Disaster
Planning Versus Succession Planning
(July,
2016)
Business
owners should have an exit strategy: a
plan for the time when they're either
unwilling or unable to keep running their
company. Often, that planning can include
a current disaster plan for relatively
young business owners and a future long-
term succession plan for a smooth path
to retirement.
Worst
case scenarios
No matter how young or how healthy you
are, you're not immune to tragedy. Therefore,
business owners should have a disaster
plan, which might be called a catastrophe
plan or a continuity plan or something
similar. Such a plan can protect you or
your family in case of death or disability.
To
understand why such a plan is vital, consider
what might happen in its absence.
Example:
John Smith, age 45, is the sole shareholder
of the successful John Smith Co. After
a fatal auto accident, his widow Jane
inherits John's shares. At such a time,
Jane will have to find a buyer and negotiate
the terms of the sale. Jane may have a
difficult time getting full value for
this profitable business.
Alternatively,
John might suffer a stroke and lose his
ability to work full-time. In the absence
of a disaster plan, John (or someone representing
him) will have to relinquish control of
the company and find some way to realize
the value of the business he has built.
Buy-sell
benefits
To provide protection against such possible
disasters, business owners and co-owners
of all ages should have a buy-sell agreement
in place. Such an agreement should identify
the buyer, in case a sale becomes necessary,
and specified events that will trigger
the buyout. The agreement also should
spell out how the price will be determined-it
could be a multiple of cash flow or revenue,
for instance.
If
a company has two or more co-owners, a
mutual buy-sell can be effective. For
sole shareholders, such as John Smith
in our example, finding a buyer may require
some creativity. A key employee might
be named, or even a competitor. Funding
for a possible buyout might be provided
through life and disability insurance.
Happier
ending
If all goes well, our hypothetical John
Smith will remain healthy and active throughout
his 40s and 50s. His company will continue
to prosper. In his 60s, though, John might
start to think about stepping down-or
at least slowing down. At some point,
John should begin working on a long-term
succession plan for his retirement or
semi-retirement.
Note
that John should not ignore the chance
of a catastrophe, at any age. Therefore,
his succession plan should include disaster
planning. For the long-term plan, John
may prefer to have a different buyer than
the buyer for the catastrophe plan. (The
initial catastrophe plan can contain language
allowing for cancellation of the agreement
with written notice from the buyer or
seller.)
In
addition to catastrophe coverage, the
long-term succession plan might have a
schedule for John's future participation
in the company. Will John leave altogether,
as of a certain date? Will he continue
to work at the company for a certain or
an indefinite time period? If he stays
on, what responsibilities will he have?
In some cases, the purchase price might
be reduced, if John leaves the company
altogether; a higher price might be agreed
upon if John agrees to stay for a while,
helping the company make the transition
to new ownership.
A
long-term succession plan also should
cover taxes because certain deal structures
can be more or less favorable to the seller.
Our office can help you work out the terms
of a fair agreement, for disaster protection
as well as for a satisfactory exit.
