Setting Up For Success – Succession Planning and Your Business Part 4
This article is the fourth in our series of articles on myths related to business succession planning. The first three focused on family businesses with one owner. This one will discuss the nuances of succession planning when there is more than one owner. Some people may believe that if anything happens to me my partners will make sure my family is taken care of. This may be true but there are steps that should be taken to formalize these plans to not leave things up to chance.
So let’s say you have a business with two equal partners who have not done any formal planning. In the event of the untimely death of one of the partners the remaining partner will suddenly have a new partner, the spouse of the former partner. While in some cases this could potentially be workable it is usually not. What are the chances that the spouse could just step right in and replace the deceased partner? Can the new partner bring any value? What are the odds that the two can get along? This is not usually a good situation. So what do you do?
You start by getting a business valuation to find out what the business is worth. Then you draw up a buy/sell agreement which obligates each partner to buy the other partners shares of the business in the event of the untimely death of the other partner. Unfortunately for those who have done some planning, many times the plan stops here. What’s missing is that there is no funding mechanism in place to facilitate the purchase. So where does the remaining owner go to get the funding for the buyout?
If the remaining partner has enough cash reserves to execute the buyout that is an option. If not they will have to borrow the money either in the form of a bank loan or the decedents spouse would have to hold a note. So at this point you need to ask yourself if after just losing a partner that may have brought a lot of value to the company, is now the time to go in debt. Also how likely is a bank to lend you the money in this situation? In most cases the best approach is to purchase life insurance to serve as the funding mechanism for the buyout. The life insurance could either be owned by the business or you could simply each purchase life insurance on each other which is called a cross purchase agreement.
I should mention that many of these same issues come into play if the partner doesn’t die but becomes completely disabled and can’t work or bring any value to the business? You should consider adding disability into the agreement as well.
The last step is once you have a plan in place and it’s funded, you can’t just throw it into a drawer and forget about it. You should revisit the valuation periodically to see if there has been a change in the value of the business. If you did a plan 10 years ago and the business was worth $500,000 but today the true value is closer to $1,000,000 you will have almost as much of an issue as if you didn’t plan at all. So the plan needs to stay current.
In any event, these situations are all complicated and are different in every case. As such you need to have a team of professionals to help you craft an effective plan which should include your financial planner, attorney, accountant and perhaps a consultant who has experience in putting these plans together. At Sgroi Financial we can bring the necessary resources together to help you navigate this process.
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