Business continuation Featured

8:00pm EDT October 26, 2007

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