This is Part 2 of a blog about the top 10 mistakes in Business Succession Planning. Last month’s blog looked at “process” mistakes related to the agreement itself, whether inadequately written, not updated, or overlooking certain triggers to a buy/sell event. This month the mistakes are in more of a “funding” capacity in order to execute the desired outcome of a buy/sell event.
All business owners have a business succession plan – whether they know it or not. However, the ability for the business to survive and continue to thrive in the face of adversity depends on that plan being clear, well thought out, comprehensive (covering as many possible scenarios as possible), fair to all parties, and up to date. Without this, the health of a business and the wealth of its owner(s) can be devastated by adverse tax implications, loss of value, and worst of all arguments, hurt feelings and even litigation between owners that can damage or even destroy even the strongest of businesses.
Here are 5 more “mistakes” that I see most frequently in Business Succession Planning. All of these mistakes are easily avoidable with the proper foresight and care:
A well-written buy-sell agreement will ensure that there is a well-defined prescription for how the equity in the business is to be handled in the wake of a range of specific triggers (such as death, disability, divorce, termination, etc). This minimizes the conflicts and differing viewpoints on valuation and process that so often occur in the absence of a proper agreement. However, the agreement is worthless if the means to carry out the agreement are not there. It is not always possible, or desirable to come up with the amount of liquid cash needed to buy out a partner’s share in the business at an unexpected time. Without proper funding, often times selling assets, borrowing money, or leveraging the income/assets of the company itself are the only ways to comply with the pathway of the agreement. With proper foresight, well-structured insurance programs can provide all the liquidity that is needed instead of a sudden and unexpected lump-sum obligation.
Funded plan with mismatched titling or improper use of Corporate-Owned Insurance
It’s great if your business has had the foresight to take out insurance to fund a buy-sell agreement, but if your insurance advisor isn’t experienced in the unique aspects of business succession planning (or if they haven’t communicated with your attorney/CPA) the policies can be structured in ways that can cost hundreds of thousands of dollars in taxes (capital gains, income tax) that could have been avoided. Ensuring proper tax treatment of insurance premiums, making sure individuals are not the beneficiary of corporate-owned life insurance, analyzing whether individuals or the business should be the owner/payor of the insurance policies, and ensuring proper compliance with IRS regulation 101(c) on corporate-owned life insurance are just a few of the potential landmines here.
Funded plan with inadequate type/amount of funding
How much insurance should be included in the buy-sell planning? Far too often an arbitrary amount of insurance is implemented without being linked to an informal valuation of the company. Having an amount of insurance that is too much or too little to accomplish the ultimate goal of the insurance is better than nothing, but can also have the negative impact of leaving possible points of contention between surviving parties. Often policies are structured to last for a period of time that is far too short to ensure that it is still viable for the duration of the owner’s involvement with the company.
Lack of appropriate valuation method or process
Speaking of valuation (which is ultimately the cornerstone of business succession planning) – how do you know what your company is worth? Many companies “guess-timate” on the valuation of their company, but once a triggering event occurs, it instantly creates opposing parties who will have naturally different views on how to value the equity. Having a stated valuation (updated regularly) or a method through which valuation is determined ahead of time ensures that there is minimal room for dispute at the most crucial time.
Failing to provide liquidity to company to survive
Buy-sell agreements are ideal for ensuring a peaceful and amicable transfer of ownership and control between departing owners heirs and surviving owners. However, it’s important not to overlook the impact of an owner’s absence on the business itself. Is the departed owner someone whose ideas, leadership, and input into the business can be replaced or will there be a drop in revenues, an increase in expenses, or lost clients/contracts that will ravage the value of the business itself? This too can and should be mitigated with insurance!
Business Succession Planning is a multi-faceted process requiring a thorough review of current ownership, valuation, and the desires of ownership along with careful construction of a broad plan to guide all parties to a desired solution. But beware of the pitfalls that can occur if you do not have the proper care, expert attention and communication from an experienced group of advisors. For more information and guidance through this process, feel free to reach me at [email protected] , schedule a phone appointment with me at http://bit.ly/2fLLzM9 or call me at 703-637-4339!
Michael S. Feinberg, ChFC has been working in the insurance advisory and brokerage industry since 1995. His clients include both individuals/families, and small to mid-size businesses both locally and nationwide. Michael joined forces with McLean Insurance in 2013 and through this affiliation adds value to both individual and commercial clients by offering them not only his income replacement and business planning expertise but also valuable consultation on personal and commercial insurance protection through his experienced agency colleagues.