If you are an owner or partner in a closely held business, have you given serious thought to what would happen to your company if you were to die unexpectedly? Chances are, you probably haven’t.
“Most small business owners haven’t given succession planning any real thought beyond, ‘I ought to do something,’ ” says David Geller CEO of GV Financial Advisors. “It’s absolutely critical that owners think through what they would want to happen to their companies if they were to die unexpectedly. This means assessing your family’s financial needs and what you can realistically get for the business and then coming up with a formal, written succession plan and communicating this to your key employees and family members.”
Without proper planning, your business could quickly crumble under the weight of estate taxes and battling between the competing interests of heirs and surviving owners and shareholders. The failure to deal with succession planning openly and forthrightly can have disastrous consequences on a company and its shareholders, employees and other stakeholders.
It Can’t Happen to Me
The fact is, dealing head-on with succession planning is not a comfortable process for most owners. After all, who really wants to confront the issue of his or her own mortality — especially if you’re young, healthy and successful?
But if you think, “It can’t happen to me,” think again. According to actuarial tables, in a business with two partners both 35 years of age, the probability that one of them will die before age 65 is a whopping 47 percent! For partners who are both age 50, the probability drops only slightly to 40 percent.
One year ago, Stephen Miller, the 52-year old CEO of Inter-American Data, one of Catalyst magazine’s Top 50 Entrepreneurs in 2003 and also a licensed pilot, decided to go for a relaxing Saturday morning flight on the company plane. The plane never left the ground before crashing at the end of the runway and exploding, killing Miller instantly.
At the time, he and his partner, John Moran, were well into the process of selling Inter-American Data, a leading provider of software and related services to casino hotels and major resorts. “There was a tremendous amount of interest in the company from prospective buyers,” says Michael Jacobs, president of Jacobs Capital Management, whom Miller and Moran had engaged to sell the company. “In fact, we had two calls on the Friday before Stephen’s death with very interested buyers.
“I had to contact all of the potential buyers and tell them what had happened and ask that they be patient and not let this impact the process of the sale,” he explains. “Most importantly, I wanted to buy some time for John and Stephen’s widow, Bonnie, to let everything sink in and decide what they wanted to do.”
Moran and Bonnie Miller decided to go forward with the sale of the business. “We decided we didn’t want to do any kind of earn-out,” says Moran. “We wanted to either own the business and be actively involved or sell it and not have any ongoing involvement.” So they accepted an all-cash deal from Agilysys Inc., a publicly traded firm based in Cleveland, which enabled them to do just that. The sale of the company closed in February.
The key to everything going so smoothly in spite of Miller’s tragic death was early succession planning by the partners. “Stephen and John were both young and healthy, but they were extremely well prepared in case something were to ever happen to either of them,” says Jacobs. “They had gone to great lengths to establish the right legal structures and minimize the tax impact in case of an unexpected death.”
Most buy-sell agreements are funded with life insurance on the business owners. This provides a ready source of cash that enables surviving partners to buy the deceased partner’s interest, ensuring that the deceased’s heirs receive full value for their shares regardless of the continued success or failure of the business.
There are two types of buy-sell agreements:
“Nothing can overcome a lack of preparation when something like this happens,” says Moran. “For us, something tragic and unforeseen did happen, and if we hadn’t been prepared, I might still be running the company today.
“Even though Stephen’s death was a major unexpected hurdle, nothing came off track in selling the company,” he says.
The first thing to realize when it comes to ownership succession is that the primary value in most small businesses is in relationships. To maximize the value of the business, there must be a structured plan for transitioning those relationships — and this isn’t something that happens overnight.
Geller recommends that you identify key employees and make sure they’re on board with your plan. He recently helped the sole owner of a $15 million construction business in Atlanta form a succession plan. The business has two key employees — one on the client relations side and one on the operations side — and it has purchased key-man life insurance on each.
“We decided that if the owner were to die unexpectedly, the first thing we’d do is tell these employees that we would increase their salary and give them a percentage of the business when it sells if they would stay,” Geller explains. “Then we’d hire a business broker and try to sell the company quickly. This would enable us to keep the business going, while realizing that the business lost some value the moment the owner died, and might continue to lose value.”
The next step, says Geller, would be for these key employees to identify the firm’s top clients and meet with them ASAP after the death. “They would need to emphasize that the clients’ relationships are not just with one person, but with the company,” he says.
Usually, the right amount of insurance and the deceased owner’s salary will provide enough money to hire a replacement and at least keep the business going, Geller says. “Term insurance is very cheap right now, so why not spend some money on this and give yourself a financial cushion? It’s when you’re under the financial gun,” he suggests, “that you have to make very difficult decisions quickly and under very stressful circumstances.”
With very small, service oriented companies, when the owner dies, the company usually dies too. “What many of these entrepreneurs have done is build themselves a job, and when they’re gone, so is the job and the company,” says Geller. “I’ve worked with a number of them who wondered if there was any value in their companies besides themselves and often there isn’t. They need to accept this reality and accurately assess who does what in the business and whether there’s any ongoing viability to the business without them.”
Partnerships create a different set of challenges. Aside from the issues involved in keeping the business going, there are some serious potential conflicts of interest between a deceased owner’s heirs and the surviving partners. The partners would likely hope to continue growing the business and maintaining a long-term outlook and they may not welcome the involvement of a surviving spouse who knows little about the company. The heirs, meanwhile, might not share this long-term outlook or they may just want to sell their interest for top dollar.
A formal, written agreement between partners that spells out specific plans in the event of an owner’s sudden death is the best way to avoid conflicts, and possibly even litigation, between heirs and surviving owners. The best vehicle for accomplishing this is a buy-sell agreement. This is a legal document that helps ensure the orderly transfer of an owner’s interest upon his or her death and it helps provide a smooth transition of complete control and ownership to the parties most able to keep the business going.
A buy-sell agreement establishes a mutually agreed-upon sale price for the deceased owner’s interest ahead of time. It also spells out the terms of the payment and places a value on the business that is binding on the IRS for federal estate tax purposes. Just as importantly, it provides much-needed stability for employees, customers, creditors and investors and it allows surviving partners to maintain control of the business.
Get Professional Help
Creating a formal succession plan will require a significant investment of time and effort and you’ll need the assistance and guidance of experienced estate and business planning experts as you work through the myriad issues involved. But as the real-life story of Inter-American Data so vividly illustrates, it’s a process you really can’t afford to neglect.
“It’s simply unfair to employees, partners and family if unexpected death and business succession haven’t been thought through and planned for,” says Geller. “Dealing with the death of a loved one or business associate is already overwhelming, but for heirs and surviving owners to have to deal with a business that is ill-prepared is a recipe for disaster.”