
Building and Assessing Value While Creating Autonomy: Part 2
Paul Adams interviews Marek Omilian
Welcome to Sound Financial Bites, where we help you with bite-sized pieces of financial and life knowledge to help you design and build a good life. This is part two of our Sound Financial Bites interview with Marek Omilian, a man who’s built the company that values other companies and has built enough infrastructure to actually go on an 11-month around-the-world sailing tour.
He’s going to share with us what he’s been doing on his own personal balance sheet outside the business as well as talk about how he’s prepared the business for this journey. Then we will tell us a little bit about the worldwide sailing race that he’s participating in.
Marek, given your CFA background, your summit of values companies, what kind of assets do you invest in on your personal balance sheet?
I’ve got a very long-term investment horizon, but also extremely sensitive nature when it comes to taxes. Being a business owner, I’m in a pretty high tax bracket, so minimizing current taxes is one of the top objectives for me besides, obviously, generating respectable rate of return on the portfolio of assets at a particular risk. I’m over 50 years old. My investment time horizon is still pretty long though, probably 20 years or so.
But, my asset mix has been almost one-third, one-third, one-third, and low-risk, low-return fixed income assets, or municipal bonds or other instruments. We’re third in US equities, emerging markets, and the final third in what I call alternative assets, which would include real estate portfolio of MLPs, Master Limited Partnerships energy stocks. These, by the way, are not very popular these days with the oil fluctuations, for instance. But, again, because I’ve got this long-term horizon and tax minimization objective, they’re perfect assets for me because they’re very tax advantageous and I’m not really worried about current fluctuations in something like the MLPs.
You mentioned that, along with the cash, municipal bonds, things like that that you use insurance there also?
Yeah, seven years ago or so. I never really believe in life insurance. The commissions are high, I never thought I really needed that. I like to be self-insured. But, about seven years ago, I had a bit of a family situation where I thought, “ Well, maybe, I should have death benefit,” because we had two incomes. My wife and I both work. We had a two-income family. But then, my wife had to stop working to take care of one of the relatives, and I thought to myself, “Well, maybe we should have a death benefit in case something did happen to me.
But then, what really got me off the fence was when I learned that life insurance was the whole strategy around tax avoidance. I’m not sure I want to say it too loudly, but it’s an amazing loophole that allows me to avoid paying taxes on capital appreciation of the assets sitting in my whole life policy. What I do is I max it out. There is a limit, unfortunately.
We teach that to our clients. It’s called Telfer-Tanner Corridor, the max.
There’s a max that I consume every year, but I max out and over-fund my policy, and the over-funding amount is going straight to the cash value of my policy. I use one of the mutual life underwriters to do this. It goes into cash value, which is earning the same dividend rate of 5%-7%. I think last year it was somewhere north of 6% annual dividend, which continues to compound and accumulate every year. I don’t remember the actual age, maybe you remember. I can take the loan against the policy now against the cash value, but at a certain age, that interest on that loan becomes 1%, and it really becomes basically a private pension fund that I’ve set up for myself. It’s going to finance mine and my wife’s retirement, and when I finally pass, if that loan is still outstanding, it’s just going to credit against the value of the policy. So, my beneficiaries will still receive the death penalty plus the cash value minus whatever the loan outstanding against the cash value.
It’s great. The last couple of years I’ve actually used it even more aggressively where I’ve taken a loan against the cash value and was able to deduct the interest on that loan. That interest, by the way, flows back to my account no matter what. I’m paying that interest to myself, except for the 1% that goes to administration off the loan, but I was able to then deduct that interest expense against other interest income as long as I used that loan to fund some of the other investments.
You had to track exactly where the money went so that when it went back, you could actually write it off. It gave you a pool of capital to be able to do other things with, buy another business, buy another investment, and then be able to put it back when it was convenient for you. But, now you’ve got a cash pool getting you a decent rate of return that doesn’t have any taxes on it versus a cash pool at the bank.
There’s one thing you mentioned that’s probably not familiar to our audience. You mentioned it’s a mutual life insurance company not a stock insurance company. When you own that policy, it’s going to pay back your policy. You did not do this policy with us. This is something that you had, and I haven’t seen it. We’ve been talking back and forth a little bit about how you’ve been using it, and that’s great. One of the biggest limiting factors — and why I think the IRS allows everybody to do it — is you’ve got to think ahead. Just thinking ahead several years is enough limitation to keep most people out of that game.
It’s difficult to really follow this in an interview. I think whoever is considering this strategy should sit down with Paul, or their advisor, and just look at the diagram of how the money flows, how it needs to be documented, and all that. Once you have that in front of you, it’s really super simple. One of the big things I was looking for was a qualified interest income that you can deduct the interest expense against. You can’t generate this interest expense and, say, deduct it from your ordinary income. It has to be a qualified interest income which I had from other assets. So, I was able to offset that quite nicely.
I’ve been using it as a bit of a revolver type for the investments. I’m carefully watching, making sure I have enough invested income to use this interest expense. But, really, the biggest benefit and no-brainer to me is the fact that I will never pay my children when they inherit the value of the policy. They will never pay any capital gains taxes on the dividends that this cash value is earning, which is phenomenal, which is amazing. I wish I could put more money into it.
We’ve got some inquiries of late with all the educational stuff we’ve done. We’ve not done a lot on the life insurance front, although we do help our client’s structure some of those strategies. By the time you’re reading this now, we will have some other resourced to use on YouTube etc, so check those out. I’m glad you were able to explain it from a practical point of view of how you’ve actually been using it.
The other big thing for me of how to treat this asset class is this cash value of the life insurance policy as a less risky asset. My understanding is that my mutual life insurance company invest mainly in treasuries, real estate, and very long-term sort of lower-volatility assets. I’ve got a lot of portfolio of munis that is earning maybe 2% tax-free, whereas this cash value of life insurance policy is earning 6% to 7% tax-free as well, and it has a very similar risk profile. What I like about that is when I think about this whole spectrum of risk-return for different asset classes.
That’s a great point. We’ve often pointed people to the internet to find a white paper by a gentleman named Dick Weber. He wrote a white paper called ‘Life Insurance as an Asset Class’, and he talks about it being uncorrelated. Even though our bonds go up and down in value, depending on the prevailing interest rates, that book value asset of the life insurance actually is a steadfast tool and it’s actually guaranteed. You’ll notice that even banks don’t get to say that something is guaranteed. They have to say it’s FDIC-insured, and that is almost an exclusive the word “guarantee” in the financial world to insurance companies. They get to say that the cash value is guaranteed.
Let’s shift to people wanting to sell their business. If they’re going to sell their business, they’ve got to be able to start some time ahead of that to work on those value drivers and have an idea of getting it valued. When it comes to evaluation practices, if somebody has a business that they think is worth $4–6 million or maybe even all the way up to $80–100 million in value, how often would you suggest that they actually get a valuation done on the company?
The standard consulting answer is, “It depends.” It depends if there’s multiple owners or one owner, for example.
I thought the standard consulting answer would be, “As often as possible but…”
Right, and that’s why we’re creating those values for a tool, which actually will have the valuation attached such that, unfortunately, I’ve got only prototypes in the Excel. We haven’t started coding this, but it’s going to be a web-based tool where one could come in and enter some of the information about their company, including those 50+ metrics, and even play around, or do some what-if analysis. What if you want to improve this one metric by 10%? How would my value change? And that value indication is going to be fairly accurate. They can do the valuation multiple times a day just by themselves without our help. Our help is building that tool.
Recently, we started working with a company that has two shareholders. They rewrote the shareholder agreement. They’ve been in business for 14 years. They’re really interested in knowing what their value is and really building into their shareholder agreement some sort of clause or prescription on how often the valuations should be done and how it should be done.
On the other hand, we have several clients where they have 200 or 300 shareholders or members, if it’s an LLC, and the shareholders, from time to time, or actually quite frequently, they want to buy, or sell, or exit. We’re doing evaluation once a year to facilitate that transaction to happen. It varies a lot on the circumstances, and I would say, probably, it varies a lot on the number of shareholders the company has.
Let’s say you get the agreement done, one valuation is done, and now you know what some of the metrics are. When people want to update their valuation, am I wrong that it may not be near the amount of pain and heavy lifting it was the first time around if they did want to get it done every year or every two years?
Yeah. There’s definitely a bit of a startup cost or a fixed cost to get things organized. Although we do these valuations every year, the tricky part becomes reconciling the values between what happened, what was the value a year before, what is it now and why, what are the drivers. Once we build this value score valuation tool, we’re going to be easily reconcile what changed in terms of the value drivers. But, when we do this, it will be in a static mode where we’re asking for some financial information and then we get it every year, then we need to go through this a bit of a laborious process of reconciling why the value changed.
To finish with today, Marek, I know my audience is incredibly interested. We were just in an entrepreneurs event up in Vancouver, Canada with the Entrepreneurs’ Organization, and he said something casually like, “I’ve got this sailing trip coming up.” I said, “Oh, you sail?” and he said, “Yeah, this is going to be an 11-month race around the world with groups of people who pay to do this. You’re on the water for seven months, then four months in ports around the world.”
I have two questions. One: how did you set up your business such that you could pull this off? Two: what are you doing with your family this year? You leave in two or three weeks. You’ll be on the boat when this interview is published.
Probably, yes. The race starts on August 20th in Liverpool, UK. The gun will be fired at 12:30, that’s when the boat starts racing. So, if anybody wants to come and see 12 identical clipper, 70-foot, 35 ton boats with 20+ crew on board in each boat start racing, mark the date August 20th in Liverpool. Then, if you can make that, the race finishes also in Liverpool on July 28, 2018. But, for those of you who are in Seattle, there’s a better tip. The race is coming for the second time ever to Seattle, and it’s going to be here around the second half of April 2018. Seattle is one of the stopover ports. One of the 12 boats is actually sponsored and named after Visit Seattle, which is a government organization promoting tourism in Seattle.
It’s called Clipper Round the World. If you want to check out that website, you can see the boats and they are incredible-looking. Did you have a lot of sailing experience prior?
I grew up sailing. I was in Sea Scouts. By the way, my boat has 60 crew. 10 of them circumnavigate, including myself, 30 of them do only one out of eight legs, and the remaining 20 do two or three or four legs. From all the 12 boats, there are over 700 crew that participate in this, and about 40% or 50% have never sailed before. This is very much an adventure for them on top of sailing.
In order to participate in the race, everybody has to participate in four weeks of rigorous training in company facilities either in UK or in Australia. It’s a pretty tough four weeks of training. A lot of people actually change their mind after week one or week two. I just heard we potentially had somebody try to change their mind, but then reconsidered after week four of training, because it was pretty tough. It’s a race, so those 12 boats race against each other, and as you said, Paul, about two-thirds of time of those 11 months are on the water, about one-third in port.
But wait…there’s more?!
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