Business Succession Planning
It’s ironic that as entrepreneurs, vision and planning are critical skills to success, but few small-business owners put enough thought and planning into what will happen if they’re not around to run the business. Just like with personal estate planning, business succession planning is an important, but never-urgent matter that business owners usually say they’ll get around to addressing, but don’t think about very much. Quite often, they never think about this and the consequences can be severe.
Death, along with taxes, they say are the only sure things in life. In fact, statistical evidence shows you’re much more likely to become disabled before retirement age than die. Under any of these circumstances, if the business doesn’t have a sound succession plan in place, the business may perish after all that work the owner dedicated to building it.
As a small business owner, if you were to die or become incapacitated, what would happen to:
- The business you’ve worked so hard to build?
- Your surviving loved ones and heirs?
- Your business partners/share-holders?
- Your employees?
- Your customers/clients?
- Your legacy?
Just as we promote the virtues of estate planning for individuals and families, we urge all small business owners to craft a carefully thought-out succession plan for the only sure thing in life—death (you can avoid taxes but won’t like the consequences).
Unlike most giant multi-national corporations, the death of one business owner can very likely cause permanent devastation to the stakeholders of the business, including family, employees and surviving partners.
The answer is found in business succession planning. Here’s how it works.
The Buy-Sell Agreement is a contract for business people that may include:
- Corporate shareholders
- LLC Members
- Key Employees of a Business
Through a Buy-Sell Agreement, we can ensure the transfer of business interests following death or disability in a pre-determined, mutually-agreed upon way that guarantees a market for their sale. The Buy-Sell Agreement between business partners allows the company to buy from the deceased business owners’ heirs their share of the business. The partners agree on a fair valuation for the company and the business sale is funded through life insurance policies the partners buy on each-others’ lives.
Without this kind of thoughtful planning, undesired results will follow the death of a business owner. This may include scenarios such as the surviving family members stepping into ownership to be partners with the deceased owner’s partner, often without the interest or ability to run the business. We advocate the right planning for our clients to take control of their lives and businesses, both for themselves and the people they care about—their family members, partners, employees and other stake-holders.
Another sound strategy is for business-owners to buy life insurance for “key persons” in the business. One of the inevitable and inherently unstable elements of any small business is the strong likelihood that one or a few individuals may be absolutely critical for its success and smooth operations. A true “small” business, say with less than 10 employees and/or owners can relate to the stress that comes from a “key person” being out of work for even a short vacation.
All small businesses should strive to build consistent systems and clearly (but simply) document all work flow and ways of creating their product or service in every facet of the company. This includes sales and marketing, finance and administration and operations.
Businesses that lack such structure and consistency will never achieve their optimal valuation in large part because any business relying too much on one or a few team members to do things the way they do them, without a proven method, is dangerously dependent on those few. To sell or pass along a valuable business, it must be a collection of operational systems independent of the people running it.
While it is clear that all small businesses should endeavor to think like big businesses when it comes to systems and operations, reality tells us that there will always be one or a few talented individuals upon whom there is great reliance. The death or disability of such a “key person” should make the business hedge its bets and insure against the likely losses that would result from such a tragic event.
That’s where key person insurance comes in. The business buys a life insurance policy (often with disability benefits added) on the life of the key person. The business pays the premium for the insured team member and owns the policy. Upon death, the business collects the death benefits. This money should soften the impact of the key person’s loss in several ways, including compensating for lost profits resulting from the disruption, hiring and training a replacement and any other use the business would have for the money.
The insurer would conduct its typical application and underwriting process to issue the policy. Typically, the death benefit policy limits will be around seven times the key person’s annual salary. A very inexpensive term life insurance policy can provide a death benefit significant for the business to help prevent further commercial loss following the unexpected death of an important team member.
It is also important for small business-owners to coordinate their personal and family estate plan with their business succession planning. This means taking into account important questions such as whether any family members and which ones may inherit interests and responsibilities in the business.
Many small businesses are family-run, often for multiple generations. Family members may play varying roles in the business, from running the show to having very little, if any involvement at all. The owners should put great care into considering how the family succession plan will be set forth. Much of this can be achieved through estate planning tools including a last will and testament and a family trust that may actually own the business rather than individuals.
This is the kind of holistic, big-picture integration of life, family and business that CPC Law helps its clients plan and execute. The most successful small businesses are constantly planning, setting goals and adjusting it all according to changing circumstances. We want to be your trusted small business advisor. Call us for your attorney consultation.