You’ve worked long hours to fulfill a dream and build your company from a surviving business to a thriving, successful business. Have you given any thought to succession planning; who will succeed you, and how it will be funded? Or maybe you’re a partner in a company and you want to protect the business you’ve helped build, but what if something happens to your partner?
Succession planning is an important part of any business regardless of size, but in a small to medium size business it can mean the difference between keeping the doors open or closing them forever. There are a number of ways to build and fund a succession plan, and in this post, we’ll introduce two of them.
Buy-Sell Agreement: In a tightly held business or partnership, a buy-sell agreement enables the surviving owners to buy out an owner if something happens to one of them. This “triggering event” can be when an owner dies, becomes disabled, retires, or even has a divorce or bankruptcy.
When the triggering event occurs, the buy-sell agreement stipulates the affected owner’s interest is purchased, and is either passed to the company, the surviving owners, or a combination of the two. The proceeds used to acquire the affected owner’s interest will be paid either to the affected owner or their heirs.
In many instances, funding the acquisition of an owner’s interest can be obtained with life insurance policies on each of the owners or partners. The policies are owned and the premiums are paid by the company. The company is also named as the beneficiary on each policy.
Such an arrangement protects the affected owner and their heirs, as well as, the surviving owners. The benefit of funding them with life insurance helps protect the company’s liquidity needs when something happens.
Key Person Policy: What happens to a small business if a key person dies? Whether it’s the owner, a creative genius, or the person bringing in the majority of the revenue, the unexpected death of a key person can also cause the death of the business.
A key person life insurance policy provides a help a company survive the loss of the person who makes the business run. The proceeds may be used to run the business until a replacement person can be found, or enable an orderly shut down by paying severance to employees, business debts, investors, etc.
Like the buy-sell agreement, the company owns the key person policy and is named as the beneficiary. If there are multiple key people, the business may own policies on each individual and provide funds to an orderly transition.
The key in both the buy-sell agreement and the key person policy is to know the company’s valuation. This makes it infinitely easier to obtain the right amount of life insurance. Your tax advisor should be able to help determine which valuation options make the best sense for your business and industry.
What succession planning have you done and how will you fund it? Share your comments, questions, and insight with us on our Google + and Facebook pages. I’d love to hear from you!