What if something happens to you and you can no longer manage your business? Who will take over your business and manage it the way you want?
Establishing a solid business succession plan helps ensure that your business is delivered more smoothly.
Business succession planning, also known as business continuation planning, is the planning for the continuation of the business after the exit of a business owner. A clearly articulated business succession plan specifies what happens in events such as retirement, death or disability of the owner.
A good business succession plan typically includes, but is not limited to:
Articulation of the goal, such as who will be authorized to own and manage the business;
Business owner retirement planning, disability planning, and succession planning;
Articulation of the process, such as to whom to transfer the shares, and how to do it, and how the transferee should finance the transfer;
Analyze whether life insurance and investments exist to provide funds to facilitate the transfer of ownership. If not, how to fill the gaps;
Analyzing parasocial pacts; and
Assess the business environment and strategy, management capabilities and weaknesses, corporate structure.
Why should business owners consider business succession planning?
Business can be transferred seamlessly, as potential obstacles have been anticipated and addressed.
Income for the business owner through insurance policies, for example, ongoing income for the disabled or seriously ill business owner, or source of income for the family of the deceased business owner.
Reducing the likelihood of forced liquidation of the business due to sudden death or permanent disability of the business owner.
For certain components of a good business succession plan to work, financing is required. Some common ways to finance a succession plan include investments, internal reserves, and bank loans.
However, insurance is generally preferred because it is the most effective and least expensive solution compared to other options.
Each owner’s life and disability insurance guarantees the transfer of a portion of the financial risk to an insurance company in the event that one of the owners dies. The proceeds will be used to purchase the deceased owner’s share of the business.
Owners can choose the preferred ownership of insurance policies through either “cross-purchase contract” or “entity purchase contract”.
Cross Purchase Agreement
In a cross-purchase agreement, the co-owners will purchase and own a policy on each other. When a homeowner dies, the proceeds of their policy will be paid to the surviving homeowners, who will use it to purchase the outgoing homeowner’s share of the business at an agreed-upon price.
However, this type of agreement has its limitations. One key is that, in a business with a large number of co-owners (10 or more), it is impractical for each to keep policies separate from each other. The cost of each policy may differ due to a large disparity in the age of the owners, resulting in inequity.
In this case, an entity purchase agreement is often preferred.
Entity Purchase Agreement
In a sales contract with an entity, the company itself acquires a single policy for each owner, becoming both the owner and the beneficiary of the policy. When an owner dies, the business will use the policy proceeds to purchase the deceased owner’s share of the business. All costs are absorbed by the business and equity is maintained among the co-owners.
What happens without a business succession plan?
Your business may suffer serious consequences without a proper business succession plan in the event of an unexpected death or permanent disability.
Without a business succession plan, these scenarios could occur.
If the business is shared among business owners, then the remaining owners may fight for the outgoing business owner’s shares or percentage of the business.
There could also be a possible controversy between the company’s sellers and buyers. For example, the buyer may insist on a lower price versus the seller’s higher price.
In the event of permanent incapacity or critical illness of the entrepreneur, the company’s operations may be affected, as they may not be able to work. This could also affect faith, income, and the ability to work.