Business continuity and buy-sell agreements go hand-in-hand. For many advisors, a buy-sell agreement is the extent of their business continuity planning. Indeed, buy-sell agreements are a staple of business continuity planning, but they are only one part of that planning. Today, we’ll look beyond buy-sell agreements and discuss the planning omissions that can be fatal to the continuity of a business should an owner die or become permanently incapacitated.
We find that the three common errors of omission are caused by lack of experience or understanding of what can happen to a business when an owner dies, and the consequences to the owner’s family. As a result, few business owners (or advisors) address them, yet each can kill a business when its owner dies. Not surprisingly, Exit Planning tackles all three problems head on.
The Business Errors of Omission
- Failing to deal with business, financial or leadership continuity when the sole owner dies.
- Failing to deal with financial continuity when the financially strong co-owner dies.
- Failing to deal with management and leadership continuity when the owner/leader of the business dies.
We will discuss the second two errors in future articles. Here we review the first error: failing to provide business continuity solutions for single-owner businesses.
Some advisors believe that, because most solely owned businesses are smaller and less valuable than co-owned businesses, there isn’t much to do for them.
There are almost as many solely owned businesses as co-owned businesses, regardless of business size. Yet seldom are any business continuity plans in place for single-owner companies. The reason, perhaps, is that there are few simple solutions—like a buy-sell agreement funded with life insurance. Most buy-sell agreements are not only outdated, but too simple to properly address fundamental ownership transfer issues. But there are solutions that, when used in combination, are quite effective.
Owners can create Continuity Instructions in which they name, in writing, who they want to run the business, make decisions regarding the sale of the business, and become the owner's successor. BEI has formalized these business continuity requests, allowing owners to complete the instructions in just a few minutes with an advisor's assistance.
A Stay Bonus for important employees provides a bonus, usually 50% or so of annual compensation plus a guarantee of salary, to encourage them to remain with a company after an owner’s death. It is funded with a designated life insurance policy in an amount needed to cover the salaries and stay bonuses of important employees for a year or so after the owner’s death. This year or so gives the owner’s estate time to dispose of the business in the manner the owner outlined in the Continuity Instructions. Failing to provide a reward for staying often means the best employees quickly find new employment because they believe the company cannot survive without the owner. When key employees leave, it is difficult for the business to remain afloat. Again, BEI has created a Stay Bonus Agreement and instructions for use by the attorney member of the Advisor Team.
We suggest acquiring life insurance on the business owner’s life owned in an Irrevocable Life Insurance Trust (ILIT) to benefit the owner’s family. That benefit is in an amount sufficient to ensure the continuation of the lifestyle the family currently enjoys.The amount of the insurance is dependent largely on the ability of the company to continue without the owner. If the business can’t continue, the life insurance is needed to replace the income stream lost when the owner dies and the business closes its doors. An important benefit of the ILIT is that the proceeds are protected from the owner’s creditors.
A fundamental tenet of Exit Planning is to keep key employees and the management team onboard (whether the owner sells, retires, or dies) in order to keep the business running with minimal disruption to cash flow. Comprehensive Exit Planning is the ideal solution to provide business continuity should the owner die before the planned exit, and coordination with the owner’s estate plan should the owner live to a ripe old age.
What Role Do Exit Planning Advisors Play?
How do you proactively address the business continuity needs of sole owners? Weave together the four solutions outlined here and you’ll go far. Continuity instructions and stay bonus planning are used so often in Exit Planning for sole owners that we provide templates of these documents for our Members to provide to the appropriate advisor to review, revise and execute with their business-owner clients.