Business owners should have an exit strategy: a plan for the time when they’re either unwilling or unable to keep running their company. Often, that planning can include a current disaster plan for relatively young business owners and a future long-term succession plan for a smooth path to retirement.
Worst case scenarios
No matter how young or how healthy you are, you’re not immune to tragedy. Therefore, business owners should have a disaster plan, which might be called a catastrophe plan or a continuity plan or something similar. Such a plan can protect you or your family in case of death or disability.
To understand why such a plan is vital, consider what might happen in its absence.
Example: John Smith, age 45, is the sole shareholder of the successful John Smith Co. After a fatal auto accident, his widow Jane inherits John’s shares. At such a time, Jane will have to find a buyer and negotiate the terms of the sale. Jane may have a difficult time getting full value for this profitable business.
Alternatively, John might suffer a stroke and lose his ability to work full-time. In the absence of a disaster plan, John (or someone representing him) will have to relinquish control of the company and find some way to realize the value of the business he has built.
To provide protection against such possible disasters, business owners and co-owners of all ages should have a buy-sell agreement in place. Such an agreement should identify the buyer, in case a sale becomes necessary, and specified events that will trigger the buyout. The agreement also should spell out how the price will be determined—it could be a multiple of cash flow or revenue, for instance.
If a company has two or more co-owners, a mutual buy-sell can be effective. For sole shareholders, such as John Smith in our example, finding a buyer may require some creativity. A key employee might be named, or even a competitor. Funding for a possible buyout might be provided through life and disability insurance.
If all goes well, our hypothetical John Smith will remain healthy and active throughout his 40s and 50s. His company will continue to prosper. In his 60s, though, John might start to think about stepping down—or at least slowing down. At some point, John should begin working on a long-term succession plan for his retirement or semi-retirement.
Note that John should not ignore the chance of a catastrophe, at any age. Therefore, his succession plan should include disaster planning. For the long-term plan, John may prefer to have a different buyer than the buyer for the catastrophe plan. (The initial catastrophe plan can contain language allowing for cancellation of the agreement with written notice from the buyer or seller.)
In addition to catastrophe coverage, the long-term succession plan might have a schedule for John’s future participation in the company. Will John leave altogether, as of a certain date? Will he continue to work at the company for a certain or an indefinite time period? If he stays on, what responsibilities will he have? In some cases, the purchase price might be reduced, if John leaves the company altogether; a higher price might be agreed upon if John agrees to stay for a while, helping the company make the transition to new ownership.
A long-term succession plan also should cover taxes because certain deal structures can be more or less favorable to the seller.
The American Institute of Certified Public Accountants has written the article published here and given us permission to reprint it.
For more information on succession planning, please contact Joe Musumeci at 443-725-5395.