In previous articles on the topic of business succession planning, we have discussed the need for long-term planning to assure an orderly transition of your business and receipt of value from it at the age and time of your choosing. Unfortunately, life doesn’t come with guarantees, and there is always the possibility of a premature death or a permanent disability, either from accidental or natural causes. That calls for contingency planning to make sure that you or your family receive a realistic value for the equity stake you have in your business in the event of the unexpected.
Most business owners are focused on the future of their business, and since they are not looking to sell in the near term, they don’t pay a lot of attention to the value of their business. While a buy/sell agreement may already exist in some form or another, it may not guarantee full value – and thus put your company’s future at risk.
If your company was organized or is owned by multiple shareholders, it is likely that you have already tendered an offer to sell your share of the business in the event of your death or disability as part of the business formation documents (e.g. stock redemption, buy/sell, or management control agreement). However, we often find that business owners have not reviewed the terms of that agreement since it was initially presented, if ever.
Since the agreement is binding between you and your business partners, wouldn’t it make sense to periodically review it to see that it is up-to-date and provides for a realistic valuation of each shareholder’s equity in the business? Further, in light of that value, are the individual shareholders, or the business, capable of generating the net after-tax income needed to redeem a shareholders interest? What happens if there is an incident that leads to the death or disability of more than one shareholder? While the business may be able to absorb the cash flow required to redeem one partner’s shares, can it handle the redemption of more than one interest and still leave the company viable and the remaining shareholder(s) able to maintain their personal income requirements?
Most companies will purchase some amount of insurance coverage to ensure that adequate funds are available if the unexpected happens. However, on the review of buy/sell agreements and funding provisions, we often find:
We have seen agreements with their own definitions of “disability” and “waiting period” that are not tied to the delivery of a disability claim. That puts the company or other shareholders in the position of having triggered a buyout without the anticipated insurance funding. We would suggest that an annual review and sign off on the company value should be part of the company’s annual meeting. That keeps a focus on updating values and keeping insurance up to date for funding the agreement.
So far we have discussed companies with multiple owners. What about sole-owner companies? Is a spouse or heir capable of running the company? Will employees critical to the success of the company stay on? Will the company be able to survive the loss of its leader? One consideration would be the establishment of a one-way buy/sell agreement with an individual or group of employees capable of running the business if something happened to the sole shareholder. By funding that agreement with insurance, the money needed to buy the business from the heirs will be available, helping to ensure an orderly transition of both ownership and governance for the company.
We suggest the following steps as a way to assure an orderly transition of business equity:
Multiple insurance carriers will, often at no cost to our clients, prepare an informal company valuation. In the underwriting process, the insurance carrier needs assurance that the company value is realistic in light of the amount of coverage being requested. The valuations prepared by insurance underwriters utilize the same blend of techniques and processes that a certified business valuation firm would use, but with one exception: a valuation completed by the insurance underwriter does not typically include the comparable sales of similar companies, as a formal business appraisal would. Where a formal appraisal would typically be used in IRS or court challenges, under such circumstances as inter-family gifting, divorce settlements, or value disputes, the informal valuation provided by the insurance company is typically more than adequate for guidance on values for buy/sell agreement purposes.
In addition, as the insurance carriers are interested in seeing that applied-for insurance coverage will be properly utilized in light of the buy/sell agreement commitments, multiple carriers will have their legal department provide written review of a client’s current buy/sell agreement.
Rex’s experience allows him to expertly assess clients’ needs and develop the most effective solutions. He has over 46 years of experience in the financial services industry. He has an extensive background in qualified retirement plans and health and welfare benefits plans.
Rex’s experience allows him to expertly assess clients’ needs and develop the most effective solutions. He has over 46 years of experience in the financial services industry. He has an extensive background in qualified retirement plans and health and welfare benefits plans, including both consulting in the design and implementation of plans as well as in the administration of them. He also has extensive experience in financial planning, including estate planning, business succession planning and non-qualified retirement plans.
In the current market, there are many opportunities to buy and sell companies. Acquiring a company can help meet business expansion goals, but can also create potential risk of future liability and financial loss flowing from the acquired firm or purchase agreement.
While traveling abroad for business can be exciting and fun, international travel is also stressful. Take into consideration these steps before departure to reduce risk and stress while traveling abroad.
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