business. So the group of advisors that are around them, 

Gary Shepherd (09:17.134)

You know, they're always usually pretty good, but they're not cohesively structured in any way, or form. They're only there on an as needed basis. And by default, that means that the business owner, the client is the one that has to put the plan together, populate the solution base and implement it. And they're too busy running the business. And so the structure of 

Gary Shepherd (09:44.97)

of Popeye works really, really good because my experience is the vast majority of businesses in that marketplace are either going to be A, liquidated because they don't, there's nobody to go to it. But beyond that, and assuming they're not gifted, assuming that the business owners actually need the cash that represents the equity in the business. And typically, as you know, it's the biggest single asset on a client's financial statement. So presupposing those two things. 

Gary Shepherd (10:14.946)

The question is, how am going to monetize that value and how do I do it more efficiently than traditionally? And when I read, when I heard Ron Claussen and he was talking about Popeye and it's like, wow, okay. Yeah, most of these businesses that I'm dealing with transition internally through some kind of mechanism. Usually it takes over time. We'll talk about the specifics of how that works and some of the other characteristics, but if it's going to happen over time, 

Michael Palumbos (10:36.974)

you 

Gary Shepherd (10:44.862)

and it's likely to go to a family member, a key person or a management group or something of that nature. Then if I can find a way and Claussen presented it, you know, where there is no capital gains tax to the transitioning owner and no financing costs or loans that have to be taken out by the next generation owners. And there's only one level of tax paid. It seems like, wow, that's a reasonably good thing. 

Gary Shepherd (11:14.922)

And the more I got into it, the more it was a really reasonably good thing. And it's become a seminal part of what we do for clients because it is such a viable alternative given the characteristics I just mentioned to you. 

Michael Palumbos (11:30.924)

Right. So I'll say to you, when I heard it, I got excited as well. And I came back and I started talking to people. didn't dig into it. I started asking. And so there's an attorney that I really respect, an accountant that I really respect, and another advisor, know, wealth advisor that I respect. And I started to, and they're all kind of shaking their head and scratching their heads. And they're like, nah, it doesn't seem like that makes sense. 

Michael Palumbos (12:00.054)

And so I dropped it and I didn't do anything with it. So when I found out that you were doing something with it and successful with it, I just was like, we've got to talk because I don't want to miss this opportunity for the right people. And I think it's, it would be something that would not explain properly. Most attorneys and accounts are going to, you know, be, they're going to be questioning it until they understand. 

Michael Palumbos (12:29.282)

All of the IRS code and all of the things that you dug into this to support how the, all of the pieces come together for this Popeye plan. So let's talk about big picture and then we'll start drilling down. So big picture, when you say, somebody says, what's the Popeye plan? What's the big picture of what the Popeye plan is to you. 

Gary Shepherd (12:37.869)

That's correct. 

Gary Shepherd (12:52.846)

I think I just mentioned that to you. This is an intern, 95, I hate this phrase, 95 % because it's abused terribly. But the vast majority of situations are internal transfers. 

Michael Palumbos (13:09.742)

Okay. So I'm to slow you down to have the conversation. So what we're talking about is an internal transfer from the owner to the management team, from the owner to children or relatives kind of, that's what we're thinking about. This is not an ESOP. A lot of times, yeah, this is not an ESOP. This is totally different. So step one is it's an internal, you know, transition. Go ahead. 

Gary Shepherd (13:31.096)

coming. 

Gary Shepherd (13:36.654)

All right. And you have to basically have the characteristics that an internal transfer is normally going to have in your marketplace. All right. So for instance, in the marketplace that we deal with, an internal transfer to a family member, a key individual or a key management group, 

Gary Shepherd (14:03.372)

The characteristics that you're dealing with here are A, the owner needs to get some value for the business. Okay. And then B, he's got a group of people that they, that he thinks are the likely next generation owners of the business. Okay. Either family or the other folks that we talked about. Sure. You to have those characteristics, but the problem with all of that is typically the, 

Gary Shepherd (14:29.592)

people that we just described as the next generation owners don't have the asset base or the capacity to go out and finance a transaction. And that means that the transaction is gonna be owner financed. And so it's likely to be something that the existing owner, I always try and stay away from buyer and seller in these transactions for reasons that we'll talk about. 

Gary Shepherd (14:55.116)

So the person that currently owns the business and is transitioning out of it is going to end up having to receive money for the value of this business over time, because the people that are buying it don't have the cash upfront and nor do they have the resources to go out and borrow it from the bank. And if they have some resources, the bank isn't going to lend a whole amount without a personal guarantee on the part of the individual. 

Gary Shepherd (15:18.348)

And then they're dealing with paying back notes. So the whole thing turns out to be five years, 10 years long anyways. So it looks like an installment transaction and the client is going to get the value of the business over some period of time. And, and so that's issue number one. Issue number two is you have to understand and you and I do, and most clients when you talk about it, get it, but they don't think about it intrinsically. 

Gary Shepherd (15:48.212)

Every single business owner buys himself out. It's just the way it is. If I'm going to transition my business to you, you're either going to give me a big wad of cash that you have, but the decision that you have for giving me a big wad of cash is, what is the capacity of this business to pay me back some reasonable rate of return that I could otherwise get if I deployed this asset? 

Gary Shepherd (16:15.618)

this money in a way that wasn't involved in your business. And so that's even in multiples, all that kind of mess. So clients don't seem to get that. Okay. It's like, yes, I'm transitioning my business to you. And now they're taking that income and giving it back to you. And it has to be a multiple. Okay. And so once you understand that basically you're buying yourself out, 

Gary Shepherd (16:41.602)

then the issues associated with succession and transition come into play, which is, know, you were 40 and you could do this transaction when you were 40, but you're not interested at that point because you still got your life ahead of you, more things to do. So there's all this subjective stuff. Am I tired? Is there some other thing that I want to do so that you have a profitable business? And now I want to find a way to monetize it to this particular group, but it's going to end up taking time. 

Gary Shepherd (17:11.06)

anyways. And so if it's going to do that, hey, is there any way to make the transition or the transaction more efficient than it traditionally is? And that's what I call the quandary. Because to your point, when we get to the transition or succession, most people think, okay, I'm ready to move out of my business. So I have to sell it and somebody has to buy it. 

Gary Shepherd (17:39.286)

And when I have a seller and a buyer, by definition, I have a taxable transaction. And that means I'm going to pay capital gains. And the beauty of the Popeye plan and what Ron Claussen found in his research of the, and Ron Claussen was the, is the attorney in California who, who I think is a brilliant guy 20 years ago promulgated this particular process. And I have since befriended Ron, talked to him many times. 

Gary Shepherd (18:09.722)

And he figured out how to, in that set of circumstances, be able to transition a business without the imposition of capital gains or the necessity of the next generation owners to acquire loans or financing or anything of that nature. So in our discussion, we can simply say, 

speaker-2 (18:31.66)

Thank 

Gary Shepherd (18:33.486)

If I have a $10 million business, I can sell this without the imposition of capital gains. And if I use a 10, 30 % capital gains rate, I now saved $3 million. And the person buying this can theoretically buy a $10 million business for a dollar. And so it's a good deal for the transitioning client. And it's a great deal for the next generation owner, given the facts and circumstances we talked 

Michael Palumbos (19:03.15)

love it. I think that phrase right there is the person that owns the business today stepping away without having to pay capital gains and the people buying this 10 million dollars, this asset of the owner for a buck. And I know that's generally speaking, but it's just a really nice way to start looking at that to say, okay, now you've got my interest. 

Gary Shepherd (19:29.134)

Gary Shepherd (19:30.134)

It's usually a good opening way to open a discussion with a client. 

Michael Palumbos (19:35.764)

Right. So where do we want to go next? We want to talk about the history. What were the things that Ron had discovered? And then you then have learned from Ron to say, why does this work? you know, I'll tell you, speaking to a tax attorney, speaking to a CPA, this was nuts. They both looked at me like I had five eyes on my, or seven heads, like I was nuts. And so. 

Michael Palumbos (20:05.454)

you have gone down this road and looked at the IRS codes and talked to Ron a ton to be able to pull this together. Cause it is not what, you know, it's real simple to say, $10 million sale without capital gains and a $1 purchase. I know, you know, you're not $1 transition to make all this stuff happen. And that's Nirvana for most business owners. 

Michael Palumbos (20:33.676)

And it's in the tax code. And so that's one of the things that I think is so unique is that one of the specialties that us geeky Sage Mark Lincoln guys that have been around because of Connecticut general all the way back through, we dig into those things and we like to find where's the arbitrage in the tax code to be able to put these things together. So share with us the history of this. 

Gary Shepherd (21:02.222)

Well, Ron Claussen figured out that the beauty of the Popeye plan rests in the differential between the 1954 IRS code and the 1986 creation of, I think it's titled 26, which is the S corporation rules. 

Gary Shepherd (21:31.862)

Okay, so he was really pre-ition in terms of understanding how an S corporation environment could really impact the transition of or the redemption rather of a shareholders interest. So it's probably not. 

Gary Shepherd (21:57.164)

worthwhile going down the rabbit hole of 302 B2 and 17 or 1368 and all that other kind of mess. But suffice it to say, I've been down that rabbit hole with Ron. And he's one of these guys that is really, really good when he does seminars at making something that is unbelievably technical, seem really, really simple, which is what I've just tried to do. 

Gary Shepherd (22:27.03)

And the fundamental thing I think you need to recognize here is A, you have to have an S Corp to be able to do this transaction. But just because you don't have an S Corp doesn't solve the problem. We've converted C Corps to S's. We've converted partnerships to S corporations and everything in between. And the more and more we learn about that, the easier it becomes to 

Gary Shepherd (22:56.482)

not step on all the bombs and annoying. I will tell you that when I first got involved in a series of really detailed conversations with Ron, because I'm a what my staff calls an analytical. And, you know, I think, you know, we said that jokingly here. But but being anal was is something that I don't take negatively, because in our world, as you suggested, 

Gary Shepherd (23:25.248)

know the devil's in the details, so if you understand the interplay between the historical sections of the code that deal with redemptions which are largely promulgated in the 54 code as it related to C corporations. And then you understand how the overlay of S corporations on top of that allowed for an S corporation to essentially in the right set of circumstances. 

Gary Shepherd (23:54.294)

redeem a shareholder's interest without the imposition of a capital gain. That's the beauty of the transaction. So what you're trying to do is at its core, something that is highly counterintuitive. And when I sat down with my local attorney who is also a client and a strategic partner of mine and said, hey, I've been having these conversations with Ron Claussen and I think I got it. And it's brilliant. 

Gary Shepherd (24:23.394)

but I want your opinion. And he took it, he's a tax attorney, as well as an estate planning attorney, as well as a business attorney. And he brought one of his senior partners in and they took a look at this thing and their first reaction was, don't know. But then they started digging and it was like, all of a sudden the light bulb went on. And that's usually what happens with advisors. So the idea here fundamentally is, 

Gary Shepherd (24:50.54)

When you have an S-corp, you only have one level of taxation, right? And so you're gonna earn income in a year and you're gonna pay tax on it. And you're gonna have an increase in your AAA account as a result of whatever it is that you have after tax. And you can do any number of things with that. And one of things you could do is distribute it as a dividend. And dividends have to be pro rata. 

Gary Shepherd (25:18.476)

So everybody that's a shareholder has to get a dividend based on ownership, or you can use it to redeem shares and the code allows it to be redeemed on a non pro rata basis. Okay. So, so you don't have to do that stuff pro rata. So that is essentially what we're talking about. And as long as you keep the redemptions to that year's increase in the AAA account. 

Gary Shepherd (25:48.332)

which you've already paid tax on, then there's no need to have another layer of tax vis-a-vis the capital gains tax because in that situation, it becomes entirely voluntary. the final piece is you have typically in a transaction like this, have the classic definition is a buyer and a seller. And so it would be if I'm the seller, 

Gary Shepherd (26:18.676)

and you're the buyer, we have this taxable event. But in the Popeye plan, because we have an S corporation and we have a next generation owner, what happens is the redemption occurs between the existing owner and the entity, in this case, the corporation. And all we do is bring the next generation owner into the capital structure by selling them at some point, some share. And so if the share costs, we, you know, we 

Gary Shepherd (26:47.042)

We recapitalize the corporation or structure in such a way that all shares are a dollar. I can sell a share to the next generation owner for a dollar. That transaction is a capital transaction between the corporation and the shareholder. Okay. But I'm not involved in it. And then all my redemptions are handled on an annual basis by increases in my AAA account up to that. 

Gary Shepherd (27:15.752)

And so I'm redeeming shares, which I can do disproportionately because the code allows it. And so over time, I'm redeemed out with the annual increases in AAA. And then the only person owning the stock in the corporation after all of mine have been redeemed out is the key person in the family member. And they now own the corporation because it's the only outstanding share for which they've paid a dollar for it. And I got... 

Gary Shepherd (27:45.238)

my full value out without the imposition of a capital gains. And that's how it works in technical work. 

Michael Palumbos (27:52.334)

I love it. I'm going to, I want to be able to see if I can repeat it back to you again, because I think it's important for people. You need to hear something like this twice. Yeah. So I've got, you know, a $10 million business. Okay. Right now I've got a hundred shares because I'm the sole owner really didn't matter in what I was doing. Right. I want my, I want my son to get this business. 

Gary Shepherd (28:02.412)

Yeah, it's counterintuitive. 

Gary Shepherd (28:16.611)

Yeah. 

Michael Palumbos (28:22.41)

And Lord knows he doesn't have the money to make this thing work. And he's not going to go out and be able to get a loan for $10 million. But he's been working with me for 15 or 20 years now. And he's pretty, you know, I mean, he's done great. He's got a nice lifestyle, but he doesn't have $10 million or the wherewithal to make that happen. And I know he could do it. 

Gary Shepherd (28:43.534)

Gary Shepherd (28:44.235)

But let me just intercede in that particular situation, what is absolutely a condition precedent to the sale is that you also, Michael, need the $10 million to maintain your lifestyle. So gifting the family business is not on the table for that very reason. 

Michael Palumbos (29:02.35)

Right, and so a good example is just what we went through. 2022 came along, my stock portfolio is down 20%, plus, or it could have been 2008 when that happened, I'm down 30%. And I'm like, now I'm sitting here going, how am I going to do this? I do need some of the value of this business to make this thing happen. 

Gary Shepherd (29:25.046)

Right, or you could need it. You could need it for family equalization. got a son in the business, but you have other family members and you don't know. Good point. And being the only person that got value out of this and the rest of the family got hosed in the transaction. 

Michael Palumbos (29:31.566)

country. 

Michael Palumbos (29:38.44)

That's a really good point. you. So now what we go through and we recapitalize the business. instead of a hundred shares, there's 10 million shares. 

Gary Shepherd (29:48.27)

Right. It's not really technically recapitalization. I misspoke earlier. It's really a stock split. OK, so there's no. So there's no real, you know, no taxes or implications. Just whatever whatever share was, if it's $100, 100 shares at 10 million, whatever that turns out to be. Now I'm making 10 million shares at a buck because it makes the redemptions easy and it makes purchase. It makes bringing the other next generation shareholder into the equity stream real easy. 

Gary Shepherd (30:18.286)

So you got it. 

Michael Palumbos (30:19.406)

So the next generation are the managers that are going to buy it out, buy a share for a buck, capital transaction, everything's all up and up. And now as my AAA account increases each year. So let's say AAA increased by $300,000 and I'm just picking a number out of the air. I can take and redeem those shares. instead of having 10 million, you know, 

Michael Palumbos (30:45.617)

9,999,000 shares, whatever that number is. I'm going to have 300,000 shares less, but I got $300,000 in my pocket tax free. 

Gary Shepherd (30:56.942)

Yes, capital gains tax. Okay, I mean, as an S corp, somebody had to pay in your example, somebody had to pay the income on whatever generated that $300,000 after tax. so there was a tax paid. And that's critical. So because we're not we're not messing around with the IRS here. We're just not electing to pay a completely 

Michael Palumbos (30:59.231)

Gains Tech Stream. 

Gary Shepherd (31:24.736)

of voluntary tax once you understand the tax code. So it was ordinary income tax paid at the shareholder level and at the entity level, which is the same in an S-Corp, but it's what you do with the money that's left over. 

Michael Palumbos (31:33.123)

Yep. 

Michael Palumbos (31:40.588)

And this, and so now, you know, if you're, if you're doing it at $300,000 a clip or a million dollars a clip or whatever it is that you're doing it at, that is why you need the time to be able to make this thing happen. 

Gary Shepherd (31:55.114)

Right. So, you know, it would be a real stretch. I know we're just talking theoretically here, it'd be a real stretch under a $10 million business to be only earning $300,000 a year after tax. would take a long time to transition. But there's some technical issues here that Ron has managed to boil down eloquently. And so the principles of Popeye basically revolve on what he calls TTP. 

Michael Palumbos (32:07.766)

Right, right, right, right. 

Gary Shepherd (32:23.288)

time, trust, and profitability. So without going into the technical nuances here, when you get into redemption discussions as it relates to 302, specifically 302b2, there's this whole thing called disproportionate redemptions and what is grotesquely mischaracterized as the 80 % rule. 

Gary Shepherd (32:52.558)

Again, we don't want to go there, but ideally to create a safe harbor and avoid all of this mess. And again, let me just reiterate the whole idea here, and this is the counterintuitive part, the whole idea is to avoid a capital transaction. You want ordinary income tax treatment on this, and it was not going to work until the creation of S-Corps, okay, because 

Gary Shepherd (33:21.59)

back in the time when the code was was written, ordinary income rates were 90 some percent and capital gains were in the 20s. And so people were trying to get ordinary income treatment and excuse me, capital gains treatment. And the tax code was written to make it hard to do that. Then when you get the S corporation overlay on it, it eliminates that second level of taxation you have at C corps. 

Gary Shepherd (33:51.254)

and the code was written to punish people who did not meet the capital transaction requirements by basically imposing ordinary income tax on them. Well, now we have an S-Corp and it's okay. That's what I want. I do not want to pay capital gains. I want to pay ordinary income because I only have one level of income and I've already paid it. So if I can not have a capital transaction, 

Gary Shepherd (34:20.939)

then I have an ordinary income transaction and in an S-corp, I've already paid the income on it. And so if I keep it to that year's increase in the AAA account, I can redeem stock, can give dividends to people, I can do everything. And when they receive them, they don't pay another level of tax because they've already paid it. 

Michael Palumbos (34:42.028)

Yeah, and that's really important to talk about because how many times have we met with the business owner that has said, you're telling me when I sell my business, if I do this as a capital transaction, I'm gonna lose how much in capital gains? I paid taxes my whole entire life on all of this. 

Gary Shepherd (35:01.25)

Precisely. So again, TTP. So remember what I started this discussion with almost all of these transactions take time. Okay. Either because somebody meaning this next generation owner is going to go to a bank and the bank's going to require that, that there's a loan that needs to be paid off over time and going to put a personal guarantee on the client or the client's going to finance it. It's going to be over time. Okay. 

Gary Shepherd (35:30.518)

And so if we overlay the safe harbor that Ron Claussen said is a good thing to do, particularly in non-family situations, again, another nuance, but these transactions should take a minimum of five years. Okay. All right. So a lot of them take longer in family situations and can take longer because they can flex pretty good because there's no loans and stuff. And if we have an economic turn down in the meantime, we'll just, we'll extend the 

Gary Shepherd (35:59.802)

the process, so it's very flexible there. But typically the time is at least five years. Okay. But again, if we're dealing with an installment sale, a bank loan or something, that timeframe is there anyway. So that's not a huge issue. Trust, you need to have trust on both ends. And the reason you need to have trust is if I'm the next generation owner, typically what I'm 

speaker-2 (36:17.39)

You 

Gary Shepherd (36:28.556)

banking on is that the current person is actually gonna fade away or leave at some point. And remember, we're dealing with a series of annual redemptions, but in the first time in our example, we have you owning one share. I own 999,999. And let's assume for the sake of discussion that I have $2 million of Net After Tax, AAA every year, okay? So over a five-year period of time, 

Gary Shepherd (36:58.222)

Theoretically, I would redeem all of my shares, get $10 million of money out of the business, and I haven't paid any capital gains tax on it. But during that period of time, until the last redemption, okay, at the end of year four, I still own 1,999,999 shares and you own one. 

Gary Shepherd (37:26.112)

Okay. So if there's this disagreement on what's going on with the business or I changed my mind, okay. The next generation owners got this, well, yeah, you were going to run the business kind of stuff, but I've decided to change my mind. And so the trust is quickly eroded. Okay. Or if the business owner realizes that, as I realize you're really good at running this business and it takes off like crazy. Okay. 

Gary Shepherd (37:56.238)

And I'm now, I was going to, you know, thinking about retirement, I've stepped back, I'm on my boat somewhere. I come to the office, if at all, or call in and you're running the business, right? And now all of sudden it's like, well, geez, he's, he's better hope, you know, I better hope that he actually redeems out or else I've really increased the value and I got nothing to show for it. So trust is critical on both ends. And then profitability, the P. 

Gary Shepherd (38:24.37)

You have to have profitability, obviously, because you have to have an increase in annual after-tax AAA to afford the redemptions. But you're going to need that anyways in any kind of transition to either pay the loan back or to monetize the business. But TTP is critical. 

Michael Palumbos (38:40.984)

DTP, 

Michael Palumbos (38:42.575)

time, trust, I love it. I love it. And you're making this, I know we're not getting into the technical piece of it, but you're making it easy enough to understand. It's taken a little bit to go through this, but I think this is, if I'm titling this podcast, and we'll have to work on this afterwards, but if I'm, the title is, how to avoid a second layer of taxation. 

Michael Palumbos (39:08.418)

when you're transitioning a middle market business. 

Gary Shepherd (39:11.976)

It's as good as any. 

Michael Palumbos (39:13.516)

Yeah. And that's really what we're doing. When we're doing this, I really like it. What other things, you know, what haven't we talked about at this point that, you know, if I'm a family business, I own an emerging market or, you know, emerging middle market business or a middle market business, what do I need to know? You know, I can think of one right away is that they better be working with somebody that really understands this plan because 

Michael Palumbos (39:43.616)

If it got blown up on me and I'm telling you my tax attorney that I went to talk with, I'm not putting any names on here is sharp, like sharp, sharp, sharp, my favorite guy to work with. And so when I started talking generalities, it wasn't enough for him to take, you know, and understand this now once, you know, what I'm doing is as soon as this podcast done, I'm sending it over to them and saying, I want you to listen to this. then, you know, we can put the pieces together. 

Michael Palumbos (40:12.876)

How do you build a team around this? 

Gary Shepherd (40:18.712)

You know, that's a, it's a, it's a challenging issue. I told you that when I first learned this from Ron Claussen, Ron will travel and work, you know, with the local council to kind of walk through how all of that works. But his is a, 

Gary Shepherd (40:48.142)

is a hefty cost for some of the lower end folks. And typically, typically, you know, Ron's dealing with stuff that's going to be, you know, 25 or 30 or $40,000 in terms of upfront costs. And then you got local council and all that other kind of stuff. And then you got our fees and on and on. it 

Gary Shepherd (41:17.23)

It's not without its cost, but the value proposition is substantial to our point. you're dealing with a $10 million business and you're saving $3 million of taxes and then all of the financing costs and that kind of stuff, hey, if it costs a little bit advisory money, it's good. 

Michael Palumbos (41:33.454)

And let me jump in, if you're going to sell the business on the open market, and you're doing a capital transaction, then you're not only have the $3 million of taxes, but you still have all the advisory and attorney fees as well. They're not going away. So don't put that on you. You know what I'm saying? I think you can take that out of the equation, because if you're doing a capital transaction, 

Michael Palumbos (42:03.234)

There better be some attorneys and accountants and whatnot dotting your I's and crossing your T's, you're going to be paying. 

Gary Shepherd (42:10.286)

So what I decided to do was, the vast majority of the folks that we're dealing with are in the, you know, I use the parameters as the two to $20 million space, but if I had to be honest with you, the vast majority of the substantial number of these things we've done are in the two to $10 million space. Now, the advisory group there, 

Gary Shepherd (42:38.382)

is still relatively high powered, but the challenge that I have was what you just articulated. If I am a succession and transition financial advisor, I still don't have the credibility, no matter what designation I have, to go to an attorney or an accountant. And even though I might be able to speak in detailed language about tax codes and IRC sections and all that kind of mess, I don't have the credentials. So. 

Gary Shepherd (43:05.478)

I either import Ron or what I did was create a strategic partnership and I had a substantial one already with a member of a prominent law firm here in Hampton Roads who is a noted attorney, but he's also an accountant. So he's a tax attorney, a business tax accountant having that background. And his firm is noted as business advisors. And I gave him 

Gary Shepherd (43:34.952)

all of the stuff and said, here's why I think this works, tear it apart. And I have that relationship with him. again, his first reaction was, too good to be true. But then they started digging into it because of all the stuff that I had pounded Ron Claussen about. And it ran me around, I'm an analytical guy. So all of sudden the light went on for 

Gary Shepherd (44:04.13)

this particular attorney and his firm, and they have now embraced it wholly as a part of the succession and transition opportunities they bring to clients. But more importantly, he's able to pick up the phone and talk to either another attorney that the client may have his relationship with or his accountant because he's an accountant and an attorney and it's not me. So it's 

Gary Shepherd (44:32.102)

one professional to another to say, look, I know you're looking at this thing and you probably are looking at scants. sounds like scammy type of stuff, but you're looking at it wrong because you're not. This is a counterintuitive strategy. We want ordinary income tax treatment. We do not want a capital gains treatment. And in an S corp situation done correctly, this is the result we get. And once they start to explain that, 

Gary Shepherd (45:01.866)

all of a sudden you realize as long as I avoid anything that looks like a capital transaction, then I'm going to get ordinary income. And if I keep it to the annual increase in AAA, I've already paid the income. I do not have to pay the next level. 

Gary Shepherd (45:17.912)

So that's how we put the strategic stuff together and deal with the advisors. Does that make sense? 

Michael Palumbos (45:22.988)

Yeah, perfectly good sense. I am trying, I'm running out of questions for you actually. You've done a great job of walking through this. This is not going to work in every circumstance. Okay. 

Gary Shepherd (45:37.036)

Yeah, it's 

Gary Shepherd (45:43.148)

And there's a couple of trap doors that we should probably talk about here. Sure. You know, we've put together an entire structure and system for our clients. And one of the primary things that we need to really be instrumental and, excuse me, proactive with the clients and make sure they understand. And it's good for you and I. 

Gary Shepherd (46:12.416)

A business owner in our example here that's transitioning a $10 million business is by definition, since we already talked about this, needs the value of the business to sustain their lifestyle going forward. Okay? So they've reached us a point in their life where they want to do something else. Okay? They're successful, but they're ready to actually pull back. 

Gary Shepherd (46:41.144)

But they're living off of, in my example here, let's assume that this is a 5X multiple here. Okay, so this thing is generating a couple million dollars after tax every year. And the lifestyle supports that, okay? Or let's cut it in half and say it's a $5 million business and it's generating a million, or it's a family business and it's generating 500,000, it doesn't matter. The client is living off that money. 

Gary Shepherd (47:11.246)

Right. now all of a sudden, okay, I'm going to have to, I'm going to take that asset base and I'm going to monetize it. And in our first example, if a guy's got a $10 million asset base and he's pulling $2 million out of it, right? That is a 20 % withdrawal rate, which you cannot sustain long-term. So the financial plan that comes with 

Gary Shepherd (47:38.028)

the transition is absolutely critical. And what the client needs to understand is when you get that $2 million redemption check, you have to give it to me because that's got to go get invested so that when this thing is done, you've got $10 million of investment assets together with your other assets. And hopefully that's going to be sufficient. And you've got a good plan in place to continue generating income necessary to support your lifestyle. 

Gary Shepherd (48:07.828)

If you spend that $2 million as it comes out, you will enjoy your lifestyle until such time as the checks stop and then you've got a problem. Okay. So that's critical, but it also means that I have to stay involved with the client for at least the transition period and make sure that as these monies are developed annually, 

Gary Shepherd (48:36.258)

there's internal structures on how to treat quarterly distributions as loans that we then convert to distributions at the end of the year so that we don't get behind the eight ball and we have taxable income and no cash because we're actually running a business, yada, yada, yada. So it allows us to stay involved and also make sure that the client sees that there's a process that they're going through. It's not just, hey, I showed you how to sell a business and then I walked away. 

Gary Shepherd (49:05.9)

That would almost be malpractice and it would not be any good for us or the client because there's a lot more to it. 

Michael Palumbos (49:14.978)

Yeah. So we happen to use some pretty powerful financial planning software. And it's that modeling to say, how does this fit? What does this look like? That probably starts the conversation. That's not the end all be all, but it's like, gets us on there. gets us, you know, close enough for government work, so to speak. then also, you know, one of the things we always talk about in transition planning is the value gap. 

Michael Palumbos (49:42.944)

Is it possible that you have, and this is maybe a dumb question, possible you have an owner that says, look, the business is worth $10 million. I know I could get $10 million for it, but all I need is seven. All I need is six. And my kids, if I can get six more out of here based on all the modeling and things that we've done, can you help me to make that happen? Does that work in those circumstances? 

Gary Shepherd (50:09.326)

Gary Shepherd (50:10.066)

Absolutely. You know, the interesting part about the Popeye structure is if you think about it in our in our example here, you're dealing with a $10 million business, you don't have to pay $3 million of taxes, then does it really matter if the valuation is 7 million versus 10? Because it's the same amount of money, right? And so if you only need six or seven, that's fine. There's no need for formal valuations or any of that kind of stuff. It's the whole willing buyer willing seller. 

Gary Shepherd (50:38.304)

under no compulsion to buy or sell that determines value. and, and so it's easier to do that. The value gap discussion is critical to that whole financial planning thing. And it drives the discussion of how much in my prior example, how much of that $2 million of annual increase you actually have to invest because we have to be able to essentially change the withdrawal number. 

Gary Shepherd (51:08.622)

from my theoretical thing of 20 % down to something like four or five, which represents a more long-term sustainable number. And so how much do you already have? What is the value gap? It's the same discussion we always have once we've monetized. There's another piece here when you're dealing with family members, there is an attribution issue that you'll have to deal with so that 

Gary Shepherd (51:38.976)

It helps us during the transition. But if I'm trying to make sure that the client is ultimately not an owner of the business, okay. If I've transitioned it to my children, okay, then if I have anything to do with the business at all, Section 318 is going to suck the entire value back into my estate for tax purposes. 

Gary Shepherd (52:05.922)

So the last redemption has to contain with it a pretty strong waiver of family attribution. And we need to go through the corporate structure and make sure that things like rental agreements for property between dad and the son and all of this other kind of stuff do not run a foul of 318 or else, particularly in the upper end of this stuff, if I take a $10 million business plus the other assets the individual has, 

Gary Shepherd (52:35.734)

and they start messing around with the state tax law, I could find myself in a taxable transaction, taxable estate, particularly if because we didn't pay attention, that whole business is going to get sucked into his estate through family attribution. So it's the nuance and the details you got to be aware of. OK. 

Michael Palumbos (52:58.124)

Very important. I'm thinking about this and I'm going to just throw another kind of example at you that say I'm a business owner. I've got a $10 million, a $7 million business. doing, I'm taking my salary, you know, I'm living off my salary because it's an S corporation. I have to take a salary and say, know, so my salary is $300,000. So if I've got that million dollars of growth in the AAA account, 

Michael Palumbos (53:27.212)

I'm paying taxes on all that. And typically what I'm doing is, you know, I'm bonusing myself the, you know, the taxes so that I'm not having to write a check out of my personal stuff. And now the Popeye plan really starts to make sense because I'm, you know, that there's a lot more to play with there that could be invested outside of the business. Is that? 

Gary Shepherd (53:51.944)

Yeah, all of that makes sense. Let's talk about the transition and typically what happens here. So if I'm the elder statesman and you're the younger statesman, or you're the next generation here, typically what happens is once we start this, you realize that, hey, I'm going to own a business. I don't have to pay anything for it. there is, whether you like to believe it or not, 

Gary Shepherd (54:20.192)

Most business owners that have been at this for a long time, unless you're just really on top of everything that's going on, you're making your business sclerotic just because of the fact that you're stuck in the, is the way we do it stuff. And so you tend to be an impediment in terms of recognizing the next generation of change that's going to impact your business. And the next generation of people are usually more attuned to that. 

Gary Shepherd (54:50.412)

So typically what happens is I bring you into the business and now you're running hard and it's growing and I'm comfortable with this. And so I start to step back. after a year or two, even though I'm still being redeemed out, okay, I'm kind of out of the deal. And so my salary now typically goes to something like a consulting arrangement and maybe a benefit type thing. So, 

Gary Shepherd (55:19.404)

I'm getting a company car or maybe some healthcare if I'm not yet to the point where, you know, if I'm in my early 60s, I'm not yet reached Medicaid or excuse me, Medicare, that kind of stuff. So I'm getting a transition salary and then a redemption for the value of my stuff. But I'm leaving enough cash in here that the next generation person that's running now has an opportunity to actually see some benefit 

Gary Shepherd (55:48.93)

for all the work that they're doing. Okay, so there's all of that behind the scenes things in terms of employment agreements and security arrangements and all of this other kind of mess. know, the bank isn't involved in this, but the bank is involved from the standpoint that there's usually some level of personal guarantee that if you're financing equipment and that kind of stuff. And so, you know, it's easy for the business to pay the 

Gary Shepherd (56:19.054)

the transitioning shareholder, some security agreement income or something for the fact that even though they're really stepping back and the young generation is running the business, they're still the owners of it. I don't want to suck all the capital out of it because it needs to be able to grow. But if I'm now assuming the capital function, 

Gary Shepherd (56:45.484)

by the amount of money that I'm leaving in for cashflow purposes or whatever it is, I can get paid a premium for keeping that money there. So there's lots of ways to get the client some level of normal income that looks a lot like the income they were taking before. So I can use the Net After Tax stuff for the purposes of redemption. Again, a whole nother level of discussion that needs to typically occur. 

Michael Palumbos (57:14.254)

And thus why you need to build a team and you need to have somebody that really gets this. Since you started doing these, do you mind if I ask how many, you know, how many of these Popeye plans you put together? 

Gary Shepherd (57:28.206)

Well, compliance suggested that we not talk about those kinds of things, but it is a substantial number. 

Michael Palumbos (57:41.004)

I thought they were just talking about specifics. was just like, these are numerous transactions that you put together and they've all done exactly the way they were supposed to go is the point I'm trying 

Gary Shepherd (57:51.79)

That's correct. have probably six or seven currently in... Right now. Right. But that's just stuff that we've taken on recently. Remember, most of these are transactions that occur at a minimum over a five-year period of time. They become... 

Gary Shepherd (58:18.44)

easier to handle the longer that they go because the internal structure and systems are now learned by the next generation management of the companies. So they know how to deal with this kind of stuff and the redemptions occur after the end of the year and blah, blah, blah. So it takes less and less time. And again, the team that we've put together 

Gary Shepherd (58:48.234)

After a while, if you sit down with a client, even though they have existing attorney and a client, accountant relationships, once you start getting into this, you realize you need a specialist or else I'm going to have to teach your attorney or accountant, all of this stuff. And they're going to bill you for their education. Or you can just go out and hire somebody on a task basis. That's already figured it out. And you don't have to change that relationship. 

Michael Palumbos (59:09.708)

Yeah. 

Gary Shepherd (59:18.05)

you can keep it, that's typically what happens. And for us, that means a relatively small cadre of highly technical attorneys, accountants, and ancillary business related folks that have now done a ton of these. We know where the pressure points are, we know where the opportunities are, and how to handle nuances like. 

Gary Shepherd (59:44.748)

You know, you're a C Corp and now you have to convert to an S Corp and how do you do that? Or your LLC taxes of partnership? How do I convert? How do I change that to a S Corp and, and, make this work? so yeah, it's, it's a team that's required, but we have to keep the value proposition for the client. And once, once they get it, they usually run pretty hard because they recognize that. 

Gary Shepherd (01:00:13.302)

the numbers that they were otherwise going to pay voluntarily, either in taxes or impose on family members or key people, financing requirements with banks that are very, very strident and expensive, that grist and sand that are otherwise in this transaction, the succession and transition transaction are gone. And so it makes the development of a 

Gary Shepherd (01:00:42.316)

more flexible plan a whole lot easier. 

Michael Palumbos (01:00:46.222)

All right, I think I've got my final question for you. And it's one I haven't asked yet. How in the world, why is it called a Popeye Plan? 

Gary Shepherd (01:00:55.232)

Okay, this is pretty easy to answer and we can conclude on that. Remember I told you that Ron Claussen, an attorney in California started doing this stuff now probably over 25 years ago. Okay. And his first transaction involved a key man and they were buying, I think it might've been a vineyard or something of that nature out in California. It doesn't really matter. 

Gary Shepherd (01:01:24.97)

And Ron was had figured this plan out, but he was looking for some way to visually explain it or demonstrate it. And computer graphics being what they were 25 years ago. He had decided that the next generation owner was going to be the hero of the plan, was going to continue to run the business and all that kind of stuff. Didn't need to have finance and blah, blah, blah. There's big tax savings. So he was going to be the hero. And 

Gary Shepherd (01:01:52.342)

So he was looking around in computer graphics and the only hero he could find was a picture of Popeye the sailor. Okay. And so then the company became the olive oil corporation. And, and so we had Popeye the sailor man and olive oil. And that was the visual that he used for the sale. And a couple of years after that, and by the way, the transaction worked magnificently so well that when Ron was talking with this, 

Gary Shepherd (01:02:22.2)

key person who now was running the business. He found out that he had taken to calling himself Popeye, okay, because the transaction had worked so well. And so the from Ron's perspective, the Popeye transaction was born and it means absolutely nothing other than it was the only graphic he could he came up with that seemed to demonstrate visually what it was that was going on. And hopefully this is your question. 

Michael Palumbos (01:02:50.766)

That's fabulous. I love it. I appreciate you sharing. Gary Shepherd, Shepherd Financial Group. This has been a pleasure talking about how business owners can avoid a second layer of tax during their transition planning if this works for them. I would recommend you need a fabulous wealth advisor to team up with your accountant and attorney 

Michael Palumbos (01:03:19.65)

to make this happen, but more importantly, you probably need someone like Gary or Ron Claussen that really has done these transactions a bunch of times. I know that there may come a time that I'll be knocking on your door when I knock on one of these things to put them together. 

Gary Shepherd (01:03:40.014)

It's what we do and I'm delighted to help. We're open for business. 

Michael Palumbos (01:03:41.676)

Yeah. 

Michael Palumbos (01:03:44.067)

One of the wonderful things about our organization is that joint work and working with specialists is a paramount, you know, it's one of the cornerstones that makes us successful. I, I really love that about our, you know, the corporate corporate side. Thank you everybody for listening. Really appreciate your time. My name's Michael Palumbos with family wealth and legacy in Rochester, New York. This has been the family biz show. 

Michael Palumbos (01:04:11.03)

Make sure that you tune in for the next episode. We'll have another great guest on and we look forward to sharing more information with you. Take care everybody.