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 firstname.lastname@example.org.