Consider this scenario: You’re part owner of a thriving small- to medium-sized business. You handle certain key responsibilities and rely on your partner to handle others. While your partner is away on business, the phone rings. The shaky voice at the other end of the line informs you that your partner has been fatally injured in a car accident. You’re grief-stricken. At the same time, you realize many people—you, your family, your partner’s family, your employees, customers, and creditors—depend on the uninterrupted continuation of your business. You know you should have planned for this. . .but you just never found the time.
What If I Wait?
Is this a situation you secretly dread the possibility of facing because you’ve never “found time” for business succession planning? Once tragedy strikes, it can be the worst time to deal with these issues. Under some circumstances, it may be too late. Consider the following potential risks you could face without a proper business succession plan in place.
An owner’s unexpected death may jeopardize the long-term viability of a company, whether it is a sole proprietorship, partnership, or corporation. For instance, loans may be called, or work in progress may be put on hold until a replacement can be hired. In the meantime, customers may gravitate to your competition, making it difficult to win them back.
Moreover, once a business is in crisis, selling a deceased owner’s interest may result in the surviving spouse or family members settling for a price that is less than fair market value (FMV). Since stock or partnership interests in a closely-held business are not publicly traded, their value is not established without a business succession plan.
Finally, although a deceased owner’s estate plan may have made sense for his or her estate, it could spell disaster for the business. For example, if the company is an S corporation, and the trustees of a family trust become stockholders in the business, an inadvertent termination of the S corporation election may result if the trust does not qualify.
Secure Your Future
A business succession plan helps reassure all parties the business will continue to operate. It establishes a monetary value for each owner’s business interest before the need arises. It also helps prevent problems by coordinating each owner’s estate plan with the business. One of the key components of a business succession plan is a buy-sell agreement.
A buy-sell agreement is a contract that creates a market for a deceased owner’s business interest. It obligates the owner’s estate to sell his or her shares for a predetermined price to partners or shareholders (a cross-purchase agreement); to the business itself (an entity agreement); or to both (a hybrid, or “wait and see” agreement).
Life insurance is commonly used to help fund buy-sell agreements. It provides tax-free money at the owner’s death, and can also help fund a buyout at retirement or in the event of a disability. Points to consider in choosing a policy include the size of the death benefit; the flexibility to change the death benefit as the business’s valuation changes; and the size of the cash value component. Also of importance are the policy’s ownership, beneficiary designations, and endorsements.
Smart Moves Help Beat the Odds
Relatively few closely-held businesses pass to the next generation. A demanding schedule may lead to procrastination. However, with so much riding on a proper business succession plan, investing the time to prepare one now—and to review it periodically—may be one of the smartest business moves you’ll ever make.
Keep in mind you’ll need qualified legal, financial, and insurance assistance in establishing your buy-sell agreement.
Mark Hegstrom is Certified Exit Planning Advisor and helps business owners to plan for what may be their single largest lifetime transaction: the transfer of their business. Get started by completing an exit readiness Assessment for yourself. Mark is Managing Partner at Business Owner Succession Strategies (BOSS). He currently serves as President of the Exit Planning Institute -Twin Cities Chapter.