Succession planning

While successful business owners
spend a great deal of time building
wealth through their ventures, many do not properly protect their assets
by having a business succession plan in
place. Allocating the necessary time and
resources to create a succession plan, in
which you address how you would handle
the premature departure of a partner, can
pay huge dividends in the future.

“You have to ask yourself a number of
questions, including: If my partners die or
become disabled what do I want to happen? How do I want to buy them out?” says
Christopher Lapple, vice president, regional insurance consultant for Comerica
Insurance Services.

Smart Business spoke with Lapple about
business succession plans, specific strategies that can be implemented and the
importance of obtaining an accurate business valuation.

Why is it so important to have a business
succession plan in place?

There are business owners that have
worked 30, 40 years to build their business,
but they have no plan in place to buy their
partner out in the event that he or she dies,
becomes disabled or retires. Only about 20
to 30 percent of closely held or privately
held businesses actually have a written business succession plan in place that is funded.

There are several different ways to fund a
succession plan, with life insurance generally being the most cost-effective method.
Without life insurance, the options are
either borrowing money from the bank and
paying interest or utilizing operating profits,
which hurts business profitability.

How far in advance of an anticipated departure should business succession planning
occur?

There are no anticipated departures,
except for retirement. No one knows when
someone will die or become disabled and
will never be involved with the business
again. You have to plan for the worst-case
scenario and ask yourself, ‘How am I going
to buy out my partner’s business interest if
he dies or is disabled tomorrow?’ The time to plan is now. Drafting a written plan with
your business planning attorney is essential. Your plan must address all possible
departures, planned or unplanned. Some
owners may even address the loss of a professional license as a buy out trigger. In
addition to the three obvious buy out situations, there may be areas that are critical to
address simply because of the uniqueness
of the business.

What are some scenarios involving a partner that make succession planning especially critical for closely or privately held
businesses?

Further complicating a buy out situation, the surviving partner(s) may be
faced with a loss of partner talent or
expertise. More than likely, he or she is an
integral part of the business and has significant knowledge in a specific area that
can’t be replaced immediately. For example, one partner may do all of the marketing and sales or has a highly skilled engineering background that might be difficult, if not impossible, to replace. You
have to look at each partner individually because everyone brings something to the
table. There are some cases where people
within an organization are cross-trained,
so losing a partner won’t have as much of
an impact, but usually partners complement one another in terms of knowledge,
skill and expertise.

What strategies can be incorporated into a
business succession plan to address the
departure of a partner?

Most people choose to pay an insurance
premium using pennies on the dollar and
leverage the money into a death or disability
benefit. This allows your succession plan to
be immediately and fully funded for these
events and transfers the risk to the insurance
company. The money is then certain to be
there upon any of these triggering events.

How should the valuation of a business be
determined?

It is critical to have a valid, reasonable
accounting of what your business is worth on
the open market. You need to get a business
valuation from a valuation specialist or a ballpark figure from your tax accountant or CPA.
A lot of people use a gut feel for what they
can get for their business, but a business valuation expert will value your business by a
number of different methods, including book
value, capitalized earnings or recent comparable sales in the market. This will also mitigate any disagreement among partners when
death or disability occurs.

How often should a business succession plan
be reviewed or updated?

Any time you have a significant change in
the value of your business, either upward
or downward, you should review your
plan. For example, if you know that your
net income has doubled, there is probably
a strong likelihood that your value has doubled or tripled. The need to review or
update your business succession plan
could arise every year or every five years; it
is really a case-by-case basis.

CHRISTOPHER LAPPLE is vice president, regional insurance consultant for Comerica Insurance Services. Reach him at (310) 712-6789 or [email protected].

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