How Business Succession Planning Can Protect Business Owners
What if something happens to you, and you can no longer manage your business anymore? Who will then take over your business, and will it be managed the way you want?
Establishing a sound business succession plan helps ensure that your business gets handed over more smoothly.
Business succession planning, also known as business continuation planning, is about planning for the continuation of the business after the departure of a business owner. A clearly articulated business succession plan specifies what happens upon events such as the retirement, death or disability of the owner.
A good business succession plans typically include, but not limited to:
·Goal articulation, such as who will be authorized to own and run the business;
The business owner’s retirement planning, disability planning and estate planning;
·Process articulation, such as whom to transfer shares to, and how to do it, and how the transferee is to fund the transfer;
·Analysing if existing life insurance and investments are in place to provide funds to facilitate ownership transfer. If no, how are the gaps to be filled;
·Analysing shareholder agreements; and
·Assessing the business environment and strategy, management capabilities and shortfalls, corporate structure.
Why should business owners consider business succession planning?
·The business can be transferred more smoothly as possible obstacles have been anticipated and addressed
·Income for the business owner through insurance policies, e.g. ongoing income for disabled or critically ill business owner, or income source for family of deceased business owner
·Reduced probability of forced liquidation of the business due to sudden death or permanent disability of business owner
For certain components of a good business succession plan to work, funding is required. Some common ways of funding a succession plan include investments, internal reserves and bank loans.
However, insurance is generally preferred as it is the most effective solution and the least expensive one compared to the other options.
Life and disability insurance on each owner ensure that some financial risk is transferred to an insurance company in the event that one of the owners passes on. The proceeds will be used to buy out the deceased owner’s business share.
Owners may choose their preferred ownership of the insurance policies via any of the two arrangements, “cross-purchase agreement” or “entity-purchase agreement”.
In a cross-purchase agreement, co-owners will buy and own a policy on each other. When an owner dies, their policy proceeds would be paid out to the surviving owners, who will use the proceeds to buy the departing owner’s business share at a previously agreed-on price.
However, this type of agreement has its limitations. A key one is, in a business with a large number of co-owners (10 or more), it is somewhat impractical for each owner to maintain separate policies on each other. The cost of each policy may differ due to a huge disparity between owners’ age, resulting in inequity.
In this instance, an entity-purchase agreement is often preferred.