Many business owners like yourself support their families through their businesses.
But what if something were to happen to you, such as sudden death or permanent incapacitation? It’s a high probability this event will negatively impact your business and the lifestyles of the people who rely on you.
Here are three strategies you should consider when planning to protect your business and your family.
1. Keep Ownership Agreements Up To Date
Many owners create ownership agreements early in the business’ life. As your business has evolved, those agreements may have fallen out of date.
A Buy-Sell Agreement is the most common type of ownership agreement that doesn’t evolve with the business. Having an outdated Buy-Sell Agreement can be worse than having no agreement at all. Consider two examples of how outdated ownership agreements can harm a business and an owner’s family.
Maurice’s Story
Maurice Belcher was the sole owner of a successful construction company. Each year, he brought in a salary of $275,000 for his family, on top of health benefits and other perks. One day, Maurice had a heart attack and died.
Maurice had created a plan for his business 25 years ago through his estate plan, which named his wife, Diana, as the owner should something happen to him. Maurice was not a good candidate for a Buy-Sell Agreement because he did not have anyone (at that time) who could buy him out if something happened to him. So his wife, Diana, was his best option.
Diana had no business experience and immediately called Maurice’s advisors, asking them to help her sell the business for as much as possible.
When the company’s key employees discovered she was selling the business, they began looking for new jobs and left. Revenue crashed, and Maurice’s bank began to call in the company’s debts. Diana couldn’t find a buyer for the business, so she liquidated it for $375,000. After repaying the company’s bank debts, Diana was left with just $100,000, no health coverage, and no income.
In this example, a sole owner puts his wife in an impossible situation. He left her stranded without direction by failing to update his plans as the company grew.
Janelle & Sierra’s Story
Now, consider a co-owned business with outdated ownership agreements. Janelle Black and Sierra White were co-owners of Black & White Distribution. Their business was appraised at $5 million. Each brought home $375,000 in salary.
According to their Buy-Sell Agreement, which they created just five years earlier, if one of them were to die, the surviving owner would purchase the remainder of ownership.
While driving home from work one night, Sierra was killed in a car crash.
As 50/50 owners, Janelle and Sierra had each taken out a life insurance policy on each other. After Sierra’s untimely death, Janelle used the insurance funds to pay for Sierra’s half of the business.
The $2.5 million lump sum wasn’t enough for Sierra’s family to continue living their current lifestyle. Rather than the $375,000 annual salary, Sierra’s family income fell to just $100,000 a year, based on their decision to follow the rule of thumb that one would withdraw just 4% of a critical asset’s value each year.
In this case, the Buy-Sell Agreement worked as planned, yet Sierra’s family still suffered.
If your family relies on the business to maintain a lifestyle, you should consider the consequences of your untimely departure from the business and keep any ownership agreements up to date (including insurance policies) to protect yourself and your family against the unexpected.
2. Seperate Fairness and Equality
If you have children, planning for future success becomes more complex. Consider a business owner, Joe.
Joe has three children: Doug, Glen, and Janie. Janie has worked in the business for 20 years, growing it from a $1 million enterprise to $15 million.
As Joe approached retirement, he planned to transfer ownership to Janie and leave $1 million apiece to Doug and Glen after he died.
When the brothers learned how much the business was worth, they demanded an equal amount in cash from their father. They didn’t think it was fair for Janie to receive what they considered to be more money, even though the company’s value was largely illiquid and they had nothing to do with its success.
To mitigate situations like this, you should plan to communicate your goals to your children. Consider how you’ll determine what’s fair regarding each child’s contribution to the business’s success, and how any ownership or money transfers can reflect those contributions.
Equality and fairness aren’t the same; only you can determine what’s fair.
3. Have a Backup Plan
Having a backup plan is important when planning for a successful future.
The best backup plan is to have the value drivers in your business operating at peak efficiency (see my blog on How can FROGS drive up business value?). This makes the business both attractive and transferable. Regardless of whom you want your successor to be, all potential buyers/recipients of ownership will want to see the value drivers working well in your business.
Another way is to determine whether your chosen successor can continue to grow the business. Implementing strong incentive plans is a way to determine this and reward high-performing potential successors.
If you don’t have a backup plan, don’t procrastinate, get one underway now. It will give you and your family peace of mind that the future has been considered, and there are solutions to overcome potential issues. As the saying goes … “if you fail to plan, you plan to fail”.
The information contained in this article is general in nature and is not legal, tax or financial advice. Contact a lawyer or a tax or financial professional for information regarding your particular situation. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. Clients should consult their legal, accounting, tax or financial professional in specific cases. This article is not intended to give advice or represent our firm as qualified to advise on all areas of professional services. Master Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice you need.
Any examples provided are for illustrative purposes only. Examples may include fictitious names and may not represent any particular person or entity. This article has been sourced from a licence agreement with Business Enterprise Institute, Inc.
