sellingabusiness - bernstein · 2 selling a business: getting what you need athicketofquestions...

Selling a BusinessGetting What You Need

You Can Get SatisfactionSir Michael Jagger, better known as Mick, led The Rolling Stones in proclaiming that“You can’t always get what you want…but you just might find you get what youneed.” This trade-off applies to all things in life, including investments, and it hasspecial validity when selling a private business. Although an owner’s focus may beon getting his “magic number” for the business up front, he may find that otheralternatives offer acceptable, or even superior, trade-offs.

We begin with the premise that business sales are typically complicated, and ladenwith emotional issues. The owner is selling his means of livelihood, and more—theconfiguration of his financial portfolio: He’ll have to make the transition from relyingon business earnings to living off the pool of liquid investments generated by thesale. The good news is that sellers are not in the process alone, but generallyrepresented by teams of advisors, usually quarterbacked by an investment bankerand including a portfolio-management professional such as Bernstein (display below).The role of the investment manager is not to pass judgment on one or another termsheet, but to place each in the context of the seller’s overall financial objectives. Thiscan be done at any point in the deal—but the sooner the better.

IN THIS PAPERSelling a private business is best

thought of as an ongoing planning

process that begins well before the

deal is consummated and ends well

afterward. But at every point along

this continuum, the owner and his

professional team are grappling

with and resolving both financial

and personal issues. Bernstein’s

proprietary modeling capabilities

can quantify the likelihood that a

sale will meet an owner’s critical

financial objectives and help

evaluate the trade-offs across

different deal terms.Transaction Planning: A Holistic Approach

Bernstein Expertise Long-term investment planning Asset allocation Multigenerational wealth transfer

InvestmentManager

CorporateAttorney

T&EAttorney

Client

Accountant

InvestmentBanker

Bernstein does not provide tax, legal, or accounting advice. Business sellers should discuss their individual circumstances with professionals in those areas.

Gregory D. SingerDirector of ResearchBernstein Wealth Management Group

Brian D. WodarDirectorBernstein Wealth Management Group

2 Selling a Business: Getting What You Need

A Thicket of QuestionsDisplay 2 parses some of the interconnected financial andemotional issues that arise when selling a business. For example,whether the owner receives “enough” for his business dependson how much it generates in earnings1 and how much the marketis willing to pay for those earnings. But directly connected areissues like whether now is a good time to sell, whether the ownerwants to retain an interest in the business for a while longer—often a negotiable point—and how the sale will impact theowner’s family and employees. All of these issues affect owners’personal lives as deeply as their financial wherewithal—and onboth sides of that equation professional planning can identifyopportunities and help solve problems.

Further, each of these questions leads to additional questions.Arriving at answers is made none the easier by the blizzard ofalternatives often available, and frequently buyers and sellers findthemselves in disagreement about deal terms, legalities, andtax-related matters. The job of the professional teams—theseller’s and the buyer’s—is to satisfy their respective clients,resolve as many issues as possible before the consummation ofthe deal, and monitor the transaction as it moves forward. Andthere are never one-size-fits-all answers. One seller may justifiablybe anxious to consummate the deal before taxes go up in 2011;another may be willing to pay the higher levy if he expects hisearnings to increase significantly in the near future, raising thevalue of the offers he’ll receive. The question is whether the riskof waiting will pay off. We’ll have more to say about this later.

What about the environment? Is this a good time to sell? Evidenceof an economic recovery is mounting, but financing is still tight,and there are no assurances about what the future will bring. Inaddition, the profit dynamics of every industry—and, moreimportant, for every company—are different. That last criterion isthe one that truly counts for a business seller: It’s his company andhis livelihood that are at issue. The job of his professional team isto keep him from falling into one of two traps: rushing headlonginto selling now because the “landscape” looks good, or refusingto budge because it was better several years ago and good timesmay be around the corner again.

Still, owners need a touchstone for deciding whether to sell,and one metric might be if the proceeds—whether all up frontor parceled out over time—are at least enough to provide forthe owner’s lifetime spending needs (his so-called core-capitalSM

requirements). Ideally, he’d take home even more than that andgenerate “excess capital” (see “Will You Get Enough? CoreCapital vs. Excess,” facing page).

Non-Sellers’ RemorseDuring the boom years of the mid-2000s, many business ownerswere offered and refused term sheets, hoping to do better—onlyto regret that decision when the bear market ensued. ConsiderJohn and Jane Commander (Display 3, page 4), who decided inearly 2007 that they were ready to give up their business, whichwas earning more than $7.5 million a year, and represented thevast majority of their net worth (the rest of which was investedin two IRAs totaling $1 million). They wanted to sell the businessfor $60 million, which worked out to 8× EBITDA, a high multipleeven by 2007 standards—but were offered $48 million. Theychose to pass. As we’ll see, while more money is obviously betterthan less, they didn’t need proceeds of $60 million to meet theirfinancial objectives.

Indeed, three years later new offers came in, but by now, inharder times, their earnings had declined to $6 million. They’dhave to sell at a lower multiple, yielding $27 million cash,leaving them with $23 million after taxes, including their IRAs.Should they sell this time? Could they, and meet their objectives:satisfying their core-spending needs ($500,000 a year, grown

Display 2

Typical Business-Owner Questions

EmotionalDo I want to stay involved in the business?

Do I have a plan for my life after the sale?

What effect will the sale have on my family and employees?

Do I have the risk tolerance to accept contingent deal terms?

FinancialHow much is my business worth?

What’s the best deal structure for me?

Will I get enough to meet my needs?

Is all-cash-now better than staged/contingent payments?

Professional planning is critical

1Earnings are typically defined differently in different industries and for different purposes, but in many industries, earnings calculations for sale purposes are often before interest,taxes, depreciation, and amortization (EBITDA): in other words, the cash flow generated. Throughout this paper, “earnings” and “EBITDA” are used interchangeably.

To distinguish between what you want and what you need,we’ve developed a planning framework at Bernstein thatidentifies so-called “core capital” and “excess capital”(display below, left). The core amount is what you need tomeet your spending needs, grown with inflation, for the restof your life. Because no one wants to live with the threatof running out of money, we calculate the probability ofsustaining core capital over an investor’s lifetime using ourWealth Forecasting SystemSM (see page 4) at a very highdegree of confidence: typically 90% or better.

The amount depends mostly on the investor’s age, spendingrate, and portfolio risk level. We estimate, for example(display below, right), that a 65-year-old couple with aportfolio invested 60% in stocks and 40% in bonds willneed $3.2 million of core capital for every $100,000 theyspend annually, when factoring in a range of actuarial lifeexpectancies. In general, the amount of required core capitalat higher spending rates varies by age and allocation. Forinstance, if the couple were invested 60/40 but were 15years younger, their longer time horizon would translate into

Will You Get Enough? Core Capital vs. Excessroughly $4.3 million of core capital. These are scalablenumbers: If the 50-year-old couple were also spending$400,000 a year instead of $100,000, they’d need fourtimes as much core, or $17.2 million. For more informationon core capital and spending rates see Appendices 1 and 2on page 12.

Any amount left over in an investor’s portfolio after thecore-capital requirement is satisfied is the “excess”: used forextra spending, legacy provisions, philanthropy, and, in somecases, new business ventures. The relevant issues are howmuch is in the excess pool, and how the investor intends toinvest and deploy it. Because excess capital is not a lifestylerequirement, it may be invested with more risk than aninvestor may be willing to take with his core capital—i.e.,more stocks or alternative assets.

For many business sellers, it’s key to come away with a dealthat has the highest likelihood of meeting at least theircore-capital requirements. If the sale generates excess also,so much the better. n

Projected Core-Capital Amounts by AgePer $100,000 Annual Spending ($ Mil.)*

Allocation(% Stocks/% Bonds) 0/100 20/80 40/60 60/40 80/20 100/0

Age 50 $7.1 $5.6 $4.8 $4.3 $4.3 $4.3

Age 65 4.3 3.7 3.3 3.2 3.2 3.2

Age 80 2.3 2.1 2.0 2.0 2.0 2.1

*The core-capital requirements here are for couples and assume an allocation ofglobally diversified stocks and diversified intermediate-term municipal bonds in theproportions noted. Spending budgets are assumed to grow with inflation, andmaintained with a 90% degree of confidence. Based on Bernstein’s estimates of therange of returns for the applicable capital markets for the periods analyzed. Data donot represent past performance and are not a promise of actual future results. SeeNotes on Wealth Forecasting System at the end of this paper. Information onlongevity and mortality-adjusted investment analysis in this study is based onmortality tables compiled in 2000. In our mortality-adjusted analyses, the life spanof an individual varies in our 10,000 trials in accordance with mortality tables.Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

Evaluating What You Need and What You Want

Capital for Next Venture

Extra Spending

PersonalReserve

Charity

Children andGrandchildren

LifestyleSpending

Core Capital Amount to ensure spending needs are met Often calculated at 90% level of confidence

Excess Capital Amount for expanded opportunities

How much do you spend? What is your age? What is your risk tolerance?

How much? To whom? How quickly? How allocated? What strategies?

3

A Thicket of QuestionsDisplay 2 parses some of the interconnected financial andemotional issues that arise when selling a business. For example,whether the owner receives “enough” for his business dependson how much it generates in earnings1 and how much the marketis willing to pay for those earnings. But directly connected areissues like whether now is a good time to sell, whether the ownerwants to retain an interest in the business for a while longer—often a negotiable point—and how the sale will impact theowner’s family and employees. All of these issues affect owners’personal lives as deeply as their financial wherewithal—and onboth sides of that equation professional planning can identifyopportunities and help solve problems.

Further, each of these questions leads to additional questions.Arriving at answers is made none the easier by the blizzard ofalternatives often available, and frequently buyers and sellers findthemselves in disagreement about deal terms, legalities, andtax-related matters. The job of the professional teams—theseller’s and the buyer’s—is to satisfy their respective clients,resolve as many issues as possible before the consummation ofthe deal, and monitor the transaction as it moves forward. Andthere are never one-size-fits-all answers. One seller may justifiablybe anxious to consummate the deal before taxes go up in 2011;another may be willing to pay the higher levy if he expects hisearnings to increase significantly in the near future, raising thevalue of the offers he’ll receive. The question is whether the riskof waiting will pay off. We’ll have more to say about this later.

What about the environment? Is this a good time to sell? Evidenceof an economic recovery is mounting, but financing is still tight,and there are no assurances about what the future will bring. Inaddition, the profit dynamics of every industry—and, moreimportant, for every company—are different. That last criterion isthe one that truly counts for a business seller: It’s his company andhis livelihood that are at issue. The job of his professional team isto keep him from falling into one of two traps: rushing headlonginto selling now because the “landscape” looks good, or refusingto budge because it was better several years ago and good timesmay be around the corner again.

Still, owners need a touchstone for deciding whether to sell,and one metric might be if the proceeds—whether all up frontor parceled out over time—are at least enough to provide forthe owner’s lifetime spending needs (his so-called core-capitalSM

requirements). Ideally, he’d take home even more than that andgenerate “excess capital” (see “Will You Get Enough? CoreCapital vs. Excess,” facing page).

Non-Sellers’ RemorseDuring the boom years of the mid-2000s, many business ownerswere offered and refused term sheets, hoping to do better—onlyto regret that decision when the bear market ensued. ConsiderJohn and Jane Commander (Display 3, page 4), who decided inearly 2007 that they were ready to give up their business, whichwas earning more than $7.5 million a year, and represented thevast majority of their net worth (the rest of which was investedin two IRAs totaling $1 million). They wanted to sell the businessfor $60 million, which worked out to 8× EBITDA, a high multipleeven by 2007 standards—but were offered $48 million. Theychose to pass. As we’ll see, while more money is obviously betterthan less, they didn’t need proceeds of $60 million to meet theirfinancial objectives.

Indeed, three years later new offers came in, but by now, inharder times, their earnings had declined to $6 million. They’dhave to sell at a lower multiple, yielding $27 million cash,leaving them with $23 million after taxes, including their IRAs.Should they sell this time? Could they, and meet their objectives:satisfying their core-spending needs ($500,000 a year, grown

Display 2

Typical Business-Owner Questions

EmotionalDo I want to stay involved in the business?

Do I have a plan for my life after the sale?

What effect will the sale have on my family and employees?

Do I have the risk tolerance to accept contingent deal terms?

FinancialHow much is my business worth?

What’s the best deal structure for me?

Will I get enough to meet my needs?

Is all-cash-now better than staged/contingent payments?

Professional planning is critical

1Earnings are typically defined differently in different industries and for different purposes, but in many industries, earnings calculations for sale purposes are often before interest,taxes, depreciation, and amortization (EBITDA): in other words, the cash flow generated. Throughout this paper, “earnings” and “EBITDA” are used interchangeably.

To distinguish between what you want and what you need,we’ve developed a planning framework at Bernstein thatidentifies so-called “core capital” and “excess capital”(display below, left). The core amount is what you need tomeet your spending needs, grown with inflation, for the restof your life. Because no one wants to live with the threatof running out of money, we calculate the probability ofsustaining core capital over an investor’s lifetime using ourWealth Forecasting SystemSM (see page 4) at a very highdegree of confidence: typically 90% or better.

The amount depends mostly on the investor’s age, spendingrate, and portfolio risk level. We estimate, for example(display below, right), that a 65-year-old couple with aportfolio invested 60% in stocks and 40% in bonds willneed $3.2 million of core capital for every $100,000 theyspend annually, when factoring in a range of actuarial lifeexpectancies. In general, the amount of required core capitalat higher spending rates varies by age and allocation. Forinstance, if the couple were invested 60/40 but were 15years younger, their longer time horizon would translate into

Will You Get Enough? Core Capital vs. Excessroughly $4.3 million of core capital. These are scalablenumbers: If the 50-year-old couple were also spending$400,000 a year instead of $100,000, they’d need fourtimes as much core, or $17.2 million. For more informationon core capital and spending rates see Appendices 1 and 2on page 12.

Any amount left over in an investor’s portfolio after thecore-capital requirement is satisfied is the “excess”: used forextra spending, legacy provisions, philanthropy, and, in somecases, new business ventures. The relevant issues are howmuch is in the excess pool, and how the investor intends toinvest and deploy it. Because excess capital is not a lifestylerequirement, it may be invested with more risk than aninvestor may be willing to take with his core capital—i.e.,more stocks or alternative assets.

For many business sellers, it’s key to come away with a dealthat has the highest likelihood of meeting at least theircore-capital requirements. If the sale generates excess also,so much the better. n

Projected Core-Capital Amounts by AgePer $100,000 Annual Spending ($ Mil.)*


Age 50 $7.1 $5.6 $4.8 $4.3 $4.3 $4.3

Age 65 4.3 3.7 3.3 3.2 3.2 3.2

Age 80 2.3 2.1 2.0 2.0 2.0 2.1

*The core-capital requirements here are for couples and assume an allocation ofglobally diversified stocks and diversified intermediate-term municipal bonds in theproportions noted. Spending budgets are assumed to grow with inflation, andmaintained with a 90% degree of confidence. Based on Bernstein’s estimates of therange of returns for the applicable capital markets for the periods analyzed. Data donot represent past performance and are not a promise of actual future results. SeeNotes on Wealth Forecasting System at the end of this paper. Information onlongevity and mortality-adjusted investment analysis in this study is based onmortality tables compiled in 2000. In our mortality-adjusted analyses, the life spanof an individual varies in our 10,000 trials in accordance with mortality tables.Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

Evaluating What You Need and What You Want

Capital for Next Venture

Extra Spending

PersonalReserve

Charity

Children andGrandchildren

LifestyleSpending

Core Capital Amount to ensure spending needs are met Often calculated at 90% level of confidence

Excess Capital Amount for expanded opportunities

How much do you spend? What is your age? What is your risk tolerance?

How much? To whom? How quickly? How allocated? What strategies?


with inflation), purchasing a $3 million vacation home they’dhad their eye on for decades, and establishing a substantiallegacy for their two children?

With so much money on the table, you wouldn’t think that corecapital would even be an issue, but the Commanders live anupscale lifestyle, and there are subtractions from the top. They’dwant to set aside their capital-gains tax bill in cash, for example,and the 10% of the purchase price that would go into escrow isnever entirely safe. The couple and their team justifiably wanteda specific core number from us—an estimate of how muchthey’d need to support themselves even in dreadful markets. Toanswer that question, and others related to the deal, we inputthe Commanders’ goals, assets, risk tolerance, time horizon,

and other data specific to their situation into our proprietaryWealth Forecasting System.SM The couple were fortunateenough to be able to consider three different deal structures, sowe studied all three term sheets, various asset allocations forthe proceeds, and several “what-ifs” for their business earningsover the next five years. After subjecting these data to 10,000simulated future returns in markets ranging from spectacular todismal, we generated a probability distribution of outcomes(Display 4). We projected their required core at $16.6 million,but that was a function of how they invested the deal proceeds.

Determining Allocation and Required Core CapitalLike many business owners who can no longer rely totally onearned income, the Commanders had a conservative bent whenit came to investing their sale proceeds—a portfolio weightedtoward bonds. We used our Wealth Forecasting System toevaluate the potential returns and volatility of a portfolio invested20% in globally diversified stocks and 80% in bonds (Display 5).While the model suggested that the portfolio would almost nevergenerate a peak-to-trough loss as great as 20%, that securitycame at a price: Bonds have limited growth potential. Weprojected that the couple’s age, budget, and portfolio allocationwould translate into a core-capital requirement of $18.6 million(at the 90th percentile of probability) and an expected portfoliovalue after 30 years of spending and taxes of $30.4 million. Thatdoesn’t sound at all bad—but the Commanders and their teamwondered if the couple could do even better.

The Commanders were aware that stocks tend to grow morequickly than bonds, so they wanted to see how much more

Display 3

Case Study: John and Jane Commander—Disappointment…Or Opportunity?

In 2007Business earning $7.5 Mil./yr.

Appraised at 6.5× earnings=$48 Mil.

Commanders passed on a sale

Their Questions:Will we have enough to support our core needs?Will we be able to buy a $3 million second home?Should we hold off selling again, and hope for better? How should we evaluate alternative deal terms?Will we leave a sizable estate?

In 2010 (65 years old)Earnings down to $6 Mil.


Net proceeds after taxes: $23 Mil.*

*Includes $1 million in IRAs

Display 4

Quantifying the Possibilities: The Wealth Forecasting System

Family Profile Data Scenarios Bernstein Wealth Forecasting Model Probability DistributionDistribution of 10,000 Outcomes

10,000 Simulated

Observations Based on

Bernstein’s Proprietary

Capital-Markets Research

10%

50%—Median Outcome

90%

5%—Top 5% of Outcomes

95%—Bottom 5% of Outcomes

Financial Goals

Assets

Income Requirements

Risk Tolerance

Tax Rates

Time Horizon

DealTerms

AssetAllocation

See Notes on Wealth Forecasting System at the end of this paper.Source: AllianceBernstein

wealth they might accumulate over 30 years if they invested ata higher risk level. If we pushed stocks to 60% of the portfolio,we projected the 30-year wealth figure at $48.8 million—$18.4million more than a 20/80 mix. And with the extra growth ofstocks, we’d expect the Commanders to need less corecapital—$16.2 million. But the trade-off for stock growth isvolatility. We estimated that the Commanders would face aone-in-three chance that at some point they’d lose as much as20%. This went far beyond the limits of their risk tolerance.

The optimal solution—for this particular couple—turned out tobe a bond-tilted 40/60 portfolio, which would require corecapital of $16.6 million. Our analysis convinced the Command-ers and their team that a 40/60 investment strategy could meetthat hurdle even if markets were very poor, and with a verysmall risk (6%) of ever experiencing a 20% portfolio correctionover the next 30 years. Our median 30-year wealth expectationwas $39.4 million. Altogether, this was an attractive picture forthe couple, one they could readily embrace as the centerpieceof their financial planning. The question is, would the deal netthem their core capital, and an additional $3 million to fundthe vacation home—$19.6 million in all, plus enough extra tosupport a legacy for their kids?

Take the Money and Run…or Wait Awhile?And so the Commanders would have to work through differentterm sheets with their professional team, since they were

considering three different types of transactions. It turned outthat all were variants of cash deals, but the cash would come tothem at different times and from different sources.

n One offer was straight cash up front: $27 million. After payingcapital-gains taxes at 15% on the federal level and 5% totheir state, and assuming a zero cost basis in the business,the Commanders would have $23 million (counting their $1million in IRA funds). It wasn’t the $60 million they werelooking for in 2007, but it was substantially more than theirspending plans required. They could easily satisfy their coreneeds, buy the vacation home, and have $3.4 million left overfor legacy purposes on Day 1—even in very poor marketsand before any multigenerational planning. Why couldn’tthey take the offer and walk away satisfied? The fact is, theycould—if they were willing to leave behind their disappoint-ment about not garnering $60 million. In business sales, thefinancial and the emotional issues are inextricably tied to oneanother. There’s another angle to consider about accepting alower offer than the peak the couple had hoped for: Lowervaluations for a business often coincide with lower valuationsin the capital markets—and hence higher return potential forthe liquid portfolios that house business-sale proceeds. For theCommanders this could even translate into more wealth in theout years than if they sold at the higher 2007 offer.

n Another sale alternative was a leveraged recapitalization.What if the company took on some debt in hopes of usingthe extra money to improve their operations, and hence theirearnings? They might find a prospective buyer interestedin the growing potential of the business. In the deal theinvestment bankers laid out for the Commanders, a newpartner would enter the business right away, with a 20%ownership interest in the Commanders’ shares. Under thisstructure, combining proceeds from the sale of equity and asubstantial portion of the debt assumed by the business, theCommanders would come away with $13.5 million.2 They’dalso be paid an annual salary of $400,000 for five yearsfor continuing to participate in the company’s operations.Meanwhile, the couple would be using their company’searnings to pay down the debt and work toward a profitableexit—in this representative case, five years after inception of

Display 5

Core-Capital Requirements and Volatility:Three Representative Asset Mixes*

% Stock/Bond Allocation 20/80 40/60 60/40

Core Capital Required $18.6 Mil. $16.6 Mil. $16.2 Mil.

Probability of ≥ 20%Peak-to-Trough Loss, 30 Yrs.

2% 6% 33%

Median Wealth, 30 Yrs. $30.4 Mil. $39.4 Mil. $48.8 Mil.

*Core-capital assumptions are based on lifestyle spending needs of $500,000 per year,growing with inflation, and not including the $3 million vacation home or any legacyplans. Based on Bernstein’s estimates of the range of returns for the applicable capitalmarkets over the next 30 years. Data do not represent any past performance and are nota promise of actual future results. See Notes on Wealth Forecasting System at the end ofthis paper.Source: AllianceBernstein

2The debt on the balance sheet is a double-edged sword. On the one hand, it would presumably be used to improve the business; on the other, much of the earnings would have to beused to pay down the debt—which is why recaps tend to be so contingent on earnings. However, the Commanders would not be liable for any of the debt personally, which is anobligation of the business.

5

with inflation), purchasing a $3 million vacation home they’dhad their eye on for decades, and establishing a substantiallegacy for their two children?

With so much money on the table, you wouldn’t think that corecapital would even be an issue, but the Commanders live anupscale lifestyle, and there are subtractions from the top. They’dwant to set aside their capital-gains tax bill in cash, for example,and the 10% of the purchase price that would go into escrow isnever entirely safe. The couple and their team justifiably wanteda specific core number from us—an estimate of how muchthey’d need to support themselves even in dreadful markets. Toanswer that question, and others related to the deal, we inputthe Commanders’ goals, assets, risk tolerance, time horizon,

and other data specific to their situation into our proprietaryWealth Forecasting System.SM The couple were fortunateenough to be able to consider three different deal structures, sowe studied all three term sheets, various asset allocations forthe proceeds, and several “what-ifs” for their business earningsover the next five years. After subjecting these data to 10,000simulated future returns in markets ranging from spectacular todismal, we generated a probability distribution of outcomes(Display 4). We projected their required core at $16.6 million,but that was a function of how they invested the deal proceeds.

Determining Allocation and Required Core CapitalLike many business owners who can no longer rely totally onearned income, the Commanders had a conservative bent whenit came to investing their sale proceeds—a portfolio weightedtoward bonds. We used our Wealth Forecasting System toevaluate the potential returns and volatility of a portfolio invested20% in globally diversified stocks and 80% in bonds (Display 5).While the model suggested that the portfolio would almost nevergenerate a peak-to-trough loss as great as 20%, that securitycame at a price: Bonds have limited growth potential. Weprojected that the couple’s age, budget, and portfolio allocationwould translate into a core-capital requirement of $18.6 million(at the 90th percentile of probability) and an expected portfoliovalue after 30 years of spending and taxes of $30.4 million. Thatdoesn’t sound at all bad—but the Commanders and their teamwondered if the couple could do even better.

The Commanders were aware that stocks tend to grow morequickly than bonds, so they wanted to see how much more

Display 3

Case Study: John and Jane Commander—Disappointment…Or Opportunity?

In 2007Business earning $7.5 Mil./yr.


Commanders passed on a sale

Their Questions:Will we have enough to support our core needs?Will we be able to buy a $3 million second home?Should we hold off selling again, and hope for better? How should we evaluate alternative deal terms?Will we leave a sizable estate?

In 2010 (65 years old)Earnings down to $6 Mil.


Net proceeds after taxes: $23 Mil.*

*Includes $1 million in IRAs

Display 4

Quantifying the Possibilities: The Wealth Forecasting System

Family Profile Data Scenarios Bernstein Wealth Forecasting Model Probability DistributionDistribution of 10,000 Outcomes

10,000 Simulated

Observations Based on

Bernstein’s Proprietary

Capital-Markets Research

10%

50%—Median Outcome

90%

5%—Top 5% of Outcomes

95%—Bottom 5% of Outcomes

Financial Goals

Assets

Income Requirements

Risk Tolerance

Tax Rates

Time Horizon

DealTerms

AssetAllocation

See Notes on Wealth Forecasting System at the end of this paper.Source: AllianceBernstein

wealth they might accumulate over 30 years if they invested ata higher risk level. If we pushed stocks to 60% of the portfolio,we projected the 30-year wealth figure at $48.8 million—$18.4million more than a 20/80 mix. And with the extra growth ofstocks, we’d expect the Commanders to need less corecapital—$16.2 million. But the trade-off for stock growth isvolatility. We estimated that the Commanders would face aone-in-three chance that at some point they’d lose as much as20%. This went far beyond the limits of their risk tolerance.

The optimal solution—for this particular couple—turned out tobe a bond-tilted 40/60 portfolio, which would require corecapital of $16.6 million. Our analysis convinced the Command-ers and their team that a 40/60 investment strategy could meetthat hurdle even if markets were very poor, and with a verysmall risk (6%) of ever experiencing a 20% portfolio correctionover the next 30 years. Our median 30-year wealth expectationwas $39.4 million. Altogether, this was an attractive picture forthe couple, one they could readily embrace as the centerpieceof their financial planning. The question is, would the deal netthem their core capital, and an additional $3 million to fundthe vacation home—$19.6 million in all, plus enough extra tosupport a legacy for their kids?

Take the Money and Run…or Wait Awhile?And so the Commanders would have to work through differentterm sheets with their professional team, since they were

considering three different types of transactions. It turned outthat all were variants of cash deals, but the cash would come tothem at different times and from different sources.

n One offer was straight cash up front: $27 million. After payingcapital-gains taxes at 15% on the federal level and 5% totheir state, and assuming a zero cost basis in the business,the Commanders would have $23 million (counting their $1million in IRA funds). It wasn’t the $60 million they werelooking for in 2007, but it was substantially more than theirspending plans required. They could easily satisfy their coreneeds, buy the vacation home, and have $3.4 million left overfor legacy purposes on Day 1—even in very poor marketsand before any multigenerational planning. Why couldn’tthey take the offer and walk away satisfied? The fact is, theycould—if they were willing to leave behind their disappoint-ment about not garnering $60 million. In business sales, thefinancial and the emotional issues are inextricably tied to oneanother. There’s another angle to consider about accepting alower offer than the peak the couple had hoped for: Lowervaluations for a business often coincide with lower valuationsin the capital markets—and hence higher return potential forthe liquid portfolios that house business-sale proceeds. For theCommanders this could even translate into more wealth in theout years than if they sold at the higher 2007 offer.

n Another sale alternative was a leveraged recapitalization.What if the company took on some debt in hopes of usingthe extra money to improve their operations, and hence theirearnings? They might find a prospective buyer interestedin the growing potential of the business. In the deal theinvestment bankers laid out for the Commanders, a newpartner would enter the business right away, with a 20%ownership interest in the Commanders’ shares. Under thisstructure, combining proceeds from the sale of equity and asubstantial portion of the debt assumed by the business, theCommanders would come away with $13.5 million.2 They’dalso be paid an annual salary of $400,000 for five yearsfor continuing to participate in the company’s operations.Meanwhile, the couple would be using their company’searnings to pay down the debt and work toward a profitableexit—in this representative case, five years after inception of

Display 5

Core-Capital Requirements and Volatility:Three Representative Asset Mixes*

% Stock/Bond Allocation 20/80 40/60 60/40

Core Capital Required $18.6 Mil. $16.6 Mil. $16.2 Mil.

Probability of ≥ 20%Peak-to-Trough Loss, 30 Yrs.

2% 6% 33%

Median Wealth, 30 Yrs. $30.4 Mil. $39.4 Mil. $48.8 Mil.

*Core-capital assumptions are based on lifestyle spending needs of $500,000 per year,growing with inflation, and not including the $3 million vacation home or any legacyplans. Based on Bernstein’s estimates of the range of returns for the applicable capitalmarkets over the next 30 years. Data do not represent any past performance and are nota promise of actual future results. See Notes on Wealth Forecasting System at the end ofthis paper.Source: AllianceBernstein

2The debt on the balance sheet is a double-edged sword. On the one hand, it would presumably be used to improve the business; on the other, much of the earnings would have to beused to pay down the debt—which is why recaps tend to be so contingent on earnings. However, the Commanders would not be liable for any of the debt personally, which is anobligation of the business.


the recap.3 True, the up-front cash would fall short ofsatisfying their spending needs—but the couple wouldn’tconsider a leveraged recap in the first place unless they wereconfident about their company’s five-year earnings prospects.In a worst (and unlikely) case, if earnings plummeted enough,a deal would probably be worked out through negotiationsbetween the would-be buyer and seller, albeit probably at aprice that both sides would see as a compromise.

n Finally, the Commanders received a so-called “earn-out” offer:also cash with a five-year contingency, but not as dependent asa recapitalization on an earnings upswing. In this transaction,the Commanders would give up their entire interest in thebusiness in exchange for a share of the earnings: as muchas $2.4 million annually over a five-year period. If post-saleearnings were to fall short of agreed-upon targets, theearn-out payments would be reduced proportionately. If theCommanders agreed to the terms, the couple would beoffered $19 million on Day 1, plus $400,000 a year in consult-ing fees for five years—not quite enough to meet their coreneeds and the cost of the vacation home at the critical 90%level of confidence, though close. But unlike all-cash up front,the final value of the earn-out would be dependent on howthe business performed over the near term—and like a recap,the Commanders would have to be interested in stayinginvolved in business operations.

Working Through the Trade-OffsOf course, there’s no “right” alternative for every businessowner. Some owners feel both emotionally and financiallysecure staying tied to their business for a longer period. Otherowners are eager to take the cash immediately, if they can getit, and go on to the next phase of their lives (which may not beretirement but another business venture). Similarly, there wasno perfect alternative for the Commanders. It depended on thetrade-offs they were most comfortable with—which is wherewe and their other professional advisors came in. We knew,though, that working together, we’d enable the Commandersto identify the strategy best tailored to meet their goals.Display 6 lays out the issues in schematic form.

But why all these complications? As we said, the Commanderscould take the all-cash $27 million up front and avoid theuncertainties, a strategy that many business owners embrace.Along those lines, we compare the up-front cash portion of eachoffer in Display 7. The all-cash-now deal was the only one thatvirtually ensured the couple would meet their needs in anyplausible scenario; in the other two cases, a significant portion ofthe transaction involved contingent payouts. (With the recap, weestimated the chance of the up-front cash meeting the Com-manders’ core needs at only 29%.) Deferring completion to a laterdate would mean exposure to a whole host of issues outside thescope of this paper, including future market conditions and buyerinsolvency. Extreme cases, as we re-learned in 2008, do occur.

Display 6

Three Representative Commander Sale Alternatives

All Cash Now Leveraged Recap Earn-Out

$13.5 MillionUp Front

Salary:$400K/Year

80% RetainedEquity

$19 MillionUp Front

Consulting Fee:$400K/Year

Up to $12 Mil.in Earn-Outsover 5 Years

Exit from Business Expected After Five Years Transaction Complete

$27 Million Up Front

3The ultimate buyer could be the 20% owner, but the final transaction is more commonly an outright sale of 100% of the business interests to a third party.

“The Icing on the Cake”?But the case isn’t closed. Often, business owners regard thecontingency payouts as merely icing on the cake. But with ourWealth Forecasting System, we can help sellers systematicallyevaluate the sensitivity of different offers to varying earningsscenarios. The more the business earns over the contingencyperiod, the more the sellers will benefit—and the odds aregenerally in their favor. Display 8 adds the potential future proceedsfrom the final sale of the Commander business in the recap caseand from continuing distributions in the earn-out scenario, as wellas the salary and consulting fee, respectively. For the immediate-cash alternative, of course, there are no contingencies.

Using this scenario analysis, we were able to help themstress-test different earnings outcomes versus the security ofimmediate cash. The leveraged recap and the earn-out bothoffered the opportunity for more upside—and the potentialfor greater downside as well. But because of its reliance onleverage, the recap was far more sensitive to earnings changes

on both sides. So, for example, we estimated that just 5%earnings growth would be enough to deliver a median resultof almost $100 million—and an upside above $175 million.4

A 10% earnings decline, on the other hand, would leavethe Commanders with about $8 million of excess capital indownside markets—not a dismal outcome by any means, butthe Commanders wouldn’t want to test a recap much beyond a10% earnings falloff. As we’ve said, they wouldn’t want to takethe risk of a recap unless they were quite sanguine about thefuture of their business.

An earn-out is also sensitive to profits, as its name implies—butless so. The earn-out considered by the Commanders would

Display 8

Adding In Future Earnings:Cash vs. Leveraged Recap vs. Earn-Out

Commander Nominal Wealth Values, Year 30After Taxes, Spending, and $3 Million Home Purchase

40% Stocks/60% Bonds*

0

×

5%Decline

20%Decline

5%Growth

10%Decline

Earnings: Leveraged Recap

Earnings:Earn-Out

ImmediateCash

5%10%

50%

90%95%

Levelof

Confidence

85.2

39.413.2

66.4

30.48.2

178.0

94.8

50.0

104.8

51.4

22.0

78.4

36.011.4

>98%96%>98%95%97%Probability of Meeting Spending Needs

$ M

illio

ns

*See second footnote to Display 7. Leveraged recapitalization examples assume fiveyears of annual pretax salary income at $400,000, annual rates of growth or declinein EBITDA as noted, and pretax sale proceeds at Year 5 of $12,484,000 and$34,030,000, respectively. Earn-out examples assume five years of annual pretaxconsulting income at $400,000 and annual rates of decline in pretax payments relatedto the earn-out schedule. All sale proceeds are assumed to be taxed at the capital-gainsrates in effect upon distribution. See Notes on Wealth Forecasting System at the end ofthis paper.Source: AllianceBernstein

Display 7

Up-Front Cash:* All-Cash vs. Leveraged Recap and Earn-Out


40% Stocks/60% Bonds†

85.2

39.4

13.2 9.80.0

41.8

14.20.0

82%29%97%

$ M

illio

ns

Levelof

Confidence

0.0

Probability of Meeting Spending Needs

5%10%

50%

90%95%

Immediate Cash Leveraged Recap Earn-Out

Levelof

Confidence

0

*Cash includes $1 million total in John and Jane’s IRAs.†Basis in business assumed to be zero. Spending assumed to grow with inflation eachyear. Based on Bernstein’s estimates of the range of returns for the applicable capitalmarkets over the next 30 years. Data do not represent any past performance and are nota promise of actual future results. See Notes on Wealth Forecasting System at the end ofthis paper.Source: AllianceBernstein

4Assuming that the business was now valued at 5× EBITDA rather than 4.5, reflecting the improved earnings

7

the recap.3 True, the up-front cash would fall short ofsatisfying their spending needs—but the couple wouldn’tconsider a leveraged recap in the first place unless they wereconfident about their company’s five-year earnings prospects.In a worst (and unlikely) case, if earnings plummeted enough,a deal would probably be worked out through negotiationsbetween the would-be buyer and seller, albeit probably at aprice that both sides would see as a compromise.

n Finally, the Commanders received a so-called “earn-out” offer:also cash with a five-year contingency, but not as dependent asa recapitalization on an earnings upswing. In this transaction,the Commanders would give up their entire interest in thebusiness in exchange for a share of the earnings: as muchas $2.4 million annually over a five-year period. If post-saleearnings were to fall short of agreed-upon targets, theearn-out payments would be reduced proportionately. If theCommanders agreed to the terms, the couple would beoffered $19 million on Day 1, plus $400,000 a year in consult-ing fees for five years—not quite enough to meet their coreneeds and the cost of the vacation home at the critical 90%level of confidence, though close. But unlike all-cash up front,the final value of the earn-out would be dependent on howthe business performed over the near term—and like a recap,the Commanders would have to be interested in stayinginvolved in business operations.

Working Through the Trade-OffsOf course, there’s no “right” alternative for every businessowner. Some owners feel both emotionally and financiallysecure staying tied to their business for a longer period. Otherowners are eager to take the cash immediately, if they can getit, and go on to the next phase of their lives (which may not beretirement but another business venture). Similarly, there wasno perfect alternative for the Commanders. It depended on thetrade-offs they were most comfortable with—which is wherewe and their other professional advisors came in. We knew,though, that working together, we’d enable the Commandersto identify the strategy best tailored to meet their goals.Display 6 lays out the issues in schematic form.

But why all these complications? As we said, the Commanderscould take the all-cash $27 million up front and avoid theuncertainties, a strategy that many business owners embrace.Along those lines, we compare the up-front cash portion of eachoffer in Display 7. The all-cash-now deal was the only one thatvirtually ensured the couple would meet their needs in anyplausible scenario; in the other two cases, a significant portion ofthe transaction involved contingent payouts. (With the recap, weestimated the chance of the up-front cash meeting the Com-manders’ core needs at only 29%.) Deferring completion to a laterdate would mean exposure to a whole host of issues outside thescope of this paper, including future market conditions and buyerinsolvency. Extreme cases, as we re-learned in 2008, do occur.

Display 6

Three Representative Commander Sale Alternatives

All Cash Now Leveraged Recap Earn-Out

$13.5 MillionUp Front

Salary:$400K/Year

80% RetainedEquity

$19 MillionUp Front

Consulting Fee:$400K/Year

Up to $12 Mil.in Earn-Outsover 5 Years

Exit from Business Expected After Five Years Transaction Complete

$27 Million Up Front

3The ultimate buyer could be the 20% owner, but the final transaction is more commonly an outright sale of 100% of the business interests to a third party.

“The Icing on the Cake”?But the case isn’t closed. Often, business owners regard thecontingency payouts as merely icing on the cake. But with ourWealth Forecasting System, we can help sellers systematicallyevaluate the sensitivity of different offers to varying earningsscenarios. The more the business earns over the contingencyperiod, the more the sellers will benefit—and the odds aregenerally in their favor. Display 8 adds the potential future proceedsfrom the final sale of the Commander business in the recap caseand from continuing distributions in the earn-out scenario, as wellas the salary and consulting fee, respectively. For the immediate-cash alternative, of course, there are no contingencies.

Using this scenario analysis, we were able to help themstress-test different earnings outcomes versus the security ofimmediate cash. The leveraged recap and the earn-out bothoffered the opportunity for more upside—and the potentialfor greater downside as well. But because of its reliance onleverage, the recap was far more sensitive to earnings changes

on both sides. So, for example, we estimated that just 5%earnings growth would be enough to deliver a median resultof almost $100 million—and an upside above $175 million.4

A 10% earnings decline, on the other hand, would leavethe Commanders with about $8 million of excess capital indownside markets—not a dismal outcome by any means, butthe Commanders wouldn’t want to test a recap much beyond a10% earnings falloff. As we’ve said, they wouldn’t want to takethe risk of a recap unless they were quite sanguine about thefuture of their business.

An earn-out is also sensitive to profits, as its name implies—butless so. The earn-out considered by the Commanders would

Display 8

Adding In Future Earnings:Cash vs. Leveraged Recap vs. Earn-Out


40% Stocks/60% Bonds*

0

×

5%Decline

20%Decline

5%Growth

10%Decline

Earnings: Leveraged Recap

Earnings:Earn-Out

ImmediateCash

5%10%

50%

90%95%

Levelof

Confidence

85.2

39.413.2

66.4

30.48.2

178.0

94.8

50.0

104.8

51.4

22.0

78.4

36.011.4

>98%96%>98%95%97%Probability of Meeting Spending Needs

$ M

illio

ns

*See second footnote to Display 7. Leveraged recapitalization examples assume fiveyears of annual pretax salary income at $400,000, annual rates of growth or declinein EBITDA as noted, and pretax sale proceeds at Year 5 of $12,484,000 and$34,030,000, respectively. Earn-out examples assume five years of annual pretaxconsulting income at $400,000 and annual rates of decline in pretax payments relatedto the earn-out schedule. All sale proceeds are assumed to be taxed at the capital-gainsrates in effect upon distribution. See Notes on Wealth Forecasting System at the end ofthis paper.Source: AllianceBernstein

Display 7

Up-Front Cash:* All-Cash vs. Leveraged Recap and Earn-Out


40% Stocks/60% Bonds†

85.2

39.4

13.2 9.80.0

41.8

14.20.0

82%29%97%

$ M

illio

ns

Levelof

Confidence

0.0

Probability of Meeting Spending Needs

5%10%

50%

90%95%

Immediate Cash Leveraged Recap Earn-Out

Levelof

Confidence

0

*Cash includes $1 million total in John and Jane’s IRAs.†Basis in business assumed to be zero. Spending assumed to grow with inflation eachyear. Based on Bernstein’s estimates of the range of returns for the applicable capitalmarkets over the next 30 years. Data do not represent any past performance and are nota promise of actual future results. See Notes on Wealth Forecasting System at the end ofthis paper.Source: AllianceBernstein

4Assuming that the business was now valued at 5× EBITDA rather than 4.5, reflecting the improved earnings


Taxes Slated to Increase

Top Marginal Tax Rates

15

15

35

35

%Capital Gains

Dividends

Taxable Interest

Earned Income

2010

20.0

39.6

39.6

39.6

%

2011

23.8

43.4

43.4

40.5

%

‡

2013†

59

189

24

16

%

% Change(2013/Current)

†Based on recent healthcare legislation; assumes joint filers with annual incomeabove $250K or single filer with income above $200K.‡Increase in Medicare tax of 0.9%; currently, Medicare tax is 1.45%, so the newMedicare tax would total 2.35%. Including ordinary income tax and Medicaretax, the effective tax rate in 2010 is 35% + 1.45% = 36.45%; in 2013, thetop rate would be 39.6% + 2.35% = 41.95%, and the change would thereforebe 15%. Figures exclude Social Security tax and state income tax.Source: AllianceBernstein

*For a detailed study of the investment implications of the coming shift in the Tax Code, see our April 2010 white paper, Investment Opportunity amid Tax Uncertainty?**Aside from the analysis in this box, we have not accounted for the Medicare surtaxes in this paper. Further, in all analyses, we assume a 5% state capital-gains tax, and weassume ordinary-income tax on dividends starting in 2011. In the 20%, 23.8%, and 28% scenarios for capital-gains tax, we assume that the tax rate is in effect the year thesale is consummated and remains constant thereafter.

The Impact of Taxes: Growth in Assets

Commander Business Sold for $27 MillionNominal Wealth Values, Year 30

After Taxes, Spending, and $3 Million Home Purchase40% Stocks/60% Bonds§

85.2

39.4

13.2

74.8

33.2

51.6

21.4

0.6

63.8

27.6

4.9

Federal Capital-Gains Tax Rate

$ M

illio

ns

8.800

105

15% 20% 28%23.8%

5%10%

50%

90%95%

Levelof

Confidence

§Basis in business assumed to be zero. Spending assumed to grow with inflation eachyear. In 15% tax case, federal capital-gains tax on the transaction and the liquidportfolio is 15% in Year 1 and 20% thereafter, consistent with current tax law. In the20%, 23.8%, and 28% tax cases, federal capital-gains tax on the transaction and theliquid portfolio is at those rates in Year 1 and in each year thereafter. Based onBernstein’s estimates of the range of returns for the applicable capital markets over thenext 30 years. Data do not represent any past performance and are not a promise ofactual future results. See Notes on Wealth Forecasting System at the end of this paper.Source: AllianceBernstein

The Tax Code has already built in large increases in an arrayof taxes for 2011, with an incremental hike in 2013 tosupport healthcare reform (display below). The maximumfederal capital-gains rate—the key tax for business sellers—isscheduled to climb from 15% today to 20% in 2011 and to23.8% two years later. Altogether, the levy is scheduled toincrease by more than half over the three-year period.*

So suppose the Commanders waited a year or more to allowtheir business to grow. And what if it didn’t? The display tothe right illustrates the 30-year wealth consequences forfour different capital-gains rates: 1) 15% in Year 1 and 20%thereafter; 2) 20% each year; 3) 23.8% each year, reflectingthe surcharge for high-bracket taxpayers to help defray thecost of healthcare reform; and 4) 28% each year; to ourknowledge, no proposal for a 28% gains tax is on the table,but we’ve seen that rate historically.**

Two conclusions emerge from the display. First, taxes have asignificant impact on wealth accumulation—no surprise there.For a business sold at $27 million with liquid proceeds investedin a 40/60 construction, the difference in median wealthbetween a 15% gains tax in the first year and a 20% levy wouldamount to $6.2 million after three decades: a 16% gap. Still, ineach of these tax scenarios, the Commanders would meet theirspending needs at the 90th percentile of probability—albeit withlittle to spare if gains taxes were as high as 28%.

How Much Taxes Countallow for an earnings decline as large as 20% and still becomparable to the all-cash offer while retaining some upsidein good markets. All the alternatives—cash, recap, and earn-out—were viable options that might be appropriate dependingon the Commanders’ priorities and risk tolerance. They mightnot have gotten what they wanted (i.e., $60 million), but theywould find that they got what they needed.

Setting the Table for the FamilyAs we’ve said, the Commanders wished to transfer some ofthe excess capital from their proceeds to family beneficiaries.Addressed early enough, planning before the sale can beespecially important. One effective means of transferring wealthis to gift shares. For gift-tax purposes, the value of the transferwill be based on a current or recent appraisal—generally lowerthan the value assigned at sale because pre-sale shares areilliquid and essentially unmarketable. In addition, if the giftrepresents a minority interest in a private company, for gift-taxpurposes the value could be further discounted because thebeneficiaries have no control over the illiquid shares. If thebusiness is indeed sold for significantly more than the valuationat appraisal, the beneficiaries would end up with more than theappraised value of the gifts.

For example, if the owner uses his $1 million lifetime applicablegift-tax exclusion amount to transfer shares of his companythat ultimately benefit from a 30% discount at the time of sale,he’s actually transferring $1.4 million. However, to takeadvantage of a discount, there needs to be a sufficient timeinterval between the gift and the sale agreement.5

Adding the Power of GRATsA grantor-retained annuity trust, or GRAT, can leverage giftingsubstantially. Here’s how it works: The owner contributes sharesof his business to the trust and receives annuity payments backthat equal his gift plus an amount of interest determined by theIRS Section 7520 rate. If the assets in the GRAT appreciate at arate faster than the 7520 hurdle, the GRAT “succeeds” and allextra appreciation passes to the beneficiaries free of transfertax. At today’s low interest rates, the GRAT bogey is especiallylow. (As of June 2010, the Section 7520 rate was 3.2%.)Further, donors pay the income and capital-gains taxes from

5Consult a valuation specialist to determine the appropriate discount in your situation.

Comparisons based on taxes are revealing. To realize thesame after-tax proceeds on a $27 million sale in 2010, abusiness would need to sell for $28.9 million in 2011 and$30 million two years later. If earnings are used as the metric,EBITDA would have to increase by a cumulative 11.7% foran owner selling in 2013 to break even after taxes versusconsummating the deal for $27 million pretax in 2010(display below). Even if he waited only until 2011 to sell, hisearnings would have to jump substantially. Alternatively,earnings multiples would need to accelerate by the sameamounts, or a combination of earnings and multiples wouldhave to achieve that rate of growth. It’s no revelation forbusiness owners or their professional teams, but tax planningcan make millions of dollars of difference.

And so, all else equal, an owner would be well-advised tosell in 2010 rather than later. But in fact, “all else” is rarelyequal, and each sale needs to be evaluated in its ownright—including the prevailing tax rate, among manycriteria. We would emphasize, though, that selling abusiness and investing the proceeds in a liquid portfolio is arisk-reducing diversification strategy, decreasing dependenceon one source of wealth. In that light, selling earlier ratherthan later tends to make more sense, especially when taxesare scheduled to rise imminently. n

Commander Earnings Required to Sell for$27 Million Pretax¶

$6.7 Mil.2013

$6.4 Mil.2011

$6.0 Mil.2010

¶Assuming capital-gains tax rates of 15% in 2010, 20% in 2011, and 23.8%in 2013Source: AllianceBernstein

9

Taxes Slated to Increase

Top Marginal Tax Rates

15

15

35

35

%Capital Gains

Dividends

Taxable Interest

Earned Income

2010

20.0

39.6

39.6

39.6

%

2011

23.8

43.4

43.4

40.5

%

‡

2013†

59

189

24

16

%

% Change(2013/Current)

†Based on recent healthcare legislation; assumes joint filers with annual incomeabove $250K or single filer with income above $200K.‡Increase in Medicare tax of 0.9%; currently, Medicare tax is 1.45%, so the newMedicare tax would total 2.35%. Including ordinary income tax and Medicaretax, the effective tax rate in 2010 is 35% + 1.45% = 36.45%; in 2013, thetop rate would be 39.6% + 2.35% = 41.95%, and the change would thereforebe 15%. Figures exclude Social Security tax and state income tax.Source: AllianceBernstein

*For a detailed study of the investment implications of the coming shift in the Tax Code, see our April 2010 white paper, Investment Opportunity amid Tax Uncertainty?**Aside from the analysis in this box, we have not accounted for the Medicare surtaxes in this paper. Further, in all analyses, we assume a 5% state capital-gains tax, and weassume ordinary-income tax on dividends starting in 2011. In the 20%, 23.8%, and 28% scenarios for capital-gains tax, we assume that the tax rate is in effect the year thesale is consummated and remains constant thereafter.

The Impact of Taxes: Growth in Assets

Commander Business Sold for $27 MillionNominal Wealth Values, Year 30

After Taxes, Spending, and $3 Million Home Purchase40% Stocks/60% Bonds§

85.2

39.4

13.2

74.8

33.2

51.6

21.4

0.6

63.8

27.6

4.9

Federal Capital-Gains Tax Rate

$ M

illio

ns

8.800

105

15% 20% 28%23.8%

5%10%

50%

90%95%

Levelof

Confidence

§Basis in business assumed to be zero. Spending assumed to grow with inflation eachyear. In 15% tax case, federal capital-gains tax on the transaction and the liquidportfolio is 15% in Year 1 and 20% thereafter, consistent with current tax law. In the20%, 23.8%, and 28% tax cases, federal capital-gains tax on the transaction and theliquid portfolio is at those rates in Year 1 and in each year thereafter. Based onBernstein’s estimates of the range of returns for the applicable capital markets over thenext 30 years. Data do not represent any past performance and are not a promise ofactual future results. See Notes on Wealth Forecasting System at the end of this paper.Source: AllianceBernstein

The Tax Code has already built in large increases in an arrayof taxes for 2011, with an incremental hike in 2013 tosupport healthcare reform (display below). The maximumfederal capital-gains rate—the key tax for business sellers—isscheduled to climb from 15% today to 20% in 2011 and to23.8% two years later. Altogether, the levy is scheduled toincrease by more than half over the three-year period.*

So suppose the Commanders waited a year or more to allowtheir business to grow. And what if it didn’t? The display tothe right illustrates the 30-year wealth consequences forfour different capital-gains rates: 1) 15% in Year 1 and 20%thereafter; 2) 20% each year; 3) 23.8% each year, reflectingthe surcharge for high-bracket taxpayers to help defray thecost of healthcare reform; and 4) 28% each year; to ourknowledge, no proposal for a 28% gains tax is on the table,but we’ve seen that rate historically.**

Two conclusions emerge from the display. First, taxes have asignificant impact on wealth accumulation—no surprise there.For a business sold at $27 million with liquid proceeds investedin a 40/60 construction, the difference in median wealthbetween a 15% gains tax in the first year and a 20% levy wouldamount to $6.2 million after three decades: a 16% gap. Still, ineach of these tax scenarios, the Commanders would meet theirspending needs at the 90th percentile of probability—albeit withlittle to spare if gains taxes were as high as 28%.

How Much Taxes Countallow for an earnings decline as large as 20% and still becomparable to the all-cash offer while retaining some upsidein good markets. All the alternatives—cash, recap, and earn-out—were viable options that might be appropriate dependingon the Commanders’ priorities and risk tolerance. They mightnot have gotten what they wanted (i.e., $60 million), but theywould find that they got what they needed.

Setting the Table for the FamilyAs we’ve said, the Commanders wished to transfer some ofthe excess capital from their proceeds to family beneficiaries.Addressed early enough, planning before the sale can beespecially important. One effective means of transferring wealthis to gift shares. For gift-tax purposes, the value of the transferwill be based on a current or recent appraisal—generally lowerthan the value assigned at sale because pre-sale shares areilliquid and essentially unmarketable. In addition, if the giftrepresents a minority interest in a private company, for gift-taxpurposes the value could be further discounted because thebeneficiaries have no control over the illiquid shares. If thebusiness is indeed sold for significantly more than the valuationat appraisal, the beneficiaries would end up with more than theappraised value of the gifts.

For example, if the owner uses his $1 million lifetime applicablegift-tax exclusion amount to transfer shares of his companythat ultimately benefit from a 30% discount at the time of sale,he’s actually transferring $1.4 million. However, to takeadvantage of a discount, there needs to be a sufficient timeinterval between the gift and the sale agreement.5

Adding the Power of GRATsA grantor-retained annuity trust, or GRAT, can leverage giftingsubstantially. Here’s how it works: The owner contributes sharesof his business to the trust and receives annuity payments backthat equal his gift plus an amount of interest determined by theIRS Section 7520 rate. If the assets in the GRAT appreciate at arate faster than the 7520 hurdle, the GRAT “succeeds” and allextra appreciation passes to the beneficiaries free of transfertax. At today’s low interest rates, the GRAT bogey is especiallylow. (As of June 2010, the Section 7520 rate was 3.2%.)Further, donors pay the income and capital-gains taxes from

5Consult a valuation specialist to determine the appropriate discount in your situation.

Comparisons based on taxes are revealing. To realize thesame after-tax proceeds on a $27 million sale in 2010, abusiness would need to sell for $28.9 million in 2011 and$30 million two years later. If earnings are used as the metric,EBITDA would have to increase by a cumulative 11.7% foran owner selling in 2013 to break even after taxes versusconsummating the deal for $27 million pretax in 2010(display below). Even if he waited only until 2011 to sell, hisearnings would have to jump substantially. Alternatively,earnings multiples would need to accelerate by the sameamounts, or a combination of earnings and multiples wouldhave to achieve that rate of growth. It’s no revelation forbusiness owners or their professional teams, but tax planningcan make millions of dollars of difference.

And so, all else equal, an owner would be well-advised tosell in 2010 rather than later. But in fact, “all else” is rarelyequal, and each sale needs to be evaluated in its ownright—including the prevailing tax rate, among manycriteria. We would emphasize, though, that selling abusiness and investing the proceeds in a liquid portfolio is arisk-reducing diversification strategy, decreasing dependenceon one source of wealth. In that light, selling earlier ratherthan later tends to make more sense, especially when taxesare scheduled to rise imminently. n

Commander Earnings Required to Sell for$27 Million Pretax¶

$6.7 Mil.2013

$6.4 Mil.2011

$6.0 Mil.2010

¶Assuming capital-gains tax rates of 15% in 2010, 20% in 2011, and 23.8%in 2013Source: AllianceBernstein


outside the GRAT, enhancing the amount transferred. Becausethe statute of limitations on the valuation of the shares is threeyears (during which time GRAT distributions can be adjustedif the IRS disputes a claimed value), professional teams oftenrecommend a three-year GRAT when contributing assets whosevalue is questionable.6

Contributing discounted shares of a business, depicted inDisplay 9, increases the potential benefit if the company is soldwithin the three-year period.7 The realization of the full valueof the discount helps the assets in the GRAT appreciate rapidly,making it very likely to outperform the 7520 rate. In this case,we presume that a three-year $6 million GRAT invests its

proceeds from the business sale in bonds for the safety oflocking in returns. Once the trust expires after three years,the proceeds intended for the children are invested for thenext 27 years in an 80% stock/20% bond portfolio—suitablystock-heavy if you assume that the beneficiaries have a longtime horizon. The display makes clear how the advantage ofdiscounting builds. If the $6 million of shares in the GRAT weresubject to a 30% discount, we’d expect the median value of the80/20 portfolio to be $15.6 million after taxes and fully $7.8million in very poor markets. Had the shares been discounted by40%, we’d project a $24.2 million median and a $12.0 milliondownside case. Discounting can be a powerful tool when put touse in a GRAT.

Quantifying the Advantages of PlanningAssembling a legacy plan yields notable benefits. Returning tothe Commander case study, let’s assume the couple sold thebusiness for $27 million in cash and did no planning prior to orafter that point. Recall that on Day 1, they’d have $3.4 millionto set aside for legacy. In the absence of any estate-planningtechniques, we’d project that even in dismal markets the legacywould grow to $13.2 million—the amount left over at the 90thpercentile of probability before any estate taxes (refer backto Display 8, page 7). But in the median case (Display 10,left side) we projected that—again, making use of no planningtools—they’d leave a hefty amount to their heirs at the end of30 years: $18.8 million after estate taxes. But they’d cede evenmore to the government.

Suppose, though, that the couple’s legacy strategy was, pre-sale,to fund a three-year GRAT with $6 million in company shares,30% discounted (Display 10, right side). Assume the Command-ers invested the proceeds in a liquid portfolio over the 27 yearsfollowing the GRAT’s term. Our models suggest that their heirscould expect the GRAT combined with the rest of the Com-manders’ assets after estate taxes to produce $11 million in

6As of this writing, Congress is considering GRATs and may require that all such trusts have terms no shorter than 10 years. In that event, a business owner may opt for a 10-yearGRAT or use another strategy. The most likely candidate is an installment sale to an Intentionally Defective Grantor Trust (IDGT). With this strategy, an outright (potentiallytaxable) gift of 10% of the overall transfer of the shares is made to the trust (a general rule under prevailing practice: No tax or legal authority expressly sanctions 10% as a necessaryor sufficient amount). The remainder of the assets is sold to the trust in exchange for an interest-bearing note. The growth of those assets can pass to the beneficiaries free of additionaltransfer tax if they appreciate at a rate higher than a hurdle interest rate. (The “Applicable Federal Rate” [AFR] is lower than the Section 7520 rate for any loan of nine years orshorter. As of this writing, the mid-term AFR for June 2010 is 2.72%.) There are, of course, advantages and disadvantages of both GRATs and installment sales to IDGTs. Forexample, if the GRAT donor dies during the term of the trust, part or all of the trust assets revert to the donor’s estate and might not be gifted to a beneficiary free of transfer taxes.Advice from the business owner’s professional team is critical in putting trust vehicles to best use. Our May 2010 white paper, Transfer Opportunities in Advance of LegislativeChange: An Interim Approach to Planning with GRATs, evaluates gifting alternatives in light of the possibility that the minimum GRAT term will be extended to 10 years.7Assuming that the GRAT was funded long enough before the sale to take full advantage of the discounted shares (see above and page 9).

Display 9

What a Difference a Discount Makes: A Short-Term Trust

Nominal $6 Million Three-Yr. GRAT Remainder Values After TaxesYear 30, 100% Bonds Post-Transaction in GRAT

80% Stocks/20% Bonds Thereafter*

32.2

15.67.8

49.8

24.2

74.8

36.4

18.0

50%40%30%

Discount

$ M

illio

ns

12.0

0

5%10%

50%

90%95%

Levelof

Confidence

*Basis in business assumed to be zero. Assumes GRAT remainder is transferred to anirrevocable trust that pays its own taxes (i.e., a non-grantor trust). Bonds are 100%intermediate-term diversified municipals for the first three years. Thereafter, theallocation is 80% globally diversified stocks and 20% intermediate-term diversifiedmunicipal bonds. Based on Bernstein’s estimates of the range of returns for the applicablecapital markets over the next 30 years. Data do not represent any past performance andare not a promise of actual future results. See Notes on Wealth Forecasting System atthe end of this paper.Source: AllianceBernstein

additional wealth.8 Through the single action of funding a trustbefore the sale with discounted shares—and then investing theproceeds appropriately—the couple would be able to increasethe legacy to their children by more than 50%—and reduce theirestate-tax liability by nearly $6 million. The benefit derives fromremoving appreciating assets from the Commanders’ estate,decreasing their estate taxes, and setting that 80/20 risk level forthe children’s portfolio rather than their own more conservative40/60. If the couple were uneasy about leaving their childrenso much money, or wanted to do even more planning, pre- orpost-sale, for any reason, there would be a variety of multigener-ational and philanthropic strategies at their disposal.

Such strategies—using vehicles including direct gifts, privatefoundations, charitable remainder unitrusts (CRUTs), andcharitable lead annuity trusts (CLATs)—could be used forphilanthropic purposes alone or for wealth transfer to both thefamily and charity. Each such strategy would absorb some of theCommanders’ gifting capacity and reduce their estate-tax bill.These techniques lie beyond the scope of this study, but the samebasic principles apply—relying on professional counsel, consider-ing various trust vehicles, and carefully timing all strategies. Evenwhen a deal is complete, it’s not too late to plan for legacy-build-ing; it’s doing nothing with excess capital that can incur a largeopportunity cost.

ConclusionWe conclude with these thoughts about the intricacies of sellinga closely held business:

n Planning for personal as well as financial issues in a businesssale can help the owner feel secure about completing a deal.Emotions count for a lot, whether they’re centered aroundthe effects of the sale on family and staff, the owner’s desire(or lack of it) to close out a phase of his life, or any otherissue not directly related to the proceeds.

n Rigorous scenario analysis is critical in understanding the impactthat uncertain future earnings, valuations, and tax rates haveon different deal structures that owners may be considering.

n Owners are well-advised to revisit their plans continuouslythroughout the sale process (before, during, and afterward).

As for the Commanders, they were strongly considering theleveraged transaction to recapture the level of upside they had in2007. But ultimately they opted for an all-cash up-front deal andthey decided to initiate a pre-transaction GRAT, a combinationthat provided them with peace of mind and virtual certainty ofleaving a significant legacy for their children. They and theirprofessional team knew they were trading off some good thingsfor others they rated even better. Sir Michael would approve.

The authors would like to acknowledge Cory Dowell, a Directorof Bernstein’s Wealth Management Group, and Matthew J.Teich, an Investment Planning Analyst in the Group, for theirinvaluable insights and quantitative research.

Display 10

Reducing Tax Impact on Legacy

$27 Million Sale: Distribution of Family Wealth, Year 30After Spending and Taxes in Typical Markets*

To Gov’t

Left forHeirs

No Planning(½ to Government)

$6 Mil. Pre-Sale GRAT, 30% Discount(More Wealth, ¼ to Gov’t)

$20.6Million

$18.8Million

To Gov’t

Left forHeirs

$14.9Million

$29.8Million

$44.7 Mil.$39.4 Mil.

3

*Median results. See footnote 6 on page 10. Assumes that the spouses die in same year,and that $1 million per person is exempt from estate taxes. The remaining estate istaxed at a 55% rate. In the GRAT case, term of trust is assumed to be three years.Median senior-generation wealth before estate taxes is $29.1 million, and medianremaining trust assets are $15.6 million.The analysis on the left assumes that with nolifetime wealth transfer the remaining assets after estate taxes pass to the children. Basedon Bernstein’s estimates of the range of returns for the applicable capital markets over thenext 30 years. Data do not represent any past performance and are not a promise ofactual future results. See Notes on Wealth Forecasting System at the end of this paper.Source: AllianceBernstein

8Assuming that the GRAT proceeds were invested in an 80/20 stock/bond mix, and that the Commanders’ portfolio was allocated 40/60 for the full 30 years.

11

outside the GRAT, enhancing the amount transferred. Becausethe statute of limitations on the valuation of the shares is threeyears (during which time GRAT distributions can be adjustedif the IRS disputes a claimed value), professional teams oftenrecommend a three-year GRAT when contributing assets whosevalue is questionable.6

Contributing discounted shares of a business, depicted inDisplay 9, increases the potential benefit if the company is soldwithin the three-year period.7 The realization of the full valueof the discount helps the assets in the GRAT appreciate rapidly,making it very likely to outperform the 7520 rate. In this case,we presume that a three-year $6 million GRAT invests its

proceeds from the business sale in bonds for the safety oflocking in returns. Once the trust expires after three years,the proceeds intended for the children are invested for thenext 27 years in an 80% stock/20% bond portfolio—suitablystock-heavy if you assume that the beneficiaries have a longtime horizon. The display makes clear how the advantage ofdiscounting builds. If the $6 million of shares in the GRAT weresubject to a 30% discount, we’d expect the median value of the80/20 portfolio to be $15.6 million after taxes and fully $7.8million in very poor markets. Had the shares been discounted by40%, we’d project a $24.2 million median and a $12.0 milliondownside case. Discounting can be a powerful tool when put touse in a GRAT.

Quantifying the Advantages of PlanningAssembling a legacy plan yields notable benefits. Returning tothe Commander case study, let’s assume the couple sold thebusiness for $27 million in cash and did no planning prior to orafter that point. Recall that on Day 1, they’d have $3.4 millionto set aside for legacy. In the absence of any estate-planningtechniques, we’d project that even in dismal markets the legacywould grow to $13.2 million—the amount left over at the 90thpercentile of probability before any estate taxes (refer backto Display 8, page 7). But in the median case (Display 10,left side) we projected that—again, making use of no planningtools—they’d leave a hefty amount to their heirs at the end of30 years: $18.8 million after estate taxes. But they’d cede evenmore to the government.

Suppose, though, that the couple’s legacy strategy was, pre-sale,to fund a three-year GRAT with $6 million in company shares,30% discounted (Display 10, right side). Assume the Command-ers invested the proceeds in a liquid portfolio over the 27 yearsfollowing the GRAT’s term. Our models suggest that their heirscould expect the GRAT combined with the rest of the Com-manders’ assets after estate taxes to produce $11 million in

6As of this writing, Congress is considering GRATs and may require that all such trusts have terms no shorter than 10 years. In that event, a business owner may opt for a 10-yearGRAT or use another strategy. The most likely candidate is an installment sale to an Intentionally Defective Grantor Trust (IDGT). With this strategy, an outright (potentiallytaxable) gift of 10% of the overall transfer of the shares is made to the trust (a general rule under prevailing practice: No tax or legal authority expressly sanctions 10% as a necessaryor sufficient amount). The remainder of the assets is sold to the trust in exchange for an interest-bearing note. The growth of those assets can pass to the beneficiaries free of additionaltransfer tax if they appreciate at a rate higher than a hurdle interest rate. (The “Applicable Federal Rate” [AFR] is lower than the Section 7520 rate for any loan of nine years orshorter. As of this writing, the mid-term AFR for June 2010 is 2.72%.) There are, of course, advantages and disadvantages of both GRATs and installment sales to IDGTs. Forexample, if the GRAT donor dies during the term of the trust, part or all of the trust assets revert to the donor’s estate and might not be gifted to a beneficiary free of transfer taxes.Advice from the business owner’s professional team is critical in putting trust vehicles to best use. Our May 2010 white paper, Transfer Opportunities in Advance of LegislativeChange: An Interim Approach to Planning with GRATs, evaluates gifting alternatives in light of the possibility that the minimum GRAT term will be extended to 10 years.7Assuming that the GRAT was funded long enough before the sale to take full advantage of the discounted shares (see above and page 9).

Display 9

What a Difference a Discount Makes: A Short-Term Trust

Nominal $6 Million Three-Yr. GRAT Remainder Values After TaxesYear 30, 100% Bonds Post-Transaction in GRAT

80% Stocks/20% Bonds Thereafter*

32.2

15.67.8

49.8

24.2

74.8

36.4

18.0

50%40%30%

Discount

$ M

illio

ns

12.0

0

5%10%

50%

90%95%

Levelof

Confidence

*Basis in business assumed to be zero. Assumes GRAT remainder is transferred to anirrevocable trust that pays its own taxes (i.e., a non-grantor trust). Bonds are 100%intermediate-term diversified municipals for the first three years. Thereafter, theallocation is 80% globally diversified stocks and 20% intermediate-term diversifiedmunicipal bonds. Based on Bernstein’s estimates of the range of returns for the applicablecapital markets over the next 30 years. Data do not represent any past performance andare not a promise of actual future results. See Notes on Wealth Forecasting System atthe end of this paper.Source: AllianceBernstein

additional wealth.8 Through the single action of funding a trustbefore the sale with discounted shares—and then investing theproceeds appropriately—the couple would be able to increasethe legacy to their children by more than 50%—and reduce theirestate-tax liability by nearly $6 million. The benefit derives fromremoving appreciating assets from the Commanders’ estate,decreasing their estate taxes, and setting that 80/20 risk level forthe children’s portfolio rather than their own more conservative40/60. If the couple were uneasy about leaving their childrenso much money, or wanted to do even more planning, pre- orpost-sale, for any reason, there would be a variety of multigener-ational and philanthropic strategies at their disposal.

Such strategies—using vehicles including direct gifts, privatefoundations, charitable remainder unitrusts (CRUTs), andcharitable lead annuity trusts (CLATs)—could be used forphilanthropic purposes alone or for wealth transfer to both thefamily and charity. Each such strategy would absorb some of theCommanders’ gifting capacity and reduce their estate-tax bill.These techniques lie beyond the scope of this study, but the samebasic principles apply—relying on professional counsel, consider-ing various trust vehicles, and carefully timing all strategies. Evenwhen a deal is complete, it’s not too late to plan for legacy-build-ing; it’s doing nothing with excess capital that can incur a largeopportunity cost.

ConclusionWe conclude with these thoughts about the intricacies of sellinga closely held business:

n Planning for personal as well as financial issues in a businesssale can help the owner feel secure about completing a deal.Emotions count for a lot, whether they’re centered aroundthe effects of the sale on family and staff, the owner’s desire(or lack of it) to close out a phase of his life, or any otherissue not directly related to the proceeds.

n Rigorous scenario analysis is critical in understanding the impactthat uncertain future earnings, valuations, and tax rates haveon different deal structures that owners may be considering.

n Owners are well-advised to revisit their plans continuouslythroughout the sale process (before, during, and afterward).

As for the Commanders, they were strongly considering theleveraged transaction to recapture the level of upside they had in2007. But ultimately they opted for an all-cash up-front deal andthey decided to initiate a pre-transaction GRAT, a combinationthat provided them with peace of mind and virtual certainty ofleaving a significant legacy for their children. They and theirprofessional team knew they were trading off some good thingsfor others they rated even better. Sir Michael would approve.

The authors would like to acknowledge Cory Dowell, a Directorof Bernstein’s Wealth Management Group, and Matthew J.Teich, an Investment Planning Analyst in the Group, for theirinvaluable insights and quantitative research.

Display 10

Reducing Tax Impact on Legacy

$27 Million Sale: Distribution of Family Wealth, Year 30After Spending and Taxes in Typical Markets*

To Gov’t

Left forHeirs

No Planning(½ to Government)

$6 Mil. Pre-Sale GRAT, 30% Discount(More Wealth, ¼ to Gov’t)

$20.6Million

$18.8Million

To Gov’t

Left forHeirs

$14.9Million

$29.8Million

$44.7 Mil.$39.4 Mil.

3

*Median results. See footnote 6 on page 10. Assumes that the spouses die in same year,and that $1 million per person is exempt from estate taxes. The remaining estate istaxed at a 55% rate. In the GRAT case, term of trust is assumed to be three years.Median senior-generation wealth before estate taxes is $29.1 million, and medianremaining trust assets are $15.6 million.The analysis on the left assumes that with nolifetime wealth transfer the remaining assets after estate taxes pass to the children. Basedon Bernstein’s estimates of the range of returns for the applicable capital markets over thenext 30 years. Data do not represent any past performance and are not a promise ofactual future results. See Notes on Wealth Forecasting System at the end of this paper.Source: AllianceBernstein

8Assuming that the GRAT proceeds were invested in an 80/20 stock/bond mix, and that the Commanders’ portfolio was allocated 40/60 for the full 30 years.


Appendix 2: Core-Capital Requirement by Allocation, Investor Age, and Annual Spending Budget ($ Millions)

AnnualSpendingBudget $100,000 $250,000 $500,000 $750,000 $1,000,000 $100,000 $250,000 $500,000 $750,000 $1,000,000

0% Stocks/100% Bonds 20% Stocks/80% Bonds

Age Age

50 $7.1 $17.9 $35.7 $53.6 $71.4 50 $5.6 $13.9 $27.8 $41.7 $55.6

65 4.3 10.9 21.7 32.6 43.5 65 3.7 9.3 18.5 27.8 37.0

80 2.3 5.7 11.4 17.0 22.7 80 2.1 5.2 10.4 15.6 20.8


Age Age

50 $4.8 $11.9 $23.8 $35.7 $47.6 50 $4.3 $10.9 $21.7 $32.6 $43.5

65 3.3 8.3 16.7 25.0 33.3 65 3.2 8.1 16.1 24.2 32.3

80 2.0 5.0 10.0 15.0 20.0 80 2.0 5.0 10.0 15.0 20.0


Age Age

50 $4.3 $10.9 $21.7 $32.6 $43.5 50 $4.3 $10.9 $21.7 $32.6 $43.5

65 3.2 8.1 16.1 24.2 32.3 65 3.2 8.1 16.1 24.2 32.3

80 2.0 5.1 10.2 15.3 20.4 80 2.1 5.2 10.4 15.6 20.8

*Spending is grown with inflation; spending rates assume maintaining spending with a 90% level of confidence.Based on Bernstein’s estimates of the range of returns for the applicable capital markets over the periods analyzed at the 90% level of confidence. Data do not represent any pastperformance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this paper.Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

Appendix 1: Sustainable Annual Spending Rate* by Allocation and Investor Age


Age

50 1.4% 1.8% 2.1% 2.3% 2.3% 2.3%

65 2.3 2.7 3.0 3.1 3.1 3.1

80 4.4 4.8 5.0 5.0 4.9 4.8

Notes on Wealth Forecasting SystemThe Bernstein Wealth Forecasting SystemSM (WFS) is designed toassist investors in making a range of key decisions, includingsetting their long-term allocation of financial assets. The WFSconsists of a four-step process: (1) Client Profile Input: theclient’s asset allocation, income, expenses, cash withdrawals, taxrate, risk-tolerance goals, and other factors; (2) Client Scenarios:in effect, questions the client would like our guidance on,which may touch on issues such as which vehicles are best forintergenerational and philanthropic giving, what his/hercash-flow stream is likely to be, whether his/her portfolio canbeat inflation long term, when to retire, and how different assetallocations might impact his/her long-term security; (3) TheCapital Markets Engine: our proprietary model that uses ourresearch and historical data to create a vast range of marketreturns, taking into account the linkages within and amongthe capital markets (not Bernstein portfolios), as well as theirunpredictability; and (4) A Probability Distribution of Outcomes:based on the assets invested pursuant to the stated assetallocation, 90% of the estimated returns and asset values theclient could expect to experience, represented within a rangeestablished by the 5th and 95th percentiles of probability.However, outcomes outside this range are expected to occur10% of the time; thus, the range does not establish theboundaries for all outcomes. Further, we often focus on the10th, 50th, and 90th percentiles to represent the upside,median, and downside cases. Asset-class projections used inthis paper are derived from the following: US value stocks arerepresented by the S&P/Barra Value Index, with an assumed50-year compounding rate of 8.9%, based on simulations withinitial market conditions as of December 31, 2009; US growth

stocks by the S&P/Barra Growth Index (compounding rate of8.5%); developed international stocks by the Morgan StanleyCapital International (MSCI) EAFE Index of major markets inEurope, Australasia, and the Far East, with countries weightedby market capitalization and currency positions unhedged(compounding rate of 9.2%); emerging markets stocks by theMSCI Emerging Markets Index (compounding rate of 7.2%);municipal bonds by diversified AA-rated securities with seven-year maturities (compounding rate of 3.9%); taxable bonds bydiversified securities with seven-year maturities (compoundingrate of 5.4%); and inflation by the Consumer Price Index(compounding rate of 3.0%). Expected market returns onbonds are derived taking into account yield and other criteria.An important assumption is that stocks will, over time, outper-form long-term bonds by a reasonable amount, although this isby no means a certainty. Moreover, actual future results may notbe consonant with Bernstein’s estimates of the range of marketreturns, as these returns are subject to a variety of economic,market, and other variables. Accordingly, this analysis shouldnot be construed as a promise of actual future results, theactual range of future results, or the actual probability thatthese results will be realized.

Mortality Assumptions: Mortality is modeled using our proprie-tary simulation model, which creates a range of death ages fora given age. The outcomes of the mortality simulation modelare then combined with the outcomes of the Capital MarketsEngine on a trial-by-trial basis to produce summarized mortality-adjusted results. Mortality simulations are based on the Societyof Actuaries Retirement Plans Experience Committee MortalityTables RP-2000. n

13

Appendix 2: Core-Capital Requirement by Allocation, Investor Age, and Annual Spending Budget ($ Millions)

AnnualSpendingBudget $100,000 $250,000 $500,000 $750,000 $1,000,000 $100,000 $250,000 $500,000 $750,000 $1,000,000


Age Age

50 $7.1 $17.9 $35.7 $53.6 $71.4 50 $5.6 $13.9 $27.8 $41.7 $55.6

65 4.3 10.9 21.7 32.6 43.5 65 3.7 9.3 18.5 27.8 37.0

80 2.3 5.7 11.4 17.0 22.7 80 2.1 5.2 10.4 15.6 20.8


Age Age

50 $4.8 $11.9 $23.8 $35.7 $47.6 50 $4.3 $10.9 $21.7 $32.6 $43.5

65 3.3 8.3 16.7 25.0 33.3 65 3.2 8.1 16.1 24.2 32.3

80 2.0 5.0 10.0 15.0 20.0 80 2.0 5.0 10.0 15.0 20.0


Age Age

50 $4.3 $10.9 $21.7 $32.6 $43.5 50 $4.3 $10.9 $21.7 $32.6 $43.5

65 3.2 8.1 16.1 24.2 32.3 65 3.2 8.1 16.1 24.2 32.3

80 2.0 5.1 10.2 15.3 20.4 80 2.1 5.2 10.4 15.6 20.8

*Spending is grown with inflation; spending rates assume maintaining spending with a 90% level of confidence.Based on Bernstein’s estimates of the range of returns for the applicable capital markets over the periods analyzed at the 90% level of confidence. Data do not represent any pastperformance and are not a promise of actual future results. See Notes on Wealth Forecasting System at the end of this paper.Source: Society of Actuaries RP-2000 mortality tables and AllianceBernstein

Appendix 1: Sustainable Annual Spending Rate* by Allocation and Investor Age


Age

50 1.4% 1.8% 2.1% 2.3% 2.3% 2.3%

65 2.3 2.7 3.0 3.1 3.1 3.1

80 4.4 4.8 5.0 5.0 4.9 4.8

Notes on Wealth Forecasting SystemThe Bernstein Wealth Forecasting SystemSM (WFS) is designed toassist investors in making a range of key decisions, includingsetting their long-term allocation of financial assets. The WFSconsists of a four-step process: (1) Client Profile Input: theclient’s asset allocation, income, expenses, cash withdrawals, taxrate, risk-tolerance goals, and other factors; (2) Client Scenarios:in effect, questions the client would like our guidance on,which may touch on issues such as which vehicles are best forintergenerational and philanthropic giving, what his/hercash-flow stream is likely to be, whether his/her portfolio canbeat inflation long term, when to retire, and how different assetallocations might impact his/her long-term security; (3) TheCapital Markets Engine: our proprietary model that uses ourresearch and historical data to create a vast range of marketreturns, taking into account the linkages within and amongthe capital markets (not Bernstein portfolios), as well as theirunpredictability; and (4) A Probability Distribution of Outcomes:based on the assets invested pursuant to the stated assetallocation, 90% of the estimated returns and asset values theclient could expect to experience, represented within a rangeestablished by the 5th and 95th percentiles of probability.However, outcomes outside this range are expected to occur10% of the time; thus, the range does not establish theboundaries for all outcomes. Further, we often focus on the10th, 50th, and 90th percentiles to represent the upside,median, and downside cases. Asset-class projections used inthis paper are derived from the following: US value stocks arerepresented by the S&P/Barra Value Index, with an assumed50-year compounding rate of 8.9%, based on simulations withinitial market conditions as of December 31, 2009; US growth

stocks by the S&P/Barra Growth Index (compounding rate of8.5%); developed international stocks by the Morgan StanleyCapital International (MSCI) EAFE Index of major markets inEurope, Australasia, and the Far East, with countries weightedby market capitalization and currency positions unhedged(compounding rate of 9.2%); emerging markets stocks by theMSCI Emerging Markets Index (compounding rate of 7.2%);municipal bonds by diversified AA-rated securities with seven-year maturities (compounding rate of 3.9%); taxable bonds bydiversified securities with seven-year maturities (compoundingrate of 5.4%); and inflation by the Consumer Price Index(compounding rate of 3.0%). Expected market returns onbonds are derived taking into account yield and other criteria.An important assumption is that stocks will, over time, outper-form long-term bonds by a reasonable amount, although this isby no means a certainty. Moreover, actual future results may notbe consonant with Bernstein’s estimates of the range of marketreturns, as these returns are subject to a variety of economic,market, and other variables. Accordingly, this analysis shouldnot be construed as a promise of actual future results, theactual range of future results, or the actual probability thatthese results will be realized.

Mortality Assumptions: Mortality is modeled using our proprie-tary simulation model, which creates a range of death ages fora given age. The outcomes of the mortality simulation modelare then combined with the outcomes of the Capital MarketsEngine on a trial-by-trial basis to produce summarized mortality-adjusted results. Mortality simulations are based on the Societyof Actuaries Retirement Plans Experience Committee MortalityTables RP-2000. n

14 Publication Title

Global Wealth Management

A unit of AllianceBernstein L.P.

Client-Centered Wealth Management Solutions

At Bernstein, we are dedicated to providing our clients with wealth management

solutions tailored to their unique circumstances. We start with robust planning,

to identify each client’s needs for lifetime spending, retirement, multigenerational

wealth transfer, and philanthropic pursuits. We then stress-test a range of

investment strategies, including asset-allocation approaches, to arrive at a plan

for achieving these goals. Then we implement the client’s plan through our

proprietary platform of investment services, each reliant upon dedicated research

teams and managed by dedicated portfolio management teams. In managing a

client’s plan over time, we employ active management within each service, also

rebalancing to maintain the overall portfolio’s profile and, if appropriate, managing

taxes to mitigate their impact on a client’s after-tax returns. We also place a high

degree of emphasis on informing our clients, providing transparent and real-

time performance reporting via our website, and having frequent discussions

on portfolio strategy. Throughout, we aim to meet our clients’ objectives…and

their expectations.

AssetAllocation

WealthPlanning

PortfolioSelection

Performance Monitoring

Client Reporting

Tax Management, Rebalancing, and

Currency Management

ComprehensiveSolutions

MANAGING

INFO

RM

IN

G PLANN

ING

BER–6301–0710 www.bernstein.com

Note to All Readers: The information contained herein reflects, as of the date hereof, the views of AllianceBernstein L.P. (or its applicable affiliate providing this publication)(“AllianceBernstein”) and sources believed by AllianceBernstein to be reliable. No representation or warranty is made concerning the accuracy of any data compiled herein.In addition, there can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is neither indicative of, nor a guaranteeof, future results. The views expressed herein may change at any time subsequent to the date of issue hereof. These materials are provided for informational purposes only,and under no circumstances may any information contained herein be construed as investment advice. AllianceBernstein does not provide tax, legal, or accounting advice.The information contained herein does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material,discuss your individual circumstances with professionals in those areas before making any decisions. Any information contained herein may not be construed as any salesor marketing materials in respect of, or an offer or solicitation for the purchase or sale of, any financial instrument, product, or service sponsored or provided byAllianceBernstein L.P. or any affiliate or agent thereof. References to specific securities are presented solely in the context of industry analysis and are not to be consideredrecommendations by AllianceBernstein. AllianceBernstein and its affiliates may have positions in, and may effect transactions in, the markets, industry sectors, and companiesdescribed herein.

Bernstein Global Wealth Management is a unit of AllianceBernstein L.P.

Note to UK Readers: AllianceBernstein Global Wealth Management is a unit of AllianceBernstein Limited. AllianceBernstein Limited (FRN147956) is authorised andregulated in the United Kingdom by the Financial Services Authority. Issued by AllianceBernstein Limited, Devonshire House, 1 Mayfair Place, London W1J 8AJ.

Bernstein Global Wealth Management and AllianceBernstein Global Wealth Management do not offer tax, legal, or accounting advice. In considering thismaterial, you should discuss your individual circumstances with professionals in those areas before making any decisions.

© 2010 AllianceBernstein L.P.

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212.486.5800

JULY 2010

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