(Much of the content in this article was provided by Business Enterprise Institute.)
Successful business owners are optimistic people and would rather not dwell on the more unpleasant aspects of life as a business owner. Contemplating one’s demise certainly qualifies as an unpleasant aspect. But optimistically speaking, a case can be made that business continuity planning creates immediate and very pleasant outcomes.
No one wants to think about dying anytime soon and we all hope for a long healthy life. As optimists, we think ahead to what we want to happen and then work towards making it so. We don’t think about worst case scenarios, and because it is unpleasant, we avoid doing so.
Not wanting to seem like doomers and gloomers, many advisors go along with that optimism by using buzz words. They ask, “What happens when the owner ‘passes on’ or ‘leaves the scene?’” They talk about the consequences of an owner’s death in theoretical, third-party terms: “Should an owner die…” Unfortunately, these oblique references avoid the reality owners face: you must do this planning now in case you die tomorrow.
To begin exploring the pleasant aspects of continuity planning, consider this set of premises:
- Continuity planning is very much akin to exit planning… the one significant difference being, it is planning for an unexpected, premature exit.
- Continuity planning ensures the right people control your business’ future rather than some anonymous third party.
- It is never too soon to start planning for your exit because doing so has an immediate and continuing positive impact on the success of your business
Taken together, these premises lead to discussing business continuity planning in a way that you may not expect. Typically, when owners think of business continuity, they do so at the prompting of an insurance or legal advisor who warns that unless they take prudent measures, they will leave their families unprotected in the event of death or permanent disability.
Business continuity, however, is not principally concerned with making sure an owner’s family is taken care of in the event of the owner’s death or disability. As an owner, you must address those family concerns through proper estate planning.
Business continuity (or unexpected exit planning) is, on the other hand, a means of handling a variety of transfer events and consequences that impact the business and the remaining (or new) owner when the original owner leaves. And it necessitates improvement on many levels including:
- Successor identification and preparation
- Employee retention and productivity
- Legal structure integrity
- Financial partnership continuity
- Client relationship management
- Supplier relationship continuity
- Tax liability mitigation
- Intellectual property ownership and protection
- Business systems, service models, production processes refinement
Let’s look at the multiple problems facing sole owners and owners in multi-owner companies that an owner’s death or disability creates for the business and some possible solutions to each of these problems.
MAKING SURE THAT YOUR BUSINESS CONTINUES IF YOU DO NOT
The thought of what will happen to our businesses should we die is, at most, fleeting. In that moment, we seldom think beyond making sure our families are protected should the unthinkable happen to our co-owner, of course. Yet business continuity, in its most fundamental sense, has nothing to do with protecting an owner’s family. It is about preserving and protecting the business, in the short term and in the long term, should its most important component, its owner, die or otherwise become incapable of continuing in the company.
Ownership succession is the most obvious problem facing a company, but it is one of four vital issues:
- Continuity of Business Ownership
- Company’s Loss of Financial Resources
- Loss of Key Talent – You
- Loss of Employees and Customers
Let’s look at how each problem affects both sole-owner and multi-owner companies.
Problem: CONTINUITY OF BUSINESS OWNERSHIP
Sole Owner Company
Continuity of business ownership is the critical issue in a solely-owned company. In fact, there is no continuity unless you take steps now to create a future ownership group or owner.
Multi-Owner Company
Continuity of ownership is not an issue when a funded (with life insurance) buy/sell or business continuity agreement has been implemented. The problem is that most owners (and their advisors) fail to keep their buy/sell agreements up-to-date and, as a result, those agreements often create more problems than they resolve.
Problem: LOSS OF FINANCIAL RESOURCES
Sole Owner Company
Sole owners typically give little thought to the loss of financial resources (represented by the owner and his financial statement) used for the benefit of the business. Without a replacement for that financial strength, the business may well not survive despite a plan in place for its continuity of ownership. More specifically, an owner’s sudden death or incapacity can cause other “stakeholders” to discontinue their relationships with the business. These situations include:
Multi-Owner Company
Continuity of ownership is not an issue when a funded (with life insurance) buy/sell or business continuity agreement has been implemented. The problem is that most owners (and their advisors) fail to keep their buy/sell agreements up-to-date and, as a result, those agreements often create more problems than they resolve.
Problem: COMPANY’S LOSS OF FINANCIAL RESOURCES
Sole Owner Company
Sole owners typically give little thought to the loss of financial resources (represented by the owner and his financial statement) used for the benefit of the business. Without a replacement for that financial strength, the business may well not survive despite a plan in place for its continuity of ownership. More specifically, an owner’s sudden death or incapacity can cause other “stakeholders” to discontinue their relationships with the business. These situations include:
Bank Financing. If you have personally guaranteed the company’s line of credit or permanent financing, your sudden death or departure will make the bank re-examine its lending relationship with your company.
Bonding Capability. Construction companies are just one example of firms that need and rely upon bonding capacity to bid and obtain much of their work. Your sudden death will likely cause the bonding companies to refuse to extend bonding unless the financial statements of those left behind are as strong as yours. Inability to secure bonding can mean the end of your company.
Obligations Under the Lease. If you lease space or equipment, it is likely that you personally guaranteed the lease. While the lessor may be unable to do anything to terminate the lease (provided payments stay current) he is unlikely to renew the lease without the successor owner’s guarantee backed by personal assets.
Capitalization Shortfall. Business owners periodically personally capitalize their companies because they keep little money in their companies. There can be sound liability and financial reasons for doing so. Your exit, however, may prevent your company from obtaining ongoing and adequate capitalization from any other source. Your deep pockets go out the door when you do.
Multi-Owner Company
If you, personally, are a principal source for financial funding (bond guarantees, line of credit guarantees, etc.), your death can put enormous pressure on the business to perform or face the risk of third parties refusing to lend or make guarantees on behalf of the company.
Problem: LOSS OF KEY TALENT – YOU
Sole Owner Company
Your death likely has the same impact upon your business as does the loss of any key person. Your talents, experience, relationships with customers, employees and vendors may be quite difficult to replace, especially in the short term. Without planning, few businesses have the financial resources or successor management to weather this storm.
Multi-Owner Company
Multi-owner companies seemingly avoid many of the problems endemic to single-owner companies. But, as it relates to the loss of key talent, this is only true if surviving owners can readily compensate for your loss. To the company, your death is the same as the loss of the key person. If the remaining owners do not have your experience or particular talents, the business suffers as sorely as if it had been solely-owned. Unless there is a key employee (co-owner or not) to fill the void, the business is wounded–perhaps mortally–upon the death of a co-owner who:
- was the marketing guru on whom the other owners were dependent to provide new clients;
- oversaw the operations of the company;
- or maintained most of the industry,
- customer or other key relationships.
Problem: LOSS OF EMPLOYEES AND CUSTOMERS
Sole Owner Company
A common and natural consequence of an owner’s death is the speedy emigration of employees and customers unless an existing continuation plan is immediately implemented. Without such a plan, the key and non-key employees will wonder where their next paychecks will come from. Typically, they leave for greener and more secure pastures. When the workforce leaves, contracts cannot be completed and are breached, work is unperformed and creditors call in their paper. Of course, the resulting losses often require payment by the owner’s estate as the case study below demonstrates.
Case Study
Clint was a successful and hard-working owner of two successful businesses. Like most entrepreneurs, he tended to make all the decisions himself. At age 43, he knew he was far too young to be concerned with his death or disability and how that might impact his family or business. And then one day, as he bent over to unbuckle his ski boot, he dropped dead.
Tragic as Clint’s death was to his family, his failure to make any plans whatsoever for the businesses was a death- blow to his company. No one knew what Clint’s wishes were with respect to continuing or selling the businesses.
No one, (within his family especially) knew the overall business financial condition, administrative status or operational concerns. The key employees knew only one thing for sure: the businesses would not long survive
Clint’s death. So, these employees promptly found new employment; thus hastening the inevitable shutdown of Clint’s once-vital businesses.
Multi-Owner Company
Companies with multiple owners must cope with the normal lifetime retirement of their owners. In most cases, retirement imposes a significant cash drain upon a company. In a death scenario, the surviving owners must be capable of keeping both the employees and the customers. Simply having a successor owner is not sufficient. These successors must be able to maintain cash flow as well as the confidence of the business’s employees and customers.
Confidence is best gained by having a written, well-capitalized continuity plan.
Solution: CONTINUITY OF BUSINESS OWNERSHIP
Sole Owner Company
How can you prevent the type of disaster that befell Clint’s family? First, create and implement a plan to allow the business to continue after you are gone. Since there is no co-owner, you must provide for the business’s continuity – even if owned by your estate or a trust for the benefit of your family – by securing the continued services of your important employees. Do everything you can to prevent your employees from leaving because they are indispensable to the business’s continued existence. Secure their continuation by compensating them at a substantially increased level (usually 50% to 100% more than they ordinarily receive). This is best accomplished through the use of a stay bonus.
A stay bonus is a written, funded plan providing monthly or quarterly bonuses, usually over a twelve to eighteen- month time frame, for employees who remain with the company during its transition from your ownership to new ownership. (This applies whether the business is transferred to a third party, to employees or to family members.) The stay bonus provides a cash incentive for your important employees (perhaps 20 to 50 percent of the total workforce) to stay, hence its catchy name.
Typically, the stay bonus is funded with life insurance in an amount sufficient to pay the bonuses over the specified time period. The life insurance may be owned by the company or outside the company in an estate tax-sensitive trust. The plan is communicated to the important employees when it is created so that they know a plan exists and, consequently, that thought and planning (and money to pay salaries!) will ensure the continuation of the business.
The second linchpin of single-owner continuity planning is to do exactly what Clint didn’t do – communicate your continuity wishes now. At a minimum, you must communicate, in writing, your wishes as to what should be done with the business upon your death or permanent incapacity:
- Designate key employee(s) or others who can be given the responsibility to continue and to supervise business operations, make financial decisions and oversee internal administration. Name today these individuals on the attached Business Continuity Form.
- Name advisors and others (such as a friendly competitor) who should be consulted in the ownership transfer process. (Again, put these names on the Form today.)
- If it is your wish that the business be sold, state that intention and list the names and contacts of businesses who have expressed an interest in acquiring your company or who you think would make an appropriate successor/owner. Do so on the Form.
- You may wish to indicate that it is your desire that the business be sold to key employees, continued in the family, or liquidated. The choice is yours, but you must make it while you are alive. Is there a better time than the present to do so?
- Finally, give the completed Business Continuity Form to your spouse and copies to your advisors.
Multi-Owner Company
From a continuity standpoint, the nicest thing about having multiple owners is that the business will continue if one of the owners dies, provided measures are taken (usually in the form of an up-to-date, adequately funded buy/sell agreement) for the remaining owners to acquire the deceased’s interest in the business. Having said this, chances are, your buy/sell agreement has not been recently reviewed, does not reflect current business value and does not completely address the many possible transfer events such as:
- Death,
- Disability,
- Transfer to a Third Party,
- Termination of Employment,
- Retirement,
- Involuntary Transfer Due to Bankruptcy
- or Divorce, and
- Business Dispute among Owners.
Finally, it is likely that your buy/sell agreement does not fully address each transfer event (e.g.: termination of employment of an owner) from the perspective of whether the company has (or the other owners have) an option or put a mandatory requirement to reacquire the ownership interest.
As may be apparent, the biggest risk to the continuation of businesses that are co-owned is not the death or disability of one of the owners. Rather, it is that the above-listed events are considered once and memorialized in an agreement. All further thought and action on the subject are shelved – along with the agreement.
Harness the True Power of Optimism
Remember the three premises we started with:
- Continuity planning is very much akin to exit planning… the one significant difference being, it is planning for an unexpected, premature exit.
- Continuity planning ensures the right people control your business’ future rather than some anonymous third party.
- It is never too soon to start planning for your exit because doing so has an immediate and continuing positive impact on the success of your business
An owner who wishes to maximize success can be pragmatically optimistic knowing that any continuation planning done today will accelerate their success immediately and throughout the life of the business.