Christopher Jackson, Financial Times

You and your partner have owned a successful business for several years. One evening your partner complains of chest pains and a few days later he dies of a heart attack.

What happens to you and your business? Without a current buy-sell agreement and adequate life insurance, you may not have a business at all.

Without such plans, your late partner's shares pass to his estate which distributes them to his relatives, spouse and favorite charities. Suddenly you find you are in business with someone you don't know - and who doesn't know you. The new owner may be able to sell his shares to someone else, at the best price he can get, and may well do so without concern for your interests. Key employees, suppliers, customers and creditors can become nervous. Unsecured creditors may press for faster payment. Any banker concerned about his retirement will think twice before renewing credit lines. Without warning people who unquestioning loyalty you had commanded are pressing you on all sides with their concerns and your business starts to seem much less secure. Worse still, you have lost perhaps the only other person who understood the business as thoroughly as you do and on whose business experience and personal qualities you relied completely.

All this doesn't have to happen if you plan correctly. If you partner dies, it is usually best for all concerned if his business interest passes to you, not to a family member who may not want to own it or know ho to handle it.

To make sure of this, you should have a buy-sell agreement, a document that requires each partner to sell his interest to the other partner, and requires the other to buy it. The agreement will also set out the worth of your business and tell how to evaluate it exactly if a part is to be sold. Thus the business can survive the death of a key person and keep the same management, while your partner's family will get the full value for his share of the business.

Valuing the business is a key feature in this buy-sell agreement. If it's a fairly new company, value should perhaps be based on an agreed floor value, though market value should also be taken into account because it affects capital gains liabilities. Businesses are commonly valued on their earnings history. Don't base the value on a single year's earning, though. If you have a bad year, it could mean less money for the estate. Financing a buy-sell agreement is critical.

If you partner dies, where do you find the money to quickly buy out his interest? Unless a business has large cash reserves you'd have to either finance the purchase out of future profits, or borrows the funds. Such solutions have severe disadvantages. If the business encounters difficulties, it may be unable to meet its obligations no matter what the agreements says. Such arrangements weaken the balance sheet and reduce cash flow.

Borrowing may be a problem if a lender is reluctant to commit after the death of a key person. Life insurance may be the best method to guarantee the necessary funds without increasing your obligations or affection cash flow. Your circumstances will determine the insurance arrangements but the idea is to have enough to buy out the stock of a deceased partner.

You and your partner can both have insurance on each other's lives so that if one dies, the other can use the proceeds to buy the partner's interest from his estate and vice versa. If you business is incorporated, you have even more scope. Individual shareholders may insure each other, just like partners. The disadvantage here is that each shareholder must pay life insurance premiums personally.

A better method is to have the company own and pay for the insurance. When a shareholder dies, the insurance proceeds are paid to the company, which in turn pays them to other shareholders so they can purchase the dead shareholder's shares from his estate.

Another solution is for the company to purchase the shares directly from the deceased shareholder's estate, thus increasing the proportionate holdings of the surviving shareholders. Consider having power of attorney for each principal business owner as well. If you partner is incapacitated for a length of time, such a precaution might prevent delays in making crucial business decisions.

Conditions change rapidly in business, so review all such agreements and insurance arrangements annually to ensure they meet your needs and have not been affected by changes in legislation.

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While most business owners understand the need to protect against unforeseeable risks related to their capital assets – fire and theft for example – risks relating to another key asset, HUMAN CAPITAL, are often overlooked.

These risks involve the loss of key personnel due to death, disability, or critical illness. Such events can threaten the viability of your business, and the risks are far from remote.

For a 40-year-old employee, there’s a 60 per cent chance that they will become disabled for a period of three months or more before the age of 65. Where a disability of over three months does occur, the average duration is between three and four years. The odds of an employee dying are less than this, but are still significant. What are the potential threats to your business?

 

 

 

 

 

 

 

There are several:

 

 

 

 

 

 

 

 

 

 

 

• Your business performance may lag due to the absence of the individual.– You could incur costs to replace the individual.
• Creditors may restrict or withdraw credit.
• Suppliers may tighten payment terms.
• Customers may reconsider using the business as a supplier of product or service.
• Other employees may be enticed to other career opportunities if there is confusion and uncertainty surrounding the event.

 

 

Below is a list of some of the most important issues we discuss when we work with you to develop a business Continuation plan.

 

 

 

 

 

Key Person Protection

 

 

• Identifying your key people
• Assessing your potential losses
• How key person insurance can help

Sole Owner Protection 

 

 

Sole owner protection for your Proprietorship or Single Owner Corporation

 

 

Protecting Your Business if a Co-Owner Dies 

• How death changes everything
• The need for a buy-sell agreement
• A buy-sell agreement must address "The 4 D's."
  Death or Disability of a shareholder / partner
  Disagreement between owners / shareholders
  Divorce / Bankruptcy, etc. of a partner/owner. Do you want their ex-spouse or creditors as new partners?
• Funding options for a buy-sell agreement
• Comparative costs of alternative funding methods for a buy-sell agreement in the even of at death, illness, etc.

Funding a Buy-Sell Agreement Using Insurance (Types of coverage and policy ownership)

 

• Individually-owned criss-cross
• Corporate-owned criss-cross
• Corporate-owned share redemption
• We explain the Stop-loss rules and how they affect buyouts
• We must always be careful of grandfathered arrangements
• We are also concerned about Strategies to maximize tax effectiveness
• Use of a holding company structures

Corporate Accounting and Life Insurance 

 

• Deductibility of premiums (When are they deductible? When are they not?)
• Presenting cash surrender value (CSV) in the financial statements
• Insurance proceeds and the capital dividend account
• Taxation on disposition of a policy

Exit Strategies

Business succession planning is simply the process of determining how you are going to transfer your business ownership and transition out of a business management role, while maximizing your personal financial security. 

 

Why bother with advance planning? There are several reasons.  

 

 

 

• A poor management transition plan can have a negative impact on business results, and can even result in business failure.
• The value of your business may represent a substantial source of income for you in retirement. Proper succession planning can ensure that risks to your retirement capital are minimized as you approach the end of your work career.
• If you hope to have your business continued by one or more family members, you will likely need to co-ordinate your business plan with your estate plan. You will also want to explore any tax deferral opportunities that could benefit you and other family members.

 

 

• An unforeseen event—such as the death or disability of you or a business partner—could lead to business chaos without proper planning and financial protection. Advance planning can ensure that you, your family, and your business are all properly protected, through good times and bad.

 

Here are some of the most important issues we discuss when we work with you to develop an Exit Strategy.

When You are Ready to Retire or Leave the Firm:  

• Will you leave the business completely or only "slow down?"
• Do you want to pass it to someone in your family, will you sell to someone else or will you wrap the business up?
• How will these different options affect your retirement planning now and your asset base once you retire?
• If you want to sell it how will you find a buyer? i.e. Will the buyer be an employee or someone outside the firm? i.e. A competitor, etc.
• How with the valuation for a sale be determined? Will this vary based on the type of buyer?
• Where will the money to purchase your interest come from? Ongoing revenues or the buyer’s external assets?
• If it will be an employee will you start selling some of your interest now? Can they establish a mechanism now that will ensure they have the resources when you are ready?

How long will you be expected to stay with the business once a buy out has been established? 

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