Food for Thought - Mike Brown & the Estate Tax

(warning, this post is hugely speculative and its conclusions are certainly wrong in a material way - now keep reading please!)

People call Mike Brown a good businessman from time to time.  Given how rich he has made himself off of the Bengals, it is hard to argue.  But nevertheless, I have. 

Basically I think a) he does not deserve credit for stumbling into a hugely popular monopoly and b) he leaves large amounts of money on the table by not bringing the franchise into the modern era with a front office and better facilities (a rather minor investment, quite frankly).

I think a lot about why the Bengals pursue this strategy of profitability - playing it safe with a bare-bones operation, knowing the fans will take the shit they give them, instead of building out a winning and potentially more lucrative organization.

Okay, so Mike fancies himself a football man, and the Brown's a football family, and this is how they have always done it so dammit that's the way they will continue to do it.  Surely that is part of it.

But I think more and more the estate tax might have quite a bit to do with it.  Clearly, family trumps everything in the Brown world.  They want the team to remain in the family.  It is just assumed that Mike can pass along the team to Katie but things changed post stadium deal.  The Bengals, before just nicely profitable, became hugely valuable, worth between $500 million and a $1 billion.  With an estate tax rate of about 50%, and assuming Mike Brown owns at least 51% of the team, that is at least a $125+ million liability the IRS will ask for upon Mike's death (Nancy's if she outlives him I suppose). 

They cannot meet that kind of cash liability without selling the team.

Now, the whole family is lawyers.  Likely well versed in the laws pertaining to closely-held companies and taxes.  So they have a plan.  My former boss used to be an estate tax lawyer.  He, and another small business owner I spoke to, both seemed to think they likely have set up already or will set something up where Mike sells the team to Katie while he is still alive to avoid the estate tax.

How they do this is the question.  Both seemed to think it would like something like this:  Mike sells the Bengals (at a family discount, of course) to Katie and simultaneously loans her the money (at very favorable rates of 0% - borrowing against the value of the franchise) to make the purchase.  Katie would then use the profits from the Bengals to slowly pay down the loan Mike gave her to buy the team.

Voila, estate taxes avoided.

(The devil is in the details of course, and I don't know those.  Also, I don't know how this avoids capital gains taxes, which should be large.  However, they are currently only 15% as opposed to 50% - so maybe 15% of whatever gains there are is small enough for the Brown family to be able to pay without having to sell the team)

Anyway, the point is the Bengals make nice coin right now, probably enough to make a scheme like this possible.  But if indeed they are doing something like this, they have a huge incentive not to risk their profitability, even if the Bengals aren't as profitable as they probably could be with some changes.

My take:  I suspect much of the reason why no practice facility will get built on the Brown's dime, why we probably won't keep all our young talent (JJ & Leon) when they become free agents even though we can afford it, and why no serious effort is made to hire more people in the front office is that the Brown's need to be as safely profitable as possible, so their precious team can stay in the family.  Not just because they're tightwads.

After the fold, I'll post some of the Q&A and I had over email about the these issues with a small business owner.

I was wondering how much you actually knew about the structures the Bengals have set up for ownership and what, if any, possible mechanisms they could use to transfer the team to Katie after the death of both Mike and Nancy without forcing them to sell to meet the estate tax liability.

First off I am going to make a couple of assumptions.

1. Mike does not have a pre-nup (he has been married over 40 years)
2. His wife has little to no interest in taking over for him at his death
3. Katie does want to take over for him
4. His brother and son have somehow been financially compensated and agree to the plan.

Mike does not own 100% of the Bengals. The Dutch Knowlton estate owns a big chunk (I think like 35 %) and I do not know if that suit is settled or not. There are other owners like John Sawyer.  All of these people combined own the team. However, Mike owns or controls I believe 51% of the team. I know that Katie, Troy, Pete Brown, and Paul Brown II all own a  piece of the team. I know this because Troy said a distribution was made to cover shareholder’s income tax responsibilities (which is common thing to do).

Being in the NFL, all owners no matter how small must be approved by the NFL. So, we will assume these people have been.  In most companies, there is some sort of buy/sell agreement for the sale of shares. It is very common that when say Mike dies, his shares are offered to the remaining shareholders (not his wife, she is forced to sell by contract). If none of the remaining share holders want to purchase her shares then they go on the open market or she can keep them. Usually in a tightly held corporation like this one the person selling the shares finances the sale, but because of the dollars involved I doubt that is the case here.

The most typical way to pass the team on to Katie would be to sell her Mike's shares with Mike retaining what is called the voting share. In other words they would break Mike’s 51% ownership of shares into one lump of regular shares and 1 voting share. Katie would buy the 50% regular shares with a loan provided by Mike at a reduced costs.

Mike gets a nice cash flow income until his death and then his wife gets it until her death at which time it is forgiven.  Katie pays her loan to her dad with dividends she receives on the 50 shares (last year that was $21 million). Mike retains the voting share which is the share which determines who makes decisions. This allows Mike to stay in control until he sells that share to Katie or Katie inherits it at his death. This way she only has to pay estate taxes on that one single share since she technically bought the others. This is a safe a proven method to transfer the team to her and minimize estate taxes.

Now, I have some question whether they are actually going this or not.  First off, if they were then Katie would be technically owner of the Bengals now! That would require NFL approval (I am sure they would give it to her, but maybe not if the other owners are pissed at Mike). Matter of fact, all of this would have to be approved by the NFL. However, if they are not doing this then they are doing nothing (I strongly doubt that ), or Katie has enough to cover estate taxes (I doubt that too), or  some other combination of the above.

How much do you think the Bengals are actually worth?

Hard to say. From a business deal perspective, I would put them at ten time EBITDA (earnings before interest, taxes, depreciation, amortization). Last year they earned $21 million (that's 2008, not 2009 folks). Add back in the money they paid themselves and it goes to $30 million. Ten times that is $300 million (that is for 100% of the team, not just Brown's share). However, we all know that people that buy football teams do it for the ego. Factoring that in and the NFL rule that says you can only finance 60% (they might waive that?) and I think a solid offer for the Bengals as is would be $650 to $700 million dollars in this economy.

Just your gut feeling, do you think the Bengals will remain in the Brown family after Mike/Nancy pass?

Not if someone offers north of $700 million for it. Personally, I think Mike would sell for $800 right now. He has too many issues facing him in the future.

Comments

[blester01]

Interesting post. It will be interesting to see how the switch will be made, and to whom. Does any one have an idea on how the shares passed to Mike in the first place? I don't know if trust entities can be set up for things like this so it can by-passes taxes. I am sure the one thing the Browns do pay well for is their attorneys; every wealthy person needs a great attorney, and I am positive they will find a way around the taxes. The key would be to see how Mike inherited his shares from Paul, and I bet they try the same thing unless the rules have changed.

Another thing I would like to dig up is the ownership percentage that the Browns have. In the 70's and 80's I thought Knowlton (as in the Austin E. Knowlton School of Architecture at Ohio State- the giant marble building next to the shoe) was the majority owner, he just stayed out of the picture and let Paul run the show. Am I mistaken about this? If I am correct, does anyone have a clue as to how the Browns became majority owners?

[Sleeping With Bieniemy]

At some point Mike did become the majority owner not sure how. It's also entirely possible, based on the valuation and the estate taxes at the time in 1990, that the Brown Family could afford whatever liability there was.

As I said, this post is hugely speculative. They could have some entirely different mechanism in place already with trusts and such (I really don't even know what trust means).

But in some way, shape or form, taxes should be paid on the Bengals. If they find a way around it, once again, we all lose.

[WhoDeyFans]

This is an interesting point that I thought of instantly when beginning to read this:

"Being in the NFL, all owners no matter how small must be approved by the NFL. So, we will assume these people have been."

It may be possible that the Browns are not allowed to own the team. Of course, they will be paid for the team, but if another ownership group arises, the owners may vote for them and change. If it is not truly the media and the impression is there that the bengals are a black mark on the NFL, this is a possibility.

That could be a mayhem goal somehow. Annoy the owners to the point they vote against the next generation of Browns.

Then again, the next generation may be better at running the team, hiring the correct personnel. Paul was, maybe it skipped a generation.

[The truth]

There are so many other ways to
pass the team on without paying taxes I doubt that is a basis. Since it us a Corp their options to avoid estate taxes are huge. Trusts, pay on death securities etc etc etc. Trust me I've learned in only my brief time as attorney where there is money there are loopholes

[Floyd22Debbie]

People deserve very good life and loan or short term loan would make it better. Because people's freedom bases on money state.

[James Shively]

According to the team's "Staff directory" it appears Pete is highest on the Seniority List above Katie.. And I had no idea a company could actually have FIVE Vice President's... The front office really is a complete joke! I can only imagine these guy's going through there daily routines pretending they are competent to do there jobs..

http://www.bengals.com/team/staff-directory.html

[artist formerly known as Section 101]

so lets raise $800 million the same way we did for the billboards

[kotw65]

All is OK, do not panic. MFB and his infamous family are in a position to maintain and push forward the winning philosophy, strategy (critical thinking), and physical ability to compete as a team year in and year out in today's NFL.

Do not hate, congratulate! They are an under appreciated ownership group that we just don't understand are operating a family business within a (monopoly) that if we only new how hard it is to "dictate" errr run this franchise damn, just give them a brake.

Punkin forever!

[mpr]

10x EBITDA for an NFL Franchise = $300mm... and you're saying that because of ego and lack of leverage available (financing), combined would drive the multiplier to 20-25x for the whole franchise? I'm trying to understand your argument before I interject... can someone clarify?

[It's Never Sunny in Cincinnati]

Knowlton Estate owns 30 percent of the team. The suit was settled in November 2008 with Knowlton's children getting the same amount of Bengals shares that Carl Pickens has (read: zero). The man now in charge of the estate is a dude named Charles D. Lindberg (sounds like the name of someone addicted to meth).

After the case was settled, Lindberg was quoted as saying, “We are definitely planning to sell the Bengals stock... but we don’t have a buyer.” (sounds like something a meth addict would say) He said the market will determine the price of the shares.

In November 2008, Knowlton's 30 percent share was valued at $300 million which puts the value of the Bengals at (say it in your Dr. Evil voice) One Billion Dollars.

[blester]

Never Sunny,
Great stuff. Thanks for the laugh.

So all we need to do is raise approximately $300+ million to take a significant seat at the table so we can constantly taunt Mike in person and throw shit at him in the board room. That is chump change to the uber wealthy; I think we can raise the capital in no time. Any one up for it?

Having a share of the Bengals would be great for my portfolio; at least you know you are going to be profitable on a regular basis.

[mpr]

10x EBITDA for an NFL Franchise = $300mm... and you're saying that because of ego and lack of leverage available (financing), combined would drive the multiplier to 20-25x for the whole franchise? I'm trying to understand your argument before I interject... can someone from WDR please clarify? I think i have a worth-while perspective, but i want to make sure i get this post before i lay it down... thanks.

[guttersnake]

Great article.

I just bought a powerball ticket.

[Hofbraunow]

Ditto, profound insight for anyone wondering
why the hell things are (and have been)
the way they are,
within the Bengals organization.

[Sleeping With Bieniemy]

mpr - I am not the one making the 10x ebitda argument, that's the small business owner I was emailing. I will say the ego part of it really drives a huge premium you are probably not giving enough credit. Let's say you're rich as hell and just want an NFL toy, realistically there are only so many franchises that change hands in any given decade, so when one becomes available it can easily get a value way beyond what is considered reasonable given the underlying cashflows of the business.

of course, lack of easily obtainable financing means the price should go down, not up. Either way, my poin is that run rate of $30 million ebitda is way less than it could be if the franchise was run better.

It's Never Sunny pointed out the 30% of the Knowlton estate was valued in Nov 2008 (read, just after the first major leg down in the markets) at $300 million, so assuming that's verifiable, then the guy I was emailing undervalued the Bengals.

Anyway, as I said, anywhere from $500 million to a $1 billion is probably reasonable.

[Michael]

Damn you Congress....
Damn you Health Care Bill.....
Damn you Mike Brown......

On the brighter side Xavier beat Pitt...Good day for Cincinnati....Bad day for the nation.

[Comrade Ken]

blester01,

Mikey was able to get control due to a transaction structured back in the 1980's by Paul Brown. Paul owned 118 shares while Sawyer owned 213 shares and Knowlton owned 249 shares. Mikey and Peter Brown each held minor interests in a voting trust. Paul's shares were all voting (as were the shares held in trust for Mikey & Peter). Paul sold 117 of his shares to John Sawyer at a fixed price of $30,000/share. Immediately after that, Sawyer entered into an option to sell 329 shares to Mikey and Peter for $25,000/share in 1993. Majority voting rights were maintained by the Brown family even after the transaction. This essentially fixed the value of Paul's estate which minimized his estate tax. This was challenged by the IRS as a sham but they lost (see Estate of Paul E. Brown v. Commissioner). Word on the street was the IRS attorney trying the case gave a very weak effort (probably when Mikey started complaining in the paper that he would have to move the team if they lost the case).

As far as Mikey's estate planning goes, I'm sure he's used one of several techniques to pass on the ownership to his kids. I doubt he copied his dad's technique since it was so risky. The most popular technique these days for a S-corporation (which the Bengals I assume still are) is to transfer the shares to a Grantor Retained Annuity Trust (GRAT). This allows one to transfer ownership to one's kids at a future date at little or no gift tax cost.

Of course, the best technique at the moment is for Mikey to die in 2010. There currently is no estate tax this year. Do you think he would do that on purpose just to save on estate tax? Hmmmmmmmmmmm.

[Michael]

Just saw that the Bengals got an extra 3rd and 4th round pick. Hopefully MFB gets it right this year and use the draft picks wisely.

[blester01]

Ken,
Excellent breakdown and thanks for taking the time to answer my question. I have always wondered about this b/c people would always correct me when I said that Knowlton owned the team not Paul Brown, which I read in the Gameday program when I was a kid. I knew I was right.

Where did you get all of this info?

I have worked for some very wealthy clients in KY, and the one thing I learned from them is that they will do anything to protect their money- even if it means to spending $1 million to save $1.5 million. Where there is a will there is a way. One of my former clients who did work between India and the US hired a consultant and paid him $100k an hour to help set up the business structure b/c he knew it would save him millions by avoiding taxes in both countries. From my experience, I am not too worried about their tax rates going up- to them it is one less case of wine that they cannot enjoy.

Do you have any recommendations of what type of corp would we need to setup if we wanted to go after the 30% that is available?

[Comrade Ken]

blester01,

You're welcome. The information I quoted lies within the actual US tax court case which is a matter of public record. If you have access to such records, the cite is "Estate of Paul E. Brown v. Commissioner T.C. Memo. 1997-195." The actual court case has a lot more information in it than what I quoted before and has some very interesting reading as it concerns the history of the ownership and foundation of the Bengals franchise.

If you know clients willing to spend $1M to save $1.5M, please refer them to me, I'd be willing to work for half that price (LOL).

Regarding your question about the 30%, I'm assuming you are referring to the amount owned by the Knowlton estate. If so, I would suspect that those shares have a "right of first refusal" to be purchased by Mikey & Co. before the general public would be allowed to purchase them. If Mikey passed on buying them, I suppose the Knowlton estate could sell to anyone. Assuming the Bengals are still an S-corporation, only individuals could purchase the shares. If a corporation purchased those shares, it would kill the S corporation election and possibly screw up Mikey's tax planning (wouldn't that be vindictive of someone?). Hope that didn't put too many readers to sleep.

[blester01]

Ken,

I am not attorney so there is no way in hell I am reading that case; thanks for picking up my slack.

Yes, I was referring to the Knowlton estate's shares. So basically if we raise capital for one individual to buy the shares, we could get on the board.

[Comrade Ken]

Here is the link to that case. The facts are actually easy to read. The legal stuff, not so much.

http://www.ustaxcourt.gov/InOpHistoric/BROWNpaul.TCM.WPD.pdf

Since the Knowlton shares are non-voting, I don't think you can get on the board even if you can find a way to buy them. Their only value is in the amount of "excess cash" allocable to those shares on an annual basis.

[blester01]

Hell, like I said those shares are probably safer then investing in the stock market or better than buying a CD.

I wonder what kind of the annual return you would actually see on those shares. If I only had 300 million...

[It's Never Sunny in Cincinnati]

Every Bengals fan needs to read Ken's link. I don't care if it takes you 4 hours and 12 shots or tequila to do it.

Bengals fans love Paul Brown, but the suit shows that Mike and him think exactly alike. Paul Brown was truly a football innovator, but when it came to running a team (as a GM or President, not a coach), he was as shrewd as Mike. I have to think that Paul would not have been much more successful than Mike in the salary cap era (1993-2009) if he had been GM.

Oh and blester, the only thing better than Bengals stock would be having a girlfriend that stays 19 her whole life. That stock was worth $30,000 in 1983, 27 years later it's up to 30 million per share. I don't do math, but I think that's a ONE HUNDRED THOUSAND PERCENT RETURN in 27 years.

[coach bags 2011]

Thank you, thank you, thank you for making this a better day. My tummy hurts from laughing so hard.