Even the best-laid business continuation plan, also called a succession
plan, can fail to accomplish what it was created to do, leaving families and
employees with the unwelcome prospect
of having to pick up the pieces.
“It’s more than just a process for grooming a successor,” explains Ronald L.
Gribschaw, an insurance and financial
advisor with South Hills-based Brentwood
Advisors, LLC. “Problems typically arise in
any one of three areas: Owners fail to
develop a solid buy-sell agreement as part
of the plan, they never make the necessary
arrangements to ensure that the buy-sell
agreement will be adequately funded, or
they fail to come up with a sufficient valuation estimate for the business.”
Smart Business spoke to Gribschaw
about strategies for overcoming these
obstacles and preserving a business’s legacy after the owner exits the organization by
choice or circumstance.
What exactly is a buy-sell agreement?
A buy-sell agreement is a legally binding
document that spells out how a business
will continue to operate should a specific
triggering event occur, such as the death or
disability of an owner or shareholder or
other events including resignation, retirement or termination of an owner or shareholder. It defines who will take over the
business and how the transfer of operations will be funded.
There are several ways to structure the
buy-sell agreement to transfer the business
and avoid burdening the family or employees: a cross-purchase buy-sell agreement;
an entity-purchase agreement; or a wait-and-see buy-sell agreement, for those who
aren’t sure whether a cross-purchase or
entity-purchase agreement is most appropriate.
What can undermine the agreement’s effectiveness?
The buy-sell document is only effective if
the future buyers have the money to make
good on the agreement. This is absolutely
critical and too often overlooked. A perfectly good agreement might be in place,
but no funding provision has been implemented — the funds simply aren’t available to make it happen when the time comes —
which can result in anything from minor litigation to major lawsuits.
By not having a properly funded and
structured buy-sell agreement, the business itself may be at risk, along with the
livelihood of its employees — and the well-being of their families. The business
owner’s retirement strategy may be at risk
— since the business may represent a large
percentage of his or her overall net worth.
Survivor income to the spouse and/or family may likewise be at risk, for the same
reasons. Even the credit rating of the business may be at risk, if the owner dies.
How are buy-sell agreements typically funded?
There are several ways to fund a buy-sell
agreement while the owner is living: by utilizing what’s called a ‘Sinking Fund,’ which
consists of CDs, annuities or typical investments, such as stocks, bonds or mutual
funds; or through current earnings; or by
taking out a loan in combination with utilizing life insurance (to help guarantee that
the seller or his or her family receives the
full value of the business).
Another way to fund a buy-sell agreement is to arrange for a traditional installment sale, which is appropriate if a business will transfer from one partner to another. In this case, the partner makes
payments to the owner who is selling, and
the owner holds the note. This is ideal in
cases where the business owner is retiring
or exiting the business for some other reason but still needs a revenue stream of
some sort to support his or her lifestyle and
family.
There is also something called a Private
Annuity Arrangement, which requires the
successor to make installment payments to
the owner until he or she passes. If an
owner is selling to a family owner, a Self-Canceling Installment Note (SCIN) is an
option. This is a hybrid between a private
annuity and an installment sale. When the
owner dies, the note is cancelled and
installment payments are no longer
required.
Does the buy-sell agreement protect the
owner’s heirs as well?
Not necessarily. Without a proper business valuation, an owner’s family or heirs
can suffer by paying more estate taxes on
the business after the owner’s death. The
valuation sets the price for the business
and oftentimes can be used as the value for
estate tax purposes. Without it, the worth
of a business typically is negotiated by the
IRS and the potential buyer. Needless to
say, this rarely results in an advantageous
outcome for the owner’s family or company stakeholders.
Therefore, it is absolutely critical to obtain an accurate business valuation. There
is a laundry list of variables that comes into
play when determining business value.
Usually this process is customized.
One other frequently overlooked component in the overall planning process is the
purchase of Business-Overhead Expense
Disability Insurance on the owner of the
business. This policy allows the business to
remain up and running if the business
owner becomes disabled, relieving family
members and managers of the financial
burden of covering operating expenses.
These funds can also cover the cost of
recruiting a new manager to oversee the
company, depending on the situation.
RONALD L. GRIBSCHAW is an insurance and financial advisor
with Brentwood Advisors, LLC in the South Hills. Reach him at
(412) 308-2095 or [email protected].
