Succession Planning – Why Now?

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According to the Social Security Administration, 1 in 4 of today’s 20 year olds will become disabled before reaching retirement age (3/11/2011), with 38% of these disabilities lasting longer than 5 years (CDA Personal Disability Quotient Calculator). Along with disability, the risk of a debilitating illness or death of a key executive must also be considered.

While these are not fun things to think about or make time for, they can have a big impact on a company that does not have a solid succession plan. A common misperception among business owners is that succession planning is for bigger businesses, when in fact each key member often plays a larger role in a smaller organization.

Here are some ways company owners can protect themselves and their business from the unexpected:

Documentation & Development

While a crude notion, business strategists often use the “hit by the bus” scenario to explain the importance of succession planning. This implores business owners to think about what would happen to their business if one of their key executives was suddenly hit by a bus. Would the business stay strong or be irrevocably damaged?

While day-to-day issues can make long-term planning challenging, a business must minimize their dependence on any one person. Documenting key practices and institutional knowledge as well as grooming young talent can mitigate exposure to the unknown. Relationships with high-value clients should also not be dependent on or solely managed by any one executive.

Buy/Sell Agreement

Imagine a company has multiple owners and one suddenly dies or becomes disabled and a family member inherits their interest. Would their spouse or child be capable of managing their portion of the business? Ideally the family member would recognize their inability to do so, but if they did want to sell their interest, would the other owner(s) have the funds to buy them out? If so, how would they determine what the business’s value?

A buy-sell agreement states that in the case of a death or disability how the other owner(s) can buy-out the family of that employee, it has a valuation built-in (which can be updated over the years to factor-in company growth), and is funded with life and/or disability insurance which provides the capital for the other owner(s) to purchase the stake of the business. This agreement also ensures that the family of the deceased or disabled owner is provided for in the case of these unfortunate circumstances.

Plan For Retirement

Another common problem for business owners is their ownership comprises nearly 100% of their wealth. While a buy/sell agreement provides for their families in-case of a death or disability, what happens should they reach retirement and a key employee or family member wants to buy them out but does not have the required capital? Or what if their business becomes worth drastically less in the years close to retirement?

In today’s environment, strong businesses can quickly be disrupted by emerging trends (e.g. Kodak and digital, Nokia and smart-phones/applications). Diversifying assets is therefore crucial for owners’ even if returns or elimination of market risk are never assured. For a planned buy-out, there are various products that can be set-up now to ultimately fund this transaction down the road.

Key Person & Business Overhead Insurance

While a buy/sell agreement provides capital to the owner’s family when a death or disability occurs, the costs to the other owners of keeping a business afloat while hiring, training, and integrating a new employee must also be considered (along with any interruption in business development). Key person insurance can provide a business with compensation in the event of a death or disability of a key employee and business overhead insurance can help pay for ongoing expenses during this time of flux.

Talk About It

While succession planning, a buy/sell agreement, and other strategies can mitigate the impact of a catastrophic event, ideally a business owner’s framework for addressing these issues does not come as a complete shock to the family members and key employees involved. Sharing succession strategies in advance with those ultimately affected can eliminate surprises and further confusion at a time of heightened emotions.

In Conclusion

Many business owners do not anticipate that succession planning is something they need until they are in a situation where it is of the utmost importance. It can be difficult to make time for these considerations, but they can be crucial to a business’s longevity. While this is general information and not specific advice, a trusted wealth manager can explain how your business can best address succession planning. Once this is taken care of, you can focus on day-to-day issues, knowing that you have appropriately planned for the unexpected.

Seth Salomon (seth@salomonco.com) specializes in corporate/personal finance, as well as small business operations and strategy. Seth recently moved back to Lexington, KY after 14 years in Atlanta and New York City and has joined his father at Salomon & Co., a financial services organization serving small businesses and families for over 38 years (securities offered through LPL Financial, member FINRA/SIPC).