Business Exit Strategy Series – Private Annuity
An annuity!? I’ll be honest, as an independent financial planner without any affiliation or incentive to sell particular products, I despise annuities (generally speaking). This is because you give up so much chance for asset growth for a guaranteed income stream. The fees are high, and the commissions taken by annuity sales-reps are typically very high. Why? Because they are so profitable for the annuity seller. I’ll go one step further to say that annuities prey on retired, older women. I’ll leave it at that. I don’t want to go down that rabbit hole. But I run into people all the time that have an annuity, either through work, personal purchase, or another means. For example, sometimes it’s a provided work benefit that your employer pays into, but you don’t. Then that annuity will be free money when paying out. So having an annuity isn’t necessarily bad. However, please reach out to us if you are thinking of purchasing an annuity. We really want to prove our point that annuities should only be acquired in rare circumstances.
All of this being said, it is an option when trying to sell a business. Here are the highlights of selling a business and receiving a private annuity (string of payments for life) and why a business owner might be enticed by a private annuity.
- You sell property (in this case a business) in exchange for a promise of future payments.
o Can be to a family member, other business, etc.
o Generates income in retirement.
- The value of the business is completely removed from your estate.
To be clear, you aren’t “buying” a series of payments from a private insurance company, which is what I ranted against earlier. This is a sale to a private person (or business entity) and they promise to pay you with a payment stream for life (in the case of a single life annuity).
There are some downsides that generally make private annuities for business sales undesirable.
- The promise to pay is unsecured. This means if the buyer stops paying the payments, you don’t have physical assets to reclaim. When a bank loans you money for a car, if you stop making payments, the bank can take the car (reposition or repo). The loan is “secured” by the car. This isn’t the case with a private annuity. You can’t repossess anything. Now, of course, you can take legal action to get the buyer to keep making payments, but there isn’t a tangible thing you can “repossess”. Plus, if a buyer stops paying, they probably don’t have the money to pay you anyways. So there may not be anything to go after to get the payment streams starting up again.
- You recognize the entire gain of the property (sale price – basis) in year you establish the annuity. This is a considerable tax burden, and this relatively recent legislative change has made private annuities very uncommon.
- The payments stop at death (in the case of a single life annuity), so if you sell the business tomorrow and die the next day, you wouldn’t get any money.
While we don’t recommend this for clients selling their business, it is something that can work when there’s little capital gain recognized by the sale (or enough losses to offset the gain). It’s also important that you have a close and positive relationship with the buyer. For example, a trusted younger family member could be a reliable buyer if they have some responsibility for taking care of the seller (older parent perhaps) and want to take over the family business.
Overall, we rarely recommend private annuities as a business exit strategy. However, it is an option worth considering as all options should be on the table and analyzed when it comes to making life-changing financial decisions such as selling your business. If you have questions about selling your business, reach out to us at 571-969-1459 or email us at ryan@ifpinvest.com.
