When focusing on the day-to-day operations of your business, it’s easy to overlook planning for its future. And if your adviser doesn’t bring it up, you may never put a plan in place. However, having a well-thought out succession plan can ensure that your business continues after your retirement or death.
“It’s always a delicate conversation to have,” says Michael Dreveniak, vice president and wealth market leader with First Commonwealth Advisors. “Nobody wants to talk about when they are no longer here, but this is something that you have to do.”
It’s crucial to have answers for two questions, he says — what happens to the business if you are no longer around, and what happens in the event of your incapacity?
Smart Business spoke with Dreveniak about the importance of planning and how insurance can play a critical role in the process.
Why is succession planning critical to the continuity of a business?
There are risks associated with failing to plan. For example, when an owner passes away, there could be a lack of cash flow to maintain the business, which could result in a lower company value. And if the business isn’t well funded, it will lose key individuals and be unable to attract top talent to continue running the business.
The biggest misstep business owners make is failing to address this issue at all. Talk to your advisers — accountant, attorney and wealth manager — to ensure the best interests of your beneficiaries and heirs are considered. Your advisers are paid to walk through risks and anticipate them, providing ‘what if’ scenarios to ultimately arrive at a solution.
The classic example is the mom-and-pop shop that has been in business for 30 or 40 years and then closes its doors because the owner retires and there is no plan to continue the business. Proper planning could have allowed the business to continue running and the owners to accumulate additional wealth. Small businesses — classified as those with less than $7 million in annual revenue and fewer than 500 employees — represent 99.7 percent of all employer firms, and too many of those fail to create a plan.
When should business owners start planning and what steps should they take?
Five years is the perfect time horizon. Begin with the end in mind and allow financial professionals to ensure your balance sheet is cleaned up to maximize value. If the company is more attractive, you can receive top dollar and enable the parties involved to receive financing from a bank, other financial institution or investors. Then, evaluate the plan every year or two to monitor your progress.
Being proactive and having a well-designed plan can help with unforeseen future issues. When planning, prioritize what is most important to you, such as exit planning, income protection, retirement income, business protection, wealth transfer or survivor income. This keeps you from trying to tackle everything at once.
As your business changes — for example, you bring on another employee or your personal life changes — discuss it with your advisers so those changes are reflected in your succession plan.
How does a one-way buy-sell agreement work and why should a business consider it?
Many succession plans engage a well-defined buy-sell strategy, which dictates ownership going from the owner to another individual. It’s a key component of the planning process. With a one-way buy-sell agreement, if the owner of a company has somebody in mind — whether internal or external — who plans to purchase the company, there’s an agreement that he or she will buy from the owner upon some qualifying event, such as disability, death or retirement.
This works well where there is a sole owner, oftentimes for businesses with $1 million to $5 million in annual receipts and fewer than 100 employees. The one-way buy-sell will dictate how the funds change hands to purchase the business. If the owner is not around, in many cases, it provides a way for the beneficiaries and heirs to be compensated.
How can life insurance assist with a buy-sell agreement?
If the person who is going to purchase the business buys life insurance on the life of the business owner and the owner dies prematurely or the plan is to transition at death, the insurance provides the funds needed to purchase the company quickly. It’s a plan to provide certain funding when needed.
How else can the right insurance aid with planning?
Business owners work extremely hard to grow their assets, so protecting them should also be a priority. After accumulating a large asset base, that money can go quickly for long-term care if something goes wrong with your health.
In Pennsylvania, the cost to be in a nursing home averages $8,000 per month, or $96,000 per year, for care in a semi-private room. If high costs erode your asset base, your beneficiaries or heirs are forced to have a fire sale of assets to raise money for your care. Long-term care insurance is a way to mitigate some of that risk, to transfer it to an insurance company as opposed to the owner.
Here is a final reason to ensure that you incorporate insurance into a defined plan. Though some business owners say, ‘I may never use long-term care insurance. I get no benefit and just pay out every month,’ properly placed insurance enables business operations to continue when the unthinkable occurs. Until then, it works to protect your assets and brings peace of mind so that you can concentrate on your business instead of worrying about the ‘what ifs.’
Michael Dreveniak is a vice president and wealth market leader with First Commonwealth Advisors. Reach him at (412) 518-1854 or [email protected]
Insights Wealth Management is brought to you by First Commonwealth Bank.