A couple of weeks ago I met with a man who owns a business with his sister. He kept on talking about how in sync he and his sister are in all decisions they make, which is why their business has grown by leaps and bounds over the past several years.
I asked him, “Robert, is your sister married?”
“Yes, with three kids!”
“How much do you like your sister’s husband?”
Pause. He started rubbing his hands together and he said, “He’s ok, I guess.”
“Does he work in your business?”
“No, of course not. He has nothing to do with it!”
“Would you want to run your business with him as a partner?”
“What? Why would I do that?”
“Based upon what you are telling me, if your sister dies before you do your brother-in-law would inherit her share of the business and would be a 50% owner. That means he would be your partner and have equal decision-making authority with you. Is that what you want? Is that what your sister wants?”
Pause. Robert put his head in his hands for a little while, then looked up and said, “No! Of course not! That can’t ever happen!”
Yet, that’s exactly what would have happened had we not worked together on the buy/sell provisions of his operating agreement to create a business succession plan. A business succession plan is a business continuity plan. This type of planning accounts for several variables that your business may face in the future. By having a plan in place to account for those details or possible struggles now, you can have the comfort of knowing that your business will run according to your wishes going forward.
One of the leading reasons why every business owner needs to develop a business succession plan is because it helps to protect your business from potential disasters. For example, what would happen to your business if you were to pass away tomorrow? If you have multiple partners would your equity in that business be split evenly among those partners? If you run a family business, how would your percentage of the company be distributed? Do you really want to run your business with your business partner’s spouse if your partner passes away? Or what if your partner wants to get out of the business and sell it to someone you don’t like? Do you want to work with that person? These are all crucial questions you need to answer because if you do not answer them, they will probably be answered in court and that means money you (and your families after you pass) do not want to spend.
Another important consideration when it comes to business succession is to consider what would happen if you’re married and you were to get divorced. Without a business succession plan in place, you may find that your business is a marital asset, which could lead to serious issues when it comes to the profits and overall management of your company. Taking the time to think through these different variables can help to protect your business from the unknown, which leads us to our next reason to create this type of plan.
So what’s in the plan? The heart of the business succession plan is the buy/sell agreement. A buy/sell agreement is a contract in typically a shareholder’s agreement (in the case of a corporation) or an operating agreement (in the case of a LLC) that highlights how a partner’s share of any business should be redirected if that partner were to die or leave the business.
There are also several other benefits associated with a buy/sell agreement that revolve around determining the essential question—what is the value of the business? You need to have a mechanism in place to answer that question.
Moreover, a buy/sell agreement can be used in different types of business set-ups such as sole proprietorships, corporations and partnerships and can often lead to a smoother transition in the event of a change in ownership. In short, the buy/sell agreement will answer all of the questions you have regarding what happens if something happens to you or your partner.
In the same vein, another key component of business succession planning is often life insurance. For example, are you or is someone in your company the lead money maker for your business? Or perhaps there is someone in your business who knows your internal processes thoroughly and would be tough to replace in case something happened?
If the answer is yes to either of these questions, then part of your business succession plan should include something that is commonly referred to as “key person” life insurance. If a key person (such as yourself or one of your partners) were to die unexpectedly, it’s possible that your company could suffer a financial loss that could lead to devastation. By having key person life insurance in place, you would be able to cover the financial loss that the loss of that person (or you) may bring while your company is looking for a replacement.
Another option is getting life insurance not on a key employee, per se, but on all of the partners (or shareholders) who run the business. You can either have the business purchase the life insurance, or you can have the partners buy life insurance on their fellow partners. The amount of the insurance would be as close as possible to what the partners think the value of that partner’s share might be. That life insurance could then be used to “buy out” a deceased partner’s share of the business, so that the surviving business partner can continue with the business without having to work with the deceased partner’s family, and the deceased partner’s family will receive the cash from the buy-out.
The last, and perhaps most important, piece to thinking about your business succession plan has to do with continuity. When you first started your business, it’s unquestionable that you had a certain vision for what your company would grow into. Your vision is something that you will not want to lose if you aren’t here to keep that vision intact.
One of the key aspects of business succession planning is identifying the people who will help to continue the vision that you have for the company so that it will continue to move forward. Developing a business succession plan will also help you to identify the stellar employees in your company (or perhaps identify options from outside of your company) that you may not have been aware of in the past.
You have worked really hard to build and nurture your business and its success. Make sure that you have a plan in place in case something happens. Because you don’t want to be working with your partner’s spouse, or even worse, his crazy children!
Alec Borenstein is an estate-planning attorney at Borenstein, McConnell & Calpin, P.C., and he works with many business owners in New Jersey and New York. If you have any questions related to your business you can email Alec at [email protected] or call 973-379-2444, ext. 5.