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Episode 77: The Popeye Plan For Business Owner Succession Planning

In this episode of the Family Biz Show, Michael Palumbos interviews Gary Shepherd about the Popeye Plan, a strategy for family business succession and business owner transition planning without incurring capital gains tax. Gary explains that this plan is particularly effective for internal transfers within family businesses or to key employees and is named after a graphic representation of Popeye used in its initial presentation.

Gary delves into the specifics of the plan, emphasizing the need for the business to be structured as an S corporation. This structure allows for the redemption of shares in a way that avoids capital gains tax, leveraging the increase in the Accumulated Adjustments Account (AAA) which has already been taxed. The plan relies on time, trust, and profitability, ensuring that the transition is smooth, the parties involved trust each other, and the business remains profitable throughout the process.

The discussion also touches on the necessity of involving a knowledgeable team, including financial advisors, attorneys, and accountants, to navigate the complexities of the transition. They highlight the importance of the transitioning owner investing the redemption payments to ensure their financial stability post-transition.

This episode provides valuable insights into an innovative approach to business succession, emphasizing the need for careful planning and expert guidance to ensure a successful and tax-efficient transition.

Watch the entire episode!

Episode 77 Transcript


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Michael Palumbos ChFC, CBEC: Well welcome everybody to the family. This show I'm. Your host, Michael Columbus, with family wealth and legacy in Rochester, New York.



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Michael Palumbos ChFC, CBEC: 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.



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Gary Shepherd: Thank you, Michael. I appreciate your time



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Michael Palumbos ChFC, CBEC: so, Gary, we have a a little bit of a tradition here where we just ask people.



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Michael Palumbos ChFC, CBEC: You know what was your journey? How did you get to where you are today? And then we'll dive into this topic? I just. I find it interesting.



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Michael Palumbos ChFC, CBEC: You know that most people's paths as we're going through light. 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



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Michael Palumbos ChFC, CBEC: crooked path to get here, you know, twist and turns. How about yourself?



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Gary Shepherd: Yeah, You know, I think we all share that in common. You know. How far back do you want me to go?



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Michael Palumbos ChFC, CBEC: Yeah, Whatever Whatever works for you?



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Gary Shepherd: All right.



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Gary Shepherd: Let's 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.



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Gary Shepherd: 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 graduated in December, then all the jobs are done. So I in.



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Gary Shepherd: I I had to find something to do before the next school year.



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Gary Shepherd: and so I went to a recruiter, and the person said, Well, you know I've got this job for you, and it was selling a property and casually insurance.



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Gary Shepherd: and I had never sold anything in my life to see myself as a salesman, and so



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Gary Shepherd: I said, sure what the Heck



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Gary Shepherd: did that, for



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Gary Shepherd: you know the period of time where I thought it was going to take before I went back to school and found it. I actually enjoyed it.



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Gary Shepherd: and kept at it for a little bit



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Gary Shepherd: until such time as I realized property and casually wasn't really wanted to be. I ran into somebody who was in the insurance business, the life insurance business. I joined him, and we did that for a while.



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Gary Shepherd: and then ran across



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Gary Shepherd: Connecticut General Life insurance company, and and one of the first people that impacted my life.



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Gary Shepherd: He brought me over to the company. That was.



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Gary Shepherd: you know, a long time ago, pushing, you know, almost 50 years now.



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Gary Shepherd: and so I I I



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Gary Shepherd: You know I struggled early on in my career, but they recognized apparently something. They saw, something that I didn't see, and



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Gary Shepherd: decided to stash me out on management back then, cause I I had those teaching jeans, apparently.



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Gary Shepherd: and so I I was on in management for a while, and then the system manager or the manager said, okay, you're gonna 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



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Gary Shepherd: fast forward. Many, many years after that



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Gary Shepherd: I became the regional chief executive officer for Lincoln stage mark here and basically Richmond to the ocean.



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Gary Shepherd: Because I was in Washington. There was an opportunity there.



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Gary Shepherd: and I did that for a while, but frankly, the company was going through a lot of transition back then.



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Gary Shepherd: and they were taking away control at the At the organizational level back to the Home Office. So I went back into personal production



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Gary Shepherd: in a tooth.



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Gary Shepherd: 1,000 and



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Gary Shepherd: 10 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 know. Another transition to go through.



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Gary Shepherd: I start a shepherd financial group as a result of of the



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Gary Shepherd: you know the ending of that partnership.



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Gary Shepherd: 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



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Gary Shepherd: protected from



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Gary Shepherd: and we'd always had a a terrific opportunity and some success working in what I defined as the emerging mid market space, which for us down here is



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Gary Shepherd: professional businesses between half a 1 million on a really low side and 5 million, and then operational businesses again between 2 million, 20 millionand in a half in where i'm at there's a ton of those folks.



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Gary Shepherd: We can talk about the characteristics, and why I did that.



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Gary Shepherd: But then I decided that we were going to specialize in succession and transition.



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Gary Shepherd: because that's the kind of thing that you really can't commoditize like you can a. You know, a wealth management program, or something of that nature.



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They need us in our specific expertise.



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Gary Shepherd: And so that's how we transition to how I transition the firm.



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Gary Shepherd: I have a number of folks that work with us in terms of strategic partners



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Gary Shepherd: and a number of folks on staff that help us to to deal with it. But that's where we're



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Gary Shepherd: focusing now, and that's how we got



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Gary Shepherd: to the pop. I plan which i'm sure we'll talk about here shortly, but that's my journey



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Michael Palumbos ChFC, CBEC: that I love it. Thank you for sharing. I appreciate that. So 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 B. Ii. Business Intelligence Institute and working with John Leonetti.



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Michael Palumbos ChFC, CBEC: we at Technical Equity



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Michael Palumbos ChFC, CBEC: group right? Clinical equity strategies. Yeah. And



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Michael Palumbos ChFC, CBEC: And they, you know, introduced us to this whole world of making sure that we understood everything from gifting a business to your family to and he, you know, to an East up and private equity groups, and you know everything in between, just you know. And so



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Michael Palumbos ChFC, CBEC: so you know, management, management, buyouts and and whatnot. And so you know.



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Michael Palumbos ChFC, CBEC: in one of these sessions, and I heard this con this this conversation. But you've done something pretty phenomenal with this topic, and this is the topic of the pop. I plan, which is



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Michael Palumbos ChFC, CBEC: a business transition



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Michael Palumbos ChFC, CBEC: plan that works really well, and you know, because this is the family bit. I I know it works great for family businesses, but it also works in other arenas as well. But it's that emerging market. You know that emerging middle market space you have found it works kind of the best 10.



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Gary Shepherd: Yeah. And there's a number of reasons for that.



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Gary Shepherd: You know the vast majority of the



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Gary Shepherd: businesses that we work with. You know stuff that's under 20 million dollars in terms of business value, not sales, and that kind of stuff, but business value. So you know, sales can be all over the place. It's the value number that we're talking about



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Gary Shepherd: in that marketplace. There's a number of characteristics that seem to populate almost all of those businesses.



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Gary Shepherd: and the first order of business is almost all of them transition through some form of internal transaction.



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Gary Shepherd: or could.



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Gary Shepherd: because of the



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Gary Shepherd: 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 almost



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Gary Shepherd: there's almost



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Gary Shepherd: a dearth of substantial middle management. So you know the 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.



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Gary Shepherd: and most of these business owners, particularly on the lower end of the of things, tend to spend more time working in the business than they do on the business.



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Gary Shepherd: So the group of advisors that are around them.



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Gary Shepherd: you know they're they're



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



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Gary Shepherd: And and so



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Gary Shepherd: the the structure of of of Popeye works really really good, because my experience is the vast majority of businesses in that marketplace



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Gary Shepherd: are either going to be a liquidated because they they 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 on a



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Gary Shepherd: our clients financial statements so presupposing those 2 things.



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Gary Shepherd: The question is, how am I going to monetize that value? And how do I do it more efficiently than traditionally. And when I read when I heard Ron Clausen and he was talking about Pop by.



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Gary Shepherd: and it's like, oh, wow, okay, yeah. Most of these businesses that I'm. Dealing with transition internally through



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Gary Shepherd: some kind of mechanism. Usually it takes over time.



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Gary Shepherd: We'll talk about the specifics of of how that works and some of the other characteristics. But if it's going to happen over time, and it's likely to go to a family member, a key person, or a management group or something of that nature.



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Gary Shepherd: Then, if I can find a way



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Gary Shepherd: and cost and present it, you know where there is no capital gains tax to the transitioning owner, and no financing costs or or loans that have to be taken out by the next generation owners.



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Gary Shepherd: And there's only one level of tax paid.



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Gary Shepherd: It seems like.



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Gary Shepherd: Wow! That's a reasonably good thing.



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Gary Shepherd: and the more I got into it



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Gary Shepherd: the more it was a really reasonably good thing, and it's become a seminal part



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Gary Shepherd: of what we do for clients, because it is



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Gary Shepherd: such a viable alternative given the characteristics I just mentioned to you.



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Michael Palumbos ChFC, CBEC: Great. So i'll say to you. When I heard it. I got excited as well.



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Michael Palumbos ChFC, CBEC: and I came back, and I started talking to people. I didn't dig into it. I started asking, and so there's a an attorney that I really respect an account that I really respect, and another advice, You know a wealth advisor that I respect. And I started to, and they're all



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Michael Palumbos ChFC, CBEC: kind of shaking their head and scratching their heads, and they like



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Michael Palumbos ChFC, CBEC: n it doesn't seem like that makes sense, and so I dropped it.



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Michael Palumbos ChFC, CBEC: 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 I don't want to miss this opportunity for the right people, and I think it's you would be something that would



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Michael Palumbos ChFC, CBEC: not explained properly. Most attorneys and accounts are gonna, you know, be they're gonna be questioning it until they understand 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 pop I plan



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Gary Shepherd: that's correct.



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Michael Palumbos ChFC, CBEC: So let's talk about



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Michael Palumbos ChFC, CBEC: big picture.



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Michael Palumbos ChFC, CBEC: and then we'll start drilling down so big picture. When you say somebody says, what's the pop? I plan what's the big picture of what the pop I plan is to you.



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Gary Shepherd: I think I just mentioned that to you it this is this is an in



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Gary Shepherd: 90



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Gary Shepherd: 5. I hate. I hate this phrase 95% because it's abused terribly. But



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Michael Palumbos ChFC, CBEC: the vast majority of situations are internal transfers. Okay, so I can 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.



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Michael Palumbos ChFC, CBEC: We a lot of times. Somebody. Yeah, this is not an Aesop, this is totally different. So there's so step one is. It's an internal.



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Michael Palumbos ChFC, CBEC: you know. Transition. Go ahead



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Gary Shepherd: all right. And



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Gary Shepherd: you you have to. Basically have the characteristics that an internal transfer is normally gonna have in your marketplace.



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Gary Shepherd: All right. So, for for instance.



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Gary Shepherd: in the marketplace that we deal with



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Gary Shepherd: an internal transfer to a family member, a key individual or a key management group.



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Gary Shepherd: The characteristics that you're dealing with here are a: the owner needs to get some value for the the the business. Okay? And then B. He's got a group of people that they that he thinks



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Gary Shepherd: are the likely next generation owners of the business. Okay, either family or the other folks that we talked about.



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Gary Shepherd: Sure, I have those characteristics. But the problem with all of that is



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Gary Shepherd: typically the the 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.



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and that means that they



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Gary Shepherd: transaction is going to be on or financed.



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Gary Shepherd: and and so it's likely to be something that the the existing owner and i'm trying. I always try and stay away from



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Gary Shepherd: buyer and seller in these transactions, for reasons that we'll talk about.



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Gary Shepherd: 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.



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Gary Shepherd: and if they have some resources, the bank isn't going to lend a whole amount without their personal guarantee on the part of the individual. And then they're dealing with paying back notes. So the whole thing turns out to be 5 years, 10 years along anyways, so it looks like an installment transaction.



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Gary Shepherd: and the client is going to get the value of the business over some period of time.



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Gary Shepherd: And and so that's issue. Number one



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Gary Shepherd: issue number 2, is



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Gary Shepherd: it? You have to understand? And and and you and I do, and most clients.



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Gary Shepherd: when you talk about it, get it, but they don't think about it intrinsically.



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Gary Shepherd: Every single



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Gary Shepherd: business owner buys himself out.



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Gary Shepherd: It's just the way it is, you know if i'm going to transition my business to you.



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Gary Shepherd: You're either going to give me a big water cash that you have. But the decision that you have for giving me a big water 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 in a man, this this asset, this money in a way that wasn't involved in your business.



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Gary Shepherd: and so that's even in multiples all that kind of mess.



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Gary Shepherd: So clients don't seem to get that. Okay, it's like, Yes, i'm 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.



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Gary Shepherd: then the issues associated with succession and transition come into play, which is, hey? You know, if 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.



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Gary Shepherd: Am I tired. Is there other some other thing that I want to do.



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Gary Shepherd: so that



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Gary Shepherd: 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, anyways.



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Gary Shepherd: And so if it's going to do that.



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Gary Shepherd: hey? Is there any way to make the transition or the transaction more efficient.



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Gary Shepherd: then it traditionally is, and that's what I call the quandary, because to your point.



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Gary Shepherd: 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, 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



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Gary Shepherd: and the beauty of the Popeye plan, and what Ron Costin



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Gary Shepherd: found in his research of the



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Gary Shepherd: and Ron Kloss, who was the is the attorney in California, who.



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Gary Shepherd: who, I think, is a brilliant guy.



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Gary Shepherd: 20 years ago promulgated this particular



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Gary Shepherd: process, and I have since befriended Ron. Talk to him many times.



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Gary Shepherd: and and he figured out how to, in that set of circumstances, be able to transition a business



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Gary Shepherd: without the imposition of capital gains, or the necessity of the next generation. Owners to acquire



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Gary Shepherd: loans or financing, or anything of that nature. So in our discussion we can simply say.



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Gary Shepherd: I have a 10 million dollar business.



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Gary Shepherd: I can sell this without the imposition of capital gains, and if I use a 1030% capital gains rate, I now saved 3



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Gary Shepherd: 1 million dollars.



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Gary Shepherd: and the person buying this can theoretically buy a 10 million dollar business for a dollar.



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Gary Shepherd: And so it's a good deal for the transition link client, and it's a great deal for the next generation owner. Given the facts and circumstances we talked about.



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Michael Palumbos ChFC, CBEC: love it. I think that that 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, you know.



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Michael Palumbos ChFC, CBEC: and I know that's generally speaking. But it's just a a really nice way to start looking at that. Say, okay. Now, you've got my interest, so it's usually a good opening. It's a a way to open a discussion with a client.



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Michael Palumbos ChFC, CBEC: right? So I, 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? Because, you know I i'll tell you. Well, speaking to a tax attorney speaking a Cpa.



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Michael Palumbos ChFC, CBEC: This was not. They both looked at me like I had 5 eyes on my or a 7 heads like I was nuts. And so you have gone down this road and looked at the



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Michael Palumbos ChFC, CBEC: Irs codes and talk to run a ton to be able to pull this together because it is not what you know. It's real simple to say



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Michael Palumbos ChFC, CBEC: 10 million dollars sale without capital gains, and a $1 purchase, and I know you know you know $1 transition to make all this stuff happen, and that's Nirvana for most business owners.



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Michael Palumbos ChFC, CBEC: and it's in the tax code. And so that that's one of the things that I think is so unique



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Michael Palumbos ChFC, CBEC: is that one of the specialties that



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Michael Palumbos ChFC, CBEC: us geeky stage. Mark Lincoln guys, you know, that have been around because of, you know, Connecticut General all the way back through. You know we we dig into those things, and we like to find you know. Where's the arbitrage in the tax code to be able to put these things together, so share with us the history of this.



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Gary Shepherd: Well.



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Gary Shepherd: Ron Klson figured out that



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Gary Shepherd: the the beauty of the Popeye plan rests in the



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Gary Shepherd: differential between



00:20:30.140 --> 00:20:31.580

Gary Shepherd: the



00:20:32.060 --> 00:20:35.770

Gary Shepherd: the 1,954 Irs code.



00:20:36.130 --> 00:20:40.410

Gary Shepherd: and the 1,986 creation of



00:20:41.440 --> 00:20:42.340

Gary Shepherd: Oh.



00:20:42.410 --> 00:20:43.539

Gary Shepherd: I think it's



00:20:44.380 --> 00:20:48.809

Gary Shepherd: title 26, which is the s corporation rules. Okay, so



00:20:49.250 --> 00:20:50.090

Gary Shepherd: so



00:20:51.380 --> 00:20:55.019

Gary Shepherd: he was really



00:20:55.240 --> 00:21:02.429

Gary Shepherd: creation in terms of understanding how an S corporation environment could really impact



00:21:03.340 --> 00:21:06.160

Gary Shepherd: the the the transition of.



00:21:07.200 --> 00:21:09.899

Gary Shepherd: or the redemption rather of a shareholder's interest.



00:21:10.030 --> 00:21:21.440

Gary Shepherd: so I it's probably not worthwhile going down the rabbit hole of 302 B. 2 and 17 or 1,368, and all that other kind of mess. But suffice it to say.



00:21:22.740 --> 00:21:25.849

Gary Shepherd: I've been down that rabbit hole with Ron



00:21:25.890 --> 00:21:36.989

Gary Shepherd: and and he's one of these guys that is really really good when he does seminars at making something that is unbelievably technical



00:21:37.110 --> 00:21:42.180

Gary Shepherd: seem really really simple, which is what I've just tried to do, and



00:21:42.250 --> 00:21:46.430

Gary Shepherd: A. And the the fundamental thing I think you need to recognize here is



00:21:46.700 --> 00:21:49.280

Gary Shepherd: is a You have to have an escort



00:21:49.680 --> 00:21:58.859

Gary Shepherd: to be able to do this transaction. Okay. But just because you don't have an escort doesn't solve the problem, we've converted C Corps to S's. We've converted



00:21:58.910 --> 00:22:09.300

Gary Shepherd: partnerships to s corporations and everything in in between, and the more and more we we we learn about that, the you know, the



00:22:09.330 --> 00:22:14.360

Gary Shepherd: the the easier it it to not step on all the bombs and and the like.



00:22:14.410 --> 00:22:21.719

Gary Shepherd: I will tell you that when I first got involved in a series of really detailed conversations with Ron, because



00:22:22.150 --> 00:22:26.299

Gary Shepherd: I'm. A what what my staff calls an analytical.



00:22:27.200 --> 00:22:31.430

Gary Shepherd: and you know that I I think you know what we You say that jokingly here.



00:22:31.470 --> 00:22:32.510




00:22:32.680 --> 00:22:39.999

Gary Shepherd: but being anal was is something that I I don't take negatively, because in our world, as you suggested.



00:22:40.090 --> 00:22:45.469

Gary Shepherd: you know the devil's in the details. So if you understand the interplay between



00:22:45.500 --> 00:22:53.119

Gary Shepherd: the historical sections of the code that deal with redemption, which are largely



00:22:53.180 --> 00:22:58.199

Gary Shepherd: promulgated in the 54 code as a related to C corporations.



00:22:58.690 --> 00:23:04.020

Gary Shepherd: And then you understand how the overlay of s corporations on top of that



00:23:04.260 --> 00:23:14.360

Gary Shepherd: allowed for an s corporation to essentially in the right sort of circumstances, redeem a shareholders interest without the imposition of a capital gain.



00:23:14.470 --> 00:23:16.929

Gary Shepherd: That's the beauty of the transaction.



00:23:17.400 --> 00:23:19.839

Gary Shepherd: So what you're trying to do is



00:23:19.990 --> 00:23:21.490

Gary Shepherd: and it's core



00:23:21.950 --> 00:23:32.010

Gary Shepherd: 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.



00:23:32.130 --> 00:23:43.810

Gary Shepherd: I've been having these conversations with Ron Clawson, and I think he I I think I got it. Okay, and it's brilliant. But I want your opinion, and he took it. He's a tax attorney



00:23:43.820 --> 00:23:57.320

Gary Shepherd: 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, and I don't know. But then they started digging, and it was like all of a sudden



00:23:57.410 --> 00:24:01.719

Gary Shepherd: the light Bulb went on, and that's usually what happens with advisors.



00:24:02.150 --> 00:24:05.360

Gary Shepherd: So the idea here fundamentally is



00:24:05.880 --> 00:24:09.669

Gary Shepherd: when you have an escort you only have one level of taxation.



00:24:10.710 --> 00:24:15.510

Gary Shepherd: right? And so it. And so you're going to earn income in a year.



00:24:15.820 --> 00:24:17.859

Gary Shepherd: and you're going to pay tax on it.



00:24:18.180 --> 00:24:26.329

Gary Shepherd: 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



00:24:26.520 --> 00:24:28.240

Gary Shepherd: any number of things with that.



00:24:28.290 --> 00:24:37.800

Gary Shepherd: And and one of the things you could do is distribute it as a dividend, and dividends have to be pro rata, so everybody that's a shareholder has to get a dividend based on ownership.



00:24:37.890 --> 00:24:40.699

Gary Shepherd: or you can use it to redeem shares.



00:24:41.160 --> 00:24:46.460

Gary Shepherd: and the code allows it to be redeemed on a non.



00:24:46.750 --> 00:24:49.229

Gary Shepherd: a pro rat, a basis. Okay.



00:24:49.260 --> 00:24:52.599

Gary Shepherd: So so you don't have to do that stuff pro rata.



00:24:52.920 --> 00:24:53.770

Gary Shepherd: So



00:24:53.820 --> 00:25:01.789

Gary Shepherd: that is essentially what we're talking about. And as long as you keep the redemptions to that year's increase in



00:25:02.260 --> 00:25:06.060

Gary Shepherd: the Aaa account which you've already paid tax on.



00:25:06.910 --> 00:25:17.579

Gary Shepherd: Then there's no need to have another layer of tax visa. Be the capital gains tax, because in that situation it becomes entirely



00:25:17.810 --> 00:25:19.000

Gary Shepherd: voluntary.



00:25:19.200 --> 00:25:20.050

Gary Shepherd: and the



00:25:20.120 --> 00:25:20.750

Gary Shepherd: that



00:25:21.010 --> 00:25:23.749

Gary Shepherd: the final piece is you have



00:25:23.970 --> 00:25:33.860

Gary Shepherd: typically in a transaction like this you have. The the classic definition is a buyer and a seller. Okay? And so it would be if i'm the seller.



00:25:33.990 --> 00:25:37.390

Gary Shepherd: And you're the buyer. We have this taxable event.



00:25:37.590 --> 00:25:49.950

Gary Shepherd: But in the pop I 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



00:25:50.370 --> 00:25:54.989

Gary Shepherd: and all we do is bring the next generation owner into the capital



00:25:55.070 --> 00:25:59.110

Gary Shepherd: structure by selling them at some point, some share.



00:25:59.330 --> 00:26:06.610

Gary Shepherd: And so, if the share costs we, you know, we we recapitalize the corporation or structure in such a way that



00:26:07.270 --> 00:26:13.660

Gary Shepherd: all shares are a dollar. I can sell a share to the next generation owner for a dollar.



00:26:14.440 --> 00:26:21.840

Gary Shepherd: That transaction is a capital transaction between the corporation and the shareholder. Okay, and i'm not involved in it.



00:26:22.080 --> 00:26:27.820

Gary Shepherd: And then all my redemptions are handled on an annual basis by increases in my



00:26:27.900 --> 00:26:30.590

Gary Shepherd: A aaa account up to that.



00:26:31.060 --> 00:26:39.159

Gary Shepherd: And so i'm redeeming shares, which I can do disproportionately because the code allows it. And so over time I redeem. I'm redeemed out



00:26:39.420 --> 00:26:48.610

Gary Shepherd: with the annual increases in Triple a, and then the only person owning the stock in the corporation, after all of mine have been redeemed out.



00:26:48.750 --> 00:26:50.330

Gary Shepherd: is



00:26:50.370 --> 00:26:53.900

Gary Shepherd: the key person with the family member.



00:26:54.070 --> 00:27:02.450

Gary Shepherd: and they now own the corporation because it's the only outstanding share for which they paid a dollar for it, and I got my whole value out



00:27:02.980 --> 00:27:06.960

Gary Shepherd: without the imposition of a capital gains, and that's how it works in technical



00:27:07.680 --> 00:27:17.770

Michael Palumbos ChFC, CBEC: I love, I love it so that i'm gonna I? I want to be. See if I can repeat it back to you again, because I think it's important for people you hear. You need to hear something like this twice.



00:27:17.790 --> 00:27:25.030

Michael Palumbos ChFC, CBEC: Yeah, it's it's counterintuitive, right? Yeah. So I've got, you know, a 10 million dollar business.



00:27:25.160 --> 00:27:32.859

Michael Palumbos ChFC, CBEC: Okay, right now, I've got a 100 shares because i'm the sole owner really didn't matter, and what I was doing right.



00:27:32.940 --> 00:27:35.700

Michael Palumbos ChFC, CBEC: I I want my I want my son



00:27:36.040 --> 00:27:37.720

Michael Palumbos ChFC, CBEC: to get this business.



00:27:37.770 --> 00:27:41.090

Michael Palumbos ChFC, CBEC: and Lord knows he doesn't have the money



00:27:41.380 --> 00:27:57.869

Michael Palumbos ChFC, CBEC: to make this thing work, and he's not going to go out and be able to get a loan for 10 million dollars. 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 dollars, or the wherewithal to do make that happen.



00:27:57.910 --> 00:28:07.680

Gary Shepherd: And I know we could do this right. But let me just intercede in that particular situation. What is absolutely a condition precedent to the sale is that you also.



00:28:08.450 --> 00:28:17.510

Gary Shepherd: Michael, need the 10 million dollars to maintain your lifestyle. So gifting family business to is is not on the table for that very reason



00:28:17.740 --> 00:28:34.079

Michael Palumbos ChFC, CBEC: right? And and and and so let you know. A good example is just what we went through. 22 came along my stock portfolio down 2020, you know. 20% plus, or it could have been 2,008. When that happened i'm down 30, and i'm like, you know.



00:28:34.090 --> 00:28:40.140

Michael Palumbos ChFC, CBEC: 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



00:28:40.440 --> 00:28:56.870

Gary Shepherd: right or you could. You could need it for family equalization. You got a son in the business, but you have other family members, and you, you know, the only person that got value out of this, and the rest of the family got posed in the transaction.



00:28:56.880 --> 00:29:03.440

Michael Palumbos ChFC, CBEC: What you we go through, and we recapitalize the business. So instead of a 100 shares, there's 10 million shares



00:29:03.680 --> 00:29:18.399

Gary Shepherd: right? It's not really technically recapitalization. I I misspoke early. It's it's really a stock split. Okay. So there's no real, you know, no taxes or implications. It's just whatever whatever a share was. If it's a $100



00:29:18.410 --> 00:29:24.799

Gary Shepherd: a 100 shares at 10 million, whatever that turns out to be. Now i'm just making 10 million shares at a buck



00:29:24.920 --> 00:29:27.569

Gary Shepherd: because it makes the redemption easy, and it makes



00:29:27.660 --> 00:29:30.159

Gary Shepherd: purchase. It makes bringing the other



00:29:30.250 --> 00:29:34.829

Gary Shepherd: next generation shareholder into the equity stream real easy. So you got it.



00:29:34.850 --> 00:29:39.900

Michael Palumbos ChFC, CBEC: So the next generation of the managers that are gonna buy it out, buy a share for a buck



00:29:39.950 --> 00:29:53.629

Michael Palumbos ChFC, CBEC: capital transaction, for Everything's all up, up and up. And now he has my triple. A account increases each year. So let's say Aaa increased by $300,000, and i'm just picking a number out of the air



00:29:53.820 --> 00:29:59.260

Michael Palumbos ChFC, CBEC: I can take and redeem those shares. So instead of having 10 million, she you know



00:29:59.330 --> 00:30:09.899

Michael Palumbos ChFC, CBEC: 9, 9,999,000 shares whatever that number is, I'm gonna have 300,000 shares less, but I got $300,000 in my pocket



00:30:09.920 --> 00:30:10.930

Michael Palumbos ChFC, CBEC: text-free.



00:30:12.450 --> 00:30:17.720

Gary Shepherd: Yes, capital gains text capital gains tax free. Okay, I mean as an escort



00:30:17.790 --> 00:30:22.429

Gary Shepherd: somebody had to pay in. In your example. Somebody had to pay the income



00:30:22.600 --> 00:30:30.090

Gary Shepherd: on whenever generated that $300,000 after tax. So so there was a tax paid.



00:30:30.110 --> 00:30:35.809

Gary Shepherd: and that's critical. So because we're not we, we're not messing around with the Irs. Here



00:30:36.830 --> 00:30:45.740

Gary Shepherd: we're just not electing to pay a completely a voluntary tax. Once you understand the tax code. So there was ordinary income tax paid



00:30:45.880 --> 00:30:48.449

Gary Shepherd: at the shareholder level and at the entity level.



00:30:48.480 --> 00:30:50.449

Gary Shepherd: Yeah, which is the same in an escort.



00:30:50.720 --> 00:30:51.940

Gary Shepherd: But it's



00:30:52.100 --> 00:30:54.850

Gary Shepherd: It's what you do with the money that's left over.



00:30:54.900 --> 00:30:55.700

Got it.



00:30:55.960 --> 00:31:07.439

Michael Palumbos ChFC, CBEC: and this and so now you know, if you, if you're doing it at $300,000, a clip, or a 1 million dollars a clip, or whatever it is that you're doing it at. That is why you need the time



00:31:07.960 --> 00:31:09.939

Michael Palumbos ChFC, CBEC: to be able to make this thing happen



00:31:10.470 --> 00:31:27.609

Gary Shepherd: right? So you know it would be a real stretch, and and I know we're just talking theoretically. Here it' be a real stretch of the 10 million dollar business to be only earning $300,000 a year. After that take a long time to transition it right? Right right right. But there's some technical issues here



00:31:27.790 --> 00:31:40.789

Gary Shepherd: that Ron has managed to boil down eloquently, and so the principles of Popeye basically revolve on what he calls Ttp time, Trust and Profitability.



00:31:41.020 --> 00:31:41.840

Gary Shepherd: All right.



00:31:41.950 --> 00:31:46.979

Gary Shepherd: So without going into the the technical nuances here.



00:31:48.450 --> 00:31:50.410

Gary Shepherd: when when you get into



00:31:52.320 --> 00:31:53.730

Gary Shepherd: redemption



00:31:54.340 --> 00:32:07.630

Gary Shepherd: discussions, as it relates to 302, specifically 302, B, 2. There's this whole thing called disproportionate redemptions, and what is grotesquely mischaracterized as the 80% rule. Okay.



00:32:07.980 --> 00:32:12.619

Gary Shepherd: again, we don't want to go there, but ideally to create a safe harbor



00:32:13.200 --> 00:32:23.759

Gary Shepherd: and avoid all of this mess. And and again, let me just reiterate the whole idea here, and this is the counterintuitive part. The whole idea is to avoid



00:32:25.060 --> 00:32:28.150

Gary Shepherd: a capital transaction. You want



00:32:28.500 --> 00:32:40.220

Gary Shepherd: ordinary income tax treatment on this, and it was not going to work until the creation of escorts. Okay, because back in the time when the code was really was written.



00:32:40.240 --> 00:32:55.520

Gary Shepherd: Ordinary income rates were 90. Some percent, and capital gains were in the twenties, and so people were trying to get ordinary income treatment. And Excuse me, Capital Gains treatment, and the the tax code was written to make it hard to do that.



00:32:55.730 --> 00:32:59.769

Gary Shepherd: Yeah. Then, when you get the S corporation overlay on it.



00:33:01.120 --> 00:33:06.359

Gary Shepherd: It's it. It eliminates that second level of taxation. You have it at C. Corp.



00:33:06.470 --> 00:33:07.420

Gary Shepherd: And



00:33:07.730 --> 00:33:21.900

Gary Shepherd: 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.



00:33:21.960 --> 00:33:31.889

Gary Shepherd: 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.



00:33:32.010 --> 00:33:40.730

Gary Shepherd: So if I can not have a capital transaction, then I have an ordinary income transaction, and in an S. Core



00:33:40.930 --> 00:33:43.170

Gary Shepherd: I've already paid the income on it.



00:33:43.240 --> 00:33:56.990

Gary Shepherd: and so, if I keep it to that year's increase in the triple a account I can redeem stock. I can do 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.



00:33:57.380 --> 00:34:01.159

Michael Palumbos ChFC, CBEC: Yeah. And and that's really important to talk about, because



00:34:01.380 --> 00:34:07.320

Michael Palumbos ChFC, CBEC: how many times have we met with the business owner? And then it said, You know you're telling me when I sell my business.



00:34:07.700 --> 00:34:16.130

Michael Palumbos ChFC, CBEC: I'm gonna If I do this as a capital transaction. I'm going to lose how much in capital gains I paid taxes my whole entire life on all of this.



00:34:16.650 --> 00:34:17.659

Gary Shepherd: Precisely



00:34:17.699 --> 00:34:22.879

Gary Shepherd: okay. So again, Ttp: so remember what I started this discussion with



00:34:23.100 --> 00:34:25.729

Gary Shepherd: almost all of these transactions.



00:34:25.760 --> 00:34:35.489

Gary Shepherd: Take time. Okay, either because somebody meaning this next generation owner is going to go to a bank, and the bank's gonna require that



00:34:35.550 --> 00:34:45.790

Gary Shepherd: that there's a lo that needs to be paid off over time, and i'm 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.



00:34:45.909 --> 00:34:50.270

Gary Shepherd: And so if we overlay the safe harbor that that ron classroom said.



00:34:50.290 --> 00:34:53.180

Gary Shepherd: It is a good thing to do.



00:34:53.360 --> 00:34:57.870

Gary Shepherd: particularly in non-family situations. Again, another nuance but



00:34:58.230 --> 00:35:15.109

Gary Shepherd: these transactions should take a minimum of 5 years right, so that 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



00:35:15.120 --> 00:35:21.529

Gary Shepherd: the the process. So it's very flexible there. But typically, the time is at least 5 years. Okay.



00:35:21.730 --> 00:35:29.429

Gary Shepherd: But again, if we're dealing with an installment sale of bank loan or something that timeframe is there anyways? So that's not a huge issue.



00:35:29.960 --> 00:35:32.459

Gary Shepherd: Trust you need to have trust



00:35:34.210 --> 00:35:37.429

Gary Shepherd: on both ends. And the reason I need to have trust is.



00:35:37.810 --> 00:35:38.490

Gary Shepherd: if



00:35:38.800 --> 00:35:43.310

Gary Shepherd: if i'm the next generation owner typically what



00:35:43.330 --> 00:35:47.930

Gary Shepherd: what i'm banking on is that the current person is actually gonna



00:35:47.950 --> 00:35:50.489

Gary Shepherd: fade away or leave at some point.



00:35:51.170 --> 00:36:10.819

Gary Shepherd: And remember, we're dealing with a series of annual reductions. But in the first time in our in our example we have we have you owning one share, I own 999,999. And let's assume, for the sake of discussion that that I have 2 million dollars of net after tax aaa every year.



00:36:10.890 --> 00:36:13.479

Gary Shepherd: Okay, so over a 5 year period of time.



00:36:13.630 --> 00:36:21.930

Gary Shepherd: Theoretically, I would redeem all of my shares, get 10 million dollars of of money out of the business.



00:36:22.150 --> 00:36:25.349

Gary Shepherd: and I Haven't paid any capital gains tax on.



00:36:25.720 --> 00:36:29.350

Gary Shepherd: But during that period of time until the last redemption.



00:36:29.510 --> 00:36:30.359

Gary Shepherd: Okay.



00:36:30.680 --> 00:36:32.309

Gary Shepherd: in in here



00:36:33.390 --> 00:36:35.609

Gary Shepherd: and at the end of year 4,



00:36:35.810 --> 00:36:48.169

Gary Shepherd: I still own 1,999,999 shares in you own one. Okay, so if there's this disagreement on what's going on with the business or I change my mind. Okay.



00:36:48.410 --> 00:37:03.820

Gary Shepherd: The next generation owners got this. Well, yeah, you were gonna run the business kind of stuff, but I've decided to change my mind, and so the trust is quickly eroded. Or if the business owner realizes that.



00:37:04.060 --> 00:37:07.129

Gary Shepherd: as I realize you're really good at running this business.



00:37:07.950 --> 00:37:21.659

Gary Shepherd: and it takes off like crazy. Okay? And I'm. Now, I was gonna you know, thinking about retirement. I've stepped back. I'm on my boat somewhere. I come to the office yet, if at all, or call in, and you're running the business right.



00:37:22.060 --> 00:37:23.040

Gary Shepherd: And



00:37:23.190 --> 00:37:24.899

Gary Shepherd: now, all of a sudden it's like.



00:37:25.020 --> 00:37:26.820

Gary Shepherd: Which is he better hope.



00:37:27.080 --> 00:37:36.770

Gary Shepherd: you know, I better hope that he actually redeems out, or else I've I've really increased the value, and I got nothing to show for it. So trust is critical on both ends



00:37:37.220 --> 00:37:48.169

Gary Shepherd: and then profitability. The P. You have to have profitability. Obviously, because you have to have an increase in in in annual after tax triple a to afford the reductions.



00:37:48.210 --> 00:37:52.629

Gary Shepherd: But you're going to need that anyways in any kind of transition to either pay the loan back



00:37:52.710 --> 00:37:57.799

Gary Shepherd: or to monetize the business. But



00:37:58.050 --> 00:38:00.029

Michael Palumbos ChFC, CBEC: Time trust



00:38:00.330 --> 00:38:02.250

Michael Palumbos ChFC, CBEC: I love it.



00:38:02.490 --> 00:38:20.149

Michael Palumbos ChFC, CBEC: I love it, and you and you're making this. I I know we're not getting into the technical piece of it, but you're making it easy enough to understand. It's taking a a a little bit to go through this. But I think this is, you know, if i'm titling this this podcast, and we will have to work on this afterwards. But if i'm the title is, you know



00:38:20.160 --> 00:38:23.210

Michael Palumbos ChFC, CBEC: how to avoid a second layer of taxation.



00:38:23.830 --> 00:38:26.549

Michael Palumbos ChFC, CBEC: When you're transitioning a middle market business.



00:38:27.280 --> 00:38:28.720

Gary Shepherd: it's as good as any.



00:38:28.910 --> 00:38:35.309

Michael Palumbos ChFC, CBEC: Yeah. And and that's really what we're what we're doing when we're doing this. I I I really like it.



00:38:35.620 --> 00:38:48.430

Michael Palumbos ChFC, CBEC: What other things you know what haven't we talked about at this point that you know, if i'm if i'm a family business. I'm a. I own an emerging market, or, you know, emerging middle market business or middle market business. What am I?



00:38:48.800 --> 00:38:50.419

Michael Palumbos ChFC, CBEC: What do I need to know.



00:38:50.830 --> 00:38:54.780

Michael Palumbos ChFC, CBEC: you know. Maybe I I can. I can think of one right right away



00:38:54.860 --> 00:39:10.500

Michael Palumbos ChFC, CBEC: is that they better be working with somebody that really understands this plan, because 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, my favorite guy to work with.



00:39:10.510 --> 00:39:30.149

Michael Palumbos ChFC, CBEC: 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, and then, you know we can put the pieces together. How do you build a team?



00:39:30.340 --> 00:39:31.439

Michael Palumbos ChFC, CBEC: You know.



00:39:31.890 --> 00:39:33.330

Michael Palumbos ChFC, CBEC: around this?



00:39:34.130 --> 00:39:35.320

Gary Shepherd: You know that's a



00:39:35.450 --> 00:39:36.750

Gary Shepherd: it. It's a



00:39:37.180 --> 00:39:41.019

Gary Shepherd: it's a challenging issue. I I I told you that



00:39:41.270 --> 00:39:44.509

Gary Shepherd: when I first learned this from Ron Clawson.



00:39:45.800 --> 00:39:47.709

Gary Shepherd: Ron will travel



00:39:47.950 --> 00:39:50.189

Gary Shepherd: and and and work.



00:39:51.540 --> 00:39:52.630

Gary Shepherd: you know, with



00:39:52.780 --> 00:39:55.640

Gary Shepherd: the the local council



00:39:56.070 --> 00:40:00.499

Gary Shepherd: to kind of walk through how all of that works, but



00:40:00.550 --> 00:40:02.599

Gary Shepherd: his is a



00:40:03.490 --> 00:40:04.590

Gary Shepherd: is a



00:40:05.000 --> 00:40:10.600

Gary Shepherd: hefty cost for some of the lower end folks



00:40:10.650 --> 00:40:14.499

Gary Shepherd: and and typically, typically.



00:40:14.540 --> 00:40:23.460

Gary Shepherd: you know, Ron's dealing with stuff that's gonna be, you know, 25, or 30 or $40,000 in terms of of upfront costs.



00:40:23.700 --> 00:40:27.660

Gary Shepherd: and then you got local council and all that other kind of stuff.



00:40:28.840 --> 00:40:32.599

Gary Shepherd: and then you got our fees and and on, and on. So it



00:40:32.630 --> 00:40:48.739

Gary Shepherd: it's not without its cost. But the value proposition is substantial to to our point. If you're dealing with a 10 million dollar business, and you're saving 3 million dollars of taxes, and then all of the financing costs and that kind of stuff, hey? If it costs a little advisory money that's good



00:40:48.880 --> 00:40:56.509

Michael Palumbos ChFC, CBEC: and let me jump in. If you are going to sell the business on the open market, I you know, and and you're doing a capital



00:40:56.540 --> 00:41:07.090

Michael Palumbos ChFC, CBEC: transition, you know, a a capital transaction. Then you're not only have the 3 million dollars of taxes, but you still have all the advisory and attorney fees as Well, they're not going away.



00:41:07.100 --> 00:41:25.119

Michael Palumbos ChFC, CBEC: That's true. Yeah, I want to, you know. Don't don't put that on you on. You know what i'm saying. I think you can take that out of the equation because you're gonna. If you're doing a capital transaction there better be some attorneys and accountants and whatnot that in your eyes and crossing your T's, you're gonna be paying.



00:41:25.650 --> 00:41:29.040

Gary Shepherd: So what I decided to do was



00:41:29.500 --> 00:41:46.560

Gary Shepherd: again the the vast majority of the folks that we're dealing with are in the you know. I I I use the parameters as the 2 to 20 milliondollar space. But if I had to be honest with you, the vast majority of the of the substantial number of these things we've done are in the



00:41:46.630 --> 00:41:49.640

Gary Shepherd: 2 to 10 milliondollar space. Okay.



00:41:49.770 --> 00:41:50.500

Gary Shepherd: Now



00:41:50.780 --> 00:41:51.640

Gary Shepherd: the



00:41:51.860 --> 00:42:10.600

Gary Shepherd: the advisory group there is 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 this the the credibility, no matter what designation. I have to go to an attorney or an accountant.



00:42:10.610 --> 00:42:13.520

Gary Shepherd: and even though I might be able to speak in detailed



00:42:14.470 --> 00:42:19.990

Gary Shepherd: language about tax codes and irc sections, and all that kind of mess. I don't have the credentials.



00:42:20.040 --> 00:42:28.299

Gary Shepherd: so I either import Ron or what I did was create a strategic partnership, and I had a substantial one already



00:42:28.340 --> 00:42:37.209

Gary Shepherd: with a member of a prominent law firm here in Hampton Roads, who is a noted attorney, but he's also an accountant.



00:42:37.270 --> 00:42:40.920

Gary Shepherd: So he's a tax attorney, a a business tax.



00:42:42.620 --> 00:42:45.350

Gary Shepherd: a a accountant having that background.



00:42:45.640 --> 00:42:51.839

Gary Shepherd: and his firm is noted as business advisors, and I gave him all of the stuff.



00:42:52.770 --> 00:42:53.870

Gary Shepherd: and said.



00:42:54.510 --> 00:42:56.500

Gary Shepherd: Here's why I think this works



00:42:56.840 --> 00:42:57.910

Gary Shepherd: tear it apart.



00:42:58.140 --> 00:43:08.950

Gary Shepherd: and I have that relationship with him, and and again his first reaction was: Sounds too good to be true, but then they started digging into it because of all the stuff that I had



00:43:09.060 --> 00:43:09.899

Gary Shepherd: head



00:43:10.280 --> 00:43:15.250

Gary Shepherd: pounded bronze and about, and it grammar. I'm an analytical guy.



00:43:15.330 --> 00:43:16.990

Gary Shepherd: So



00:43:17.060 --> 00:43:19.479

Gary Shepherd: all of a sudden the light went on for



00:43:19.520 --> 00:43:30.070

Gary Shepherd: this particular attorney and his firm, and they have now embraced it wholly as a part of the succession of transition



00:43:30.170 --> 00:43:34.360

Gary Shepherd: opportunities they bring to clients. But more importantly.



00:43:34.560 --> 00:43:45.350

Gary Shepherd: 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 is an accountant and an attorney, and it's not me



00:43:45.850 --> 00:43:59.189

Gary Shepherd: So it's one professional to another to say, hey, look! I know you're looking at this thing, and you you probably are looking at scance. It sounds like scammy type of stuff, but you're looking at it wrong because you're not.



00:43:59.860 --> 00:44:04.610

Gary Shepherd: This is a counterintuitive strategy. We want ordinary income



00:44:05.100 --> 00:44:16.649

Gary Shepherd: tax treatment. We do not want a capital gains treatment, and in an escort situation done correctly. This is the result we get, and once they start to explain that



00:44:17.220 --> 00:44:20.219

Gary Shepherd: all of a sudden you realize as long as I avoid



00:44:20.320 --> 00:44:32.180

Gary Shepherd: anything that looks like a capital transaction, then i'm going to get ordinary income, and if I keep it to the in annual increase in Triple a. I've already paid the income. I do not have to pay the next level of tax.



00:44:33.260 --> 00:44:40.509

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



00:44:43.110 --> 00:44:52.270

Michael Palumbos ChFC, CBEC: I am trying? I'm running out of questions for you? Actually wait. This is the you. You've done a great job of walking through this



00:44:52.400 --> 00:44:53.569

Michael Palumbos ChFC, CBEC: it it



00:44:53.650 --> 00:44:55.429

Michael Palumbos ChFC, CBEC: This is not going to work



00:44:55.510 --> 00:44:57.399

Michael Palumbos ChFC, CBEC: in every circumstance.



00:44:57.470 --> 00:44:58.410

Gary Shepherd: Okay?



00:44:58.530 --> 00:45:03.189

Gary Shepherd: And there's a couple of trap doors that we should probably talk about here.



00:45:04.870 --> 00:45:11.729

Gary Shepherd: You know we've put together an entire structure and system for our clients.



00:45:13.390 --> 00:45:18.799

Gary Shepherd: and one of the primary things that we need to really be instrumental in.



00:45:18.820 --> 00:45:25.220

Gary Shepherd: Excuse me, proactive with the clients, and make sure they understand, and it's it's good for



00:45:25.270 --> 00:45:26.499

Gary Shepherd: for you and I



00:45:27.810 --> 00:45:30.510

Gary Shepherd: a business owner in our example



00:45:30.550 --> 00:45:37.500

Gary Shepherd: here. This transitioning a 10 million dollar business is is by definition, since we already talked about this



00:45:37.650 --> 00:45:43.480

Gary Shepherd: needs the value of the business to sustain their lifestyle going forward.



00:45:43.680 --> 00:45:44.509

Gary Shepherd: Okay.



00:45:44.550 --> 00:45:55.559

Gary Shepherd: So they've reached this a point in their life where they want to do something else. Okay, they're successful, but they're ready to to actually pull back.



00:45:56.550 --> 00:46:01.789

Gary Shepherd: But they're living off of in my example. Here, let's assume that this is a



00:46:01.830 --> 00:46:09.169

Gary Shepherd: a a 5 X multiple here. Okay. So this thing is generating a couple of 1 million dollars after tax every year.



00:46:10.280 --> 00:46:13.020

Gary Shepherd: and the lifestyle supports that.



00:46:13.380 --> 00:46:24.200

Gary Shepherd: Okay? Or let's cut it in half and say it's a 5 million dollar business, and it's generating a 1 million, or it's a family business, and it's generating 500,000. It doesn't matter.



00:46:24.340 --> 00:46:26.529

Gary Shepherd: The client is living off that money.



00:46:26.670 --> 00:46:28.639

Gary Shepherd: And now, all of a sudden.



00:46:28.730 --> 00:46:34.479

Gary Shepherd: Okay, i'm going to have to. I'm going to take that asset base, and i'm going to monetize it.



00:46:34.600 --> 00:46:42.569

Gary Shepherd: And in our first example, if I guys got a 10 million dollar asset base that he's pulling 2 million dollars out of it all right. That



00:46:42.830 --> 00:46:48.169

Gary Shepherd: is a 20% withdrawal rate which you cannot sustain long term.



00:46:48.400 --> 00:46:49.259

Gary Shepherd: So



00:46:49.840 --> 00:46:53.279

Gary Shepherd: the financial plan that comes with



00:46:53.370 --> 00:46:58.610

Gary Shepherd: the transition is absolutely critical. And what the client needs to understand is



00:46:58.930 --> 00:47:13.870

Gary Shepherd: when you get that 2 million dollar redemption check, You have to give it to me because that's got to go, invest it, get invested, so that when this thing is done you've got 10 million dollars of investment assets, together with your other assets.



00:47:14.060 --> 00:47:19.610

Gary Shepherd: And hopefully, that's going to be sufficient. And you've got a good plan in place to continue



00:47:19.660 --> 00:47:23.070

Gary Shepherd: generating income necessary to support your lifestyle.



00:47:23.190 --> 00:47:25.760

Gary Shepherd: If you spend that 2 million dollars.



00:47:26.540 --> 00:47:35.289

Gary Shepherd: 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



00:47:35.320 --> 00:47:36.430

Gary Shepherd: critical.



00:47:36.680 --> 00:47:37.370

Gary Shepherd: But



00:47:37.480 --> 00:47:39.359

Gary Shepherd: it also means that



00:47:39.420 --> 00:47:45.389

Gary Shepherd: I have to stay involved with the client for at least the transition period.



00:47:45.880 --> 00:47:47.489

Gary Shepherd: and make sure that



00:47:47.720 --> 00:47:49.060

Gary Shepherd: as these



00:47:49.340 --> 00:47:54.779

Gary Shepherd: monies are developed annually. There's internal structures on how to treat



00:47:55.080 --> 00:48:12.490

Gary Shepherd: quarterly distributions as loans, that we then convert to distributions at the end of the year, so that we don't get behind the 8 ball, and and we have taxable income and no cash, because we're actually running a business. Yadda yadda yadda. So it it allows us to stay involved.



00:48:12.500 --> 00:48:23.479

Gary Shepherd: and 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. That would almost email practice.



00:48:24.520 --> 00:48:30.430

Gary Shepherd: and it would not be any good for for us or the client, because there's a lot more to it than that.



00:48:30.440 --> 00:48:48.909

Michael Palumbos ChFC, CBEC: Yeah. So I we happen to use some pretty powerful financial planning software. And and it's that modeling to say, how does this fit? What does this look like to? Probably starts the conversation. That's not the end. I'll be all but it's like it. It gets us on the it gets us, you know, close enough



00:48:48.920 --> 00:48:58.190

Michael Palumbos ChFC, CBEC: for government work, so to speak. And then they also, you know, one of the things we always talk about in in transition. Planning is the value gap.



00:48:58.310 --> 00:49:03.869

Michael Palumbos ChFC, CBEC: Is it possible that you have? And this is maybe a dumb question possible. You have an owner that says.



00:49:03.890 --> 00:49:10.040

Michael Palumbos ChFC, CBEC: look at. You know the businesses were 10 million dollars. I know I could get 10 million dollars for it, but all I need is 7,



00:49:10.690 --> 00:49:12.579

Michael Palumbos ChFC, CBEC: all 9 to 6,



00:49:13.120 --> 00:49:20.959

Michael Palumbos ChFC, CBEC: and my kids, if I can get 6 more out of here based on all the modeling and things that we've done. Can you help me to make that happen.



00:49:21.360 --> 00:49:25.440

Michael Palumbos ChFC, CBEC: Does that? Does that work in that s those circumstances



00:49:25.460 --> 00:49:30.529

Gary Shepherd: absolutely. You know the interesting part about the Popeye structure is, if you think about it in our



00:49:30.620 --> 00:49:31.759

Gary Shepherd: in our



00:49:32.160 --> 00:49:43.469

Gary Shepherd: example. Here you're dealing with a 10 million dollar business. You don't have to pay 3 million dollars to taxes. Then Does it really matter if the valuation is 7 million versus 10? Because it's the same amount of money.



00:49:43.560 --> 00:49:44.419

Gary Shepherd: right?



00:49:44.450 --> 00:49:57.659

Gary Shepherd: And so, if you only need 6 or 7. 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, under no compulsion to buy or sell that determines value.



00:49:57.750 --> 00:50:02.669

Gary Shepherd: And and and so it's easier to to do that.



00:50:04.440 --> 00:50:16.569

Gary Shepherd: The Value Gap discussion is critical to that whole financial planning thing, and it drives a discussion of how much, in my prior example, how much of that 2 million dollars, a manual increase you actually have to invest



00:50:17.030 --> 00:50:19.290

Gary Shepherd: because we have to be able to



00:50:19.820 --> 00:50:23.689

Gary Shepherd: essentially change the withdrawal number



00:50:24.010 --> 00:50:39.149

Gary Shepherd: from my theoretical thing of 20 down to something like 4 or 5, which represents a more long term sustainable number. And so how much do you already have? What is the value up? It's it's the same discussion we always have.



00:50:39.170 --> 00:50:40.669

Gary Shepherd: Once we've monetized.



00:50:41.050 --> 00:50:44.500

Gary Shepherd: There's another piece here. When you're dealing with family members.



00:50:45.590 --> 00:50:46.869

Gary Shepherd: there is a



00:50:47.000 --> 00:50:51.860

Gary Shepherd: there is an attribution issue that you'll have to deal with, so



00:50:51.990 --> 00:50:53.010

Gary Shepherd: so that



00:50:54.340 --> 00:50:57.499

Gary Shepherd: it helps us during the transition.



00:50:57.580 --> 00:51:04.580

Gary Shepherd: But if I'm trying to make sure that the client is ultimately not an owner of the business.



00:51:04.710 --> 00:51:08.370

Gary Shepherd: Okay, if I transition it to my children.



00:51:08.400 --> 00:51:20.009

Gary Shepherd: Okay, then, if I have anything to do with the business at all, Section 318, it's gonna suck the entire value back into by a State for tax purposes.



00:51:20.120 --> 00:51:34.310

Gary Shepherd: So 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



00:51:34.320 --> 00:51:42.629

Gary Shepherd: rental agreements for property between dad and the son, and all of this other kind of stuff do not run a foul of 318,



00:51:42.770 --> 00:51:43.870

Gary Shepherd: or else



00:51:44.100 --> 00:51:57.459

Gary Shepherd: particularly in the upper end of this stuff. If I take a 10 million dollar business plus the other assets the individual has, and they they start messing around with the State tax law. I could find myself in a taxable



00:51:57.610 --> 00:52:00.239

Gary Shepherd: transaction it a taxable estate.



00:52:00.530 --> 00:52:11.469

Gary Shepherd: 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 it's the nuance and the details you got to be aware of.



00:52:11.750 --> 00:52:13.350

Gary Shepherd: Okay, so my paper



00:52:13.500 --> 00:52:15.660

Michael Palumbos ChFC, CBEC: very, very important.



00:52:15.930 --> 00:52:28.779

Michael Palumbos ChFC, CBEC: I i'm thinking about this, and i'm gonna just throw another kind of example, actually, that that i'm a business owner. I've got a a 10 million dollar a 7 million dollar business.



00:52:29.060 --> 00:52:32.919

Michael Palumbos ChFC, CBEC: I'm doing. I'm taking my salary, You know. I'm living off my salary



00:52:33.170 --> 00:52:47.920

Michael Palumbos ChFC, CBEC: because it's an s corporation. I have to take a salary and say, you know, so my salary is 300,000, so if I've got that 1 million dollars of growth in the Aaa account. I'm paying taxes on all that, and typically what i'm doing is, you know, i'm bonuses myself



00:52:48.020 --> 00:52:53.890

Michael Palumbos ChFC, CBEC: the it, you know the the taxes, so that i'm not having to write a check out of my personal stuff.



00:52:54.380 --> 00:53:01.610

Michael Palumbos ChFC, CBEC: And now the the Pope, I plan really starts to make sense, because I'm. You know that there's a lot



00:53:01.640 --> 00:53:06.000

Michael Palumbos ChFC, CBEC: more to play with there that could be invested outside of the business.



00:53:06.210 --> 00:53:12.740

Gary Shepherd: Yeah, all of that makes sense. Let's talk about the transition, and typically what happens here.



00:53:13.230 --> 00:53:15.239

Gary Shepherd: So if



00:53:15.320 --> 00:53:19.290

Gary Shepherd: if i'm the elder statesman, and you're the younger statesman.



00:53:19.310 --> 00:53:23.799

Gary Shepherd: or you're in the next generation here. Typically, what happens is



00:53:25.340 --> 00:53:28.379

Gary Shepherd: once we start this, you realize



00:53:28.470 --> 00:53:32.950

Gary Shepherd: that, hey? I'm going to own a business. I don't have to pay anything for it, and



00:53:33.010 --> 00:53:38.469

Gary Shepherd: there is, whether you like to believe it or not. Most business owners that have been at this for a long time.



00:53:38.490 --> 00:53:40.520

unless You're just



00:53:40.700 --> 00:53:44.919

Gary Shepherd: really on top of everything that's going on. You're



00:53:45.370 --> 00:53:48.149

Gary Shepherd: You're making your business sclerotic.



00:53:48.230 --> 00:53:53.180

Gary Shepherd: Just because of the fact that you're stuck in. This is the way we do it stuff.



00:53:53.500 --> 00:53:56.379

Gary Shepherd: And so you tend to be an impediment in



00:53:56.400 --> 00:54:05.540

Gary Shepherd: in terms of recognizing the next generation of change. It's going to impact your business, and the next generation of people are usually more attuned to that.



00:54:05.720 --> 00:54:20.419

Gary Shepherd: 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. So after a year or 2, even though i'm still being redeemed out.



00:54:20.570 --> 00:54:23.100

Gary Shepherd: Okay, i'm kind of out of the deal.



00:54:23.880 --> 00:54:26.780

Gary Shepherd: And so my salary now



00:54:26.860 --> 00:54:28.520

Gary Shepherd: typically goes



00:54:28.680 --> 00:54:40.010

Gary Shepherd: to something like a consulting arrangement and maybe a benefit type thing. So i'm getting a company car, or maybe some health care if i'm not yet to the point where



00:54:40.080 --> 00:54:45.870

Gary Shepherd: you know if i'm if i'm in my early sixties. I'm not yet reached Medicaid, or excuse me that care.



00:54:46.640 --> 00:55:06.270

Gary Shepherd: that kind of stuff. So i'm getting a a 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 for all the work that they're doing.



00:55:06.280 --> 00:55:18.140

Gary Shepherd: 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. You know the bank



00:55:18.280 --> 00:55:29.509

Gary Shepherd: isn't involved in this, but the bank is involved from the standpoint that there's usually some level of personal guarantee that if your financing equipment and that kind of stuff.



00:55:29.580 --> 00:55:34.400

Gary Shepherd: and so you know it's easy for the business to pay the



00:55:36.290 --> 00:55:37.179

Gary Shepherd: the



00:55:37.410 --> 00:55:55.430

Gary Shepherd: the 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



00:55:55.440 --> 00:56:07.179

Gary Shepherd: if i'm now assuming the capital, the the capital function by the amount of money that I'm. Leaving in for cash, flow purposes, or whatever it is, I can get paid a



00:56:07.310 --> 00:56:11.520

Gary Shepherd: a a premium for keeping that money there.



00:56:11.550 --> 00:56:23.769

Gary Shepherd: 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 tech stuff for the purposes of redemption.



00:56:23.830 --> 00:56:29.610

Gary Shepherd: Again, a whole other level of discussion that needs to typically occur.



00:56:29.680 --> 00:56:35.729

Michael Palumbos ChFC, CBEC: Yeah, and and that's why you need to build a team. And you need to have somebody that really gets this



00:56:35.840 --> 00:56:43.229

Michael Palumbos ChFC, CBEC: since you started doing these. Do you mind if I ask, how many you know? How many of these Pop? I plans you put together?



00:56:43.540 --> 00:56:49.770

Gary Shepherd: Well, compliance suggested that we we not talk about those kinds of things.



00:56:49.900 --> 00:56:50.740

Gary Shepherd: but



00:56:50.810 --> 00:57:09.999

Gary Shepherd: it is a a substantial, a a substantial number. I thought they were just talking about specifics. I was just like, but you. But these are num num numerous transactions that you put together, and they've all done exactly the way they were supposed to go as the the point. But that's correct. We we have.



00:57:10.010 --> 00:57:13.679

Gary Shepherd: We have probably



00:57:14.650 --> 00:57:17.330

Gary Shepherd: 6 or 7 currently in



00:57:17.430 --> 00:57:24.459

Gary Shepherd: right, but that's just stuff that we've taken on recently. Remember.



00:57:25.580 --> 00:57:26.180

Gary Shepherd: Yeah.



00:57:26.200 --> 00:57:31.479

Gary Shepherd: most of these are transactions that occur at a minimum over a 5 year period of time.



00:57:31.550 --> 00:57:33.399

Gary Shepherd: They become



00:57:33.800 --> 00:57:41.790

Gary Shepherd: easier to handle the longer that they go, because the start. The internal structure and systems are now learned by



00:57:41.900 --> 00:57:55.920

Gary Shepherd: 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 so it takes less and less.



00:57:56.200 --> 00:57:57.750

Gary Shepherd: Time



00:57:59.080 --> 00:58:02.339

Gary Shepherd: and again the the team that we've put together.



00:58:02.750 --> 00:58:13.359

Gary Shepherd: After a while, if you sit down with a client, even though they have existing attorney and a client, a a accountant relationships. Once you start getting into this



00:58:14.890 --> 00:58:25.040

Gary Shepherd: that you you realize you need a specialist, or else I'm gonna have to teach your attorney or accountant all of this stuff, and they're gonna bill you for that that education.



00:58:25.130 --> 00:58:25.790

Michael Palumbos ChFC, CBEC: Yeah.



00:58:26.000 --> 00:58:41.389

Gary Shepherd: 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, you know you can keep it. That's typically what happens. And for us that means, you know, a relatively small cadre of



00:58:41.720 --> 00:58:44.890

Gary Shepherd: highly technical attorneys, accountants.



00:58:44.930 --> 00:58:52.790

Gary Shepherd: an ancillary business related folks that have now done a ton of these. We we know where the



00:58:53.010 --> 00:58:57.610

Gary Shepherd: pressure points are. We know where the opportunities are and how to



00:58:57.680 --> 00:59:12.990

Gary Shepherd: handle nuances like you know you're a C core. And now you have to convert to an escort. And how do you do that or your Llc tax as a partnership? How do I convert? How do I change that to a escort and and and make this work?



00:59:13.180 --> 00:59:19.299

Gary Shepherd: So yeah, it's it's a team that's required.



00:59:19.890 --> 00:59:24.489

Gary Shepherd: but we have to keep the value proposition for the client, and once once they get it



00:59:24.550 --> 00:59:28.620

Gary Shepherd: they usually run pretty hard because they recognize that



00:59:28.650 --> 00:59:32.240

Gary Shepherd: the numbers that they were otherwise going to pay voluntarily.



00:59:32.580 --> 00:59:42.750

Gary Shepherd: either in taxes or impose on family members or key people financing requirements with banks that are very, very strident and expensive.



00:59:42.900 --> 00:59:52.249

Gary Shepherd: all of that grist and sand that are otherwise in this transaction the succession and transition transaction are are gone.



00:59:52.610 --> 00:59:57.560

Gary Shepherd: and and so it makes the development of a



00:59:57.690 --> 01:00:00.830

Gary Shepherd: more flexible plan a a whole lot easier.



01:00:01.590 --> 01:00:06.039

Michael Palumbos ChFC, CBEC: All right, I think I've got my final question for you, and it's one I haven't asked. Yet



01:00:06.060 --> 01:00:09.919

Michael Palumbos ChFC, CBEC: how in the world Why is it called the Pop? I plan?



01:00:10.620 --> 01:00:24.000

Gary Shepherd: Okay, this is pretty easy to answer, and we can conclude on that. Remember, I told you that Ron Clawson, an attorney in California, started doing this stuff now probably over 25 years ago.



01:00:24.070 --> 01:00:30.319

Gary Shepherd: and his first transaction involved a



01:00:30.530 --> 01:00:38.900

Gary Shepherd: a key man, and they were buying. I think it might have been a vineyard or or something of that nature out in California doesn't really matter.



01:00:39.350 --> 01:00:41.140

Gary Shepherd: And



01:00:41.310 --> 01:00:46.749

Gary Shepherd: Ron was had figured this plan out, but it was looking for some way to visually



01:00:46.890 --> 01:01:05.929

Gary Shepherd: 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 that finance and blah blah blah! There's big tax things. So he was going to be the hero.



01:01:06.950 --> 01:01:22.610

Gary Shepherd: And so he was looking around in computer graphics, and the only hero he could find was a picture of Pop by the sailor. Okay. And so then the company became the Olive Oil Corporation, and and so we had Pop by the sailor man and olive oil.



01:01:22.790 --> 01:01:34.229

Gary Shepherd: and that was the visual that he used for the sale, and a couple of years after that, and, by the way, that the transaction worked magnificently so well



01:01:34.310 --> 01:01:40.039

Gary Shepherd: that when Ron was talking with this key person who now was running the business.



01:01:41.010 --> 01:01:44.460

Gary Shepherd: he found out that he had taken to calling himself Popeye



01:01:44.480 --> 01:01:48.469

Gary Shepherd: because the transaction had worked so well.



01:01:48.540 --> 01:01:50.169

Gary Shepherd: And so the



01:01:50.310 --> 01:02:09.740

Gary Shepherd: 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.



01:02:09.780 --> 01:02:29.510

Michael Palumbos ChFC, CBEC: Gary Shepherd, Shepherd, financial group. This has been a pleasure talking about how business owners can avoid a second layer of trans second layer of tax during their transition planning. If this works for them, I would recommend. You need a, you know, a a



01:02:29.520 --> 01:02:47.950

Michael Palumbos ChFC, CBEC: fabulous wealth advisor to team up with. You know your account and and attorney to make this happen. But the more importantly, you probably need someone like Gary or Ron Cla. And that really has done these transactions a bunch of times. I know that you know



01:02:48.120 --> 01:02:55.230

Michael Palumbos ChFC, CBEC: there will may come a time that i'll be knocking on your door when I knock on one of these things to you know. Put them together.



01:02:55.390 --> 01:03:11.450

Michael Palumbos ChFC, CBEC: It's what we do, and i'm delighted to help we room for business. 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. So I



01:03:11.460 --> 01:03:15.800

Michael Palumbos ChFC, CBEC: I really love that about our You know the corporate corporate side.



01:03:15.940 --> 01:03:26.450

Michael Palumbos ChFC, CBEC: Thank you. Everybody for listening really appreciate your time. My name is Michael Columbus, with family wealth and legacy in Rochester, New York. This has been the family biz show.



01:03:26.460 --> 01:03:36.699

Michael Palumbos ChFC, CBEC: 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 of everybody.



01:03:37.350 --> 01:03:38.089

Bye. Now.

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Michael Palumbos is a registered representative of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Family Wealth & Legacy, LLC is not an affiliate of Lincoln Financial Advisors Corp. Lincoln Financial Advisors Corp. and its representatives do not provide legal or tax advice. You may want to consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.