Business Continuity and Succession Planning Essentials
A business owner's mindset is geared towards long-term survival. According to the U.S. Bureau, only 25% of new businesses make it 15 years or longer. In the early years, owners are laser-focused on growing their business, often neglecting business succession planning. Not having a plan for your business when you are not around is a significant risk to its future and long-term survival.
Succession planning is not only about death. Disability and personal bankruptcy can also disrupt business operations and negatively impact its value. Instead of thinking of business succession, it should be considered as business continuity.
For a sole proprietor or single owner of an S or C corporation, death or disability can mean the end of the business. Their spouse or heirs might not have the ability or desire to run the business. Key person life insurance on the owner can provide resources to hire someone to run the business and preserve its value until it can be sold. Often, these businesses have a key person other than the owner. Key person coverage is important for that individual and can be structured with permanent insurance to help the key employee purchase the business in the event of death or disability. Business overhead insurance provides proceeds to pay the overhead of a business if the owner is disabled, allowing time for recovery or preservation of the business's value until it can be sold.
Partnerships bring their own set of unique challenges. If your partner dies, you may find yourself in business with their spouse or kids. Your partner's personal financial problems could put you in business with their creditors. These scenarios are undesirable and will disrupt your business and hurt its value. A buy-sell agreement is not only for death but also provides rules and a roadmap to handle divorce, disability, and bankruptcy. Life insurance can fund the buy-sell agreement at death, and permanent life insurance on a key person can provide resources to buy out an owner. Here are four best practices regarding buy-sell agreements:
• A buy-sell agreement should be created at the beginning. They can be updated and should be updated over time as the business evolves.
• The buy-sell agreement should include the formula for valuing the business. A formal business valuation is not always needed; a capitalization calculation or book value can be used instead.
• Establishing rules is probably the most important consideration in drafting a buy-sell agreement. This states who can or cannot be a buyer and how the sale will be funded. A trigger clause should be added, outlining the circumstances that trigger a sale, such as bankruptcy and disability.
• Buy-sell agreements have tax implications, so ensuring the agreement is structured to minimize taxes is paramount. Having your accountant involved in the process is key.
Business continuity planning provides a formal roadmap to ensure you have a desired exit strategy and a plan to handle partner disability and personal financial problems. These issues can be planned for but become crises when they are not.
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Business value estimates are not an official appraisal of a businessʼs value and may not be provided to a third party or used for lending or third party sales. A Business Value Estimate is intended to be used as part of the business planning or personal financial planning process. Business Value Estimates are provided by a third party such that LPL makes no representations regarding the accuracy of the illustrations. LPL does not independently verify the accuracy of the information you provide or of the illustrations presented (149-LPL).
