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Business Succession Plans

In this day and age, this topic is usually about technology and information recovery after a disaster. If you recall 9/11,  it was really much more than that.  While it resulted in a technological nightmare, more importantly, it resulted in tragic loss of lives and what they meant to their family and company.  

The emotional and financial loss of these men and women to their family is obvious. But as a business owner, can you imagine what impact it will have on your firm if you lose one or more of the key contributing partners in this process?  Or worst, what happens if your business losses you as the brainchild and nucleus of your company.

While we cannot control the unpredictable timing and impact of disasters and disruptions, a good business continuation plan helps you to prepare for such unforeseen events that reduces probability of failure of your firm. 

Let’s start with the worst-case scenario, the death of one of the business owners. What will happen to your business if you die? You may think that if you die, your family can maintain their income by running the business themselves or by hiring someone to handle day-to-day management. The fact is, your loved ones may not have the skills or  desire for the job and your co-owners may not like the idea of an unintended partner. With a properly funded buy-sell agreement,  your business partners will not have to scramble for money to buy out your share of the business and your survivors will be compensated fairly and promptly.

So what alternatives do you have to secure the ongoing success of your company and the financial health of your family? The following are most likely scenarios:

1)  As a business owner, you take out loans to help grow their businesses, and often secure these loans with personal assets. If you have business loans and were to pass away before they were paid off, you might think your family could sell or liquidate the business to cover the debts and provide financial security for them.

If this was possible, your family will need funds for the family,  finance the firm's daily operations and money to hire a seasoned executive to run the company professionally. 

At the best case scenario, if your family has the cashflow, they can keep the financial duress under temporary control by paying for bills on a dollar for dollar basis.... at least on an interim basis.

On an intermediate basis, without proper funding for the company, the family will likely have to resort to other funding options.

2)  Get a loan from a bank - As a banker, would you loan funds to a business which had just lost its CEO and goodwill with its vendors and partners?  In many cases, the business may be worth very little without the proprietor or partner.

 Even if a bank was willing to do this, the cost of loan will likely be higher than prior to the disastrous event. Another alternative will be:

3)  Sell the business quickly - meaning they may have to sell at a discount or during market conditions that make the business less attractive.

But if you plan ahead, you can have a business continuity plan in place.

4)  With the availability of an official buy-sell agreement in place with a prearranged  funding source for it,  you are likely looking at the most cost effective way of ensuring the continued success of your company. 

Because of the ability of life insurance to provide financial leverage, buy-sell agreements are typically funded by life insurance policies purchased on the lives of each of the business owners. The amount is usually specified in a contract created with the help of an attorney. You can enter into a buy-sell agreement at any time, but it often makes sense to do so when a business is formed or when new owners are brought into the business. Because business values can fluctuate, it's important to review the contract with your accountant at least once per year or to include a calculation method in the agreement. Also be sure the insurance coverage funding the agreement in up to date.

Just as important as insuring against death, business owners can also insure against the risk of becoming disabled and inability to work in their current position due to injury or sickness.  In this case, disability income buyout insurance and disability income overhead insurance would fund the buy-sell agreement, allowing the disabled owners to be bought out, typically after a one-year waiting period and payment of the company's overhead expenses during that period of time.

In the above 4 scenarios, using life insurance is THE ONLY funding option that will be most cost effective and least disruptive to your family and business. It will also be the only option that will cost your family less than a dollar for every dollar that is spend after the disaster to take care of matters that matter most.

Most Common Retirement Plans for Business Owners

Traditional Deferred Comp Plans (include SERPs)

In a deferred compensation plan, the executive defers a portion of his/her present compensation until retirement. Typically, the employer will provide funding for a defined benefit or defined contribution plan for a few selected people.

Under a properly designed plan, no taxes are due on this deferred compensation until it is received.

Key Person Insurance

Key person insurance is another essential component of a smart business continuation plan. Key person insurance is life or disability insurance purchased by the business on the life of such an employee and payable to the business. When a "key person" dies or becomes disabled, insurance can help make up for lost sales or earnings or cover the cost of finding or training a replacement.

In today's competitive environment, attracting and retaining top executives is more difficult than ever, and demands creative solutions. Executive benefits may offer your best employees a higher level of benefits and compensation along with significant tax advantages. They also compensate for the fact that most 401(k) programs restrict the ability of executives to accumulate enough money on a tax-favored basis to fund the retirement lifestyle they desire.

Section 162 Plans

Often called Executive Bonus Plans, Section 162 plans are a simple way to reward your top executives. Under this type of plan, the employee purchases a permanent life insurance policy on his or her life.  The company bonuses the employee the premium, which is usually considered taxable income to the employee and tax-deductible to the employer. The employee controls the policy, including the death benefit and the cash value, which accumulates tax-free until it is withdrawn.


Other Solutions for Business Owners

Key Person Insurance

Key person insurance is another essential component of a smart business continuation plan. Key person insurance is life or disability insurance purchased by the business on the life of such an employee and payable to the business. When a "key person" dies or becomes disabled, insurance can help make up for lost sales or earnings or cover the cost of finding or training a replacement.

Personal Disability Insurance

When you’re healthy and working, it’s hard to imagine being disabled by illness or injury. But it can happen. In fact:

  • One in 3 working Americans will become disabled for 90 days or more before age 65.*
  • The average disability absence is 2 and a half years.*
  • More than 80% of working Americans don’t have disability income insurance or aren’t covered adequately. **
What would happen if your paychecks suddenly stopped because you were too sick or injured to work? What if you couldn’t work for months – or years?

You’d still have to pay all your monthly bills, including food, utilities, house and car payments. Add in things like tuition and retirement funding, and it’s easy to see how savings could quickly disappear.

While life insurance is for your company and insurance,  Disability insurance is for more selfish reasons ..... it assures you that you will be getting an income through age 65 if you are unable to work in your profession due to injury or sickness.

Assuming you are looking at 2 businesses as potential investment. Here is how they compare:

                            Revenue per year
                              Co. A                 Co. B  
Working         $100,000      $98,000
Disabled             $0                  $65,000

In the illustration above, if you can work at the company A, you can derive an income of $100K per year and no income if you are disabled and unable to work at the company.

With company B, even if you were disabled, it can generate an income of $65,000 per year. 

The morale of the  story is this.........  if you decide to purchase company B verses company A, it implies that you understand the importance of purchasing a Disability Income policy.

Business Owners Policy  (BOP)
Workers Compensation
Professional Liability
Business Liability
General Liability

401K Cafeteria Plans
Golden Handcuff for Executives

For more information on any of the above plans, please contact us for more information.

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