By Jacob A. Stewart JD
Two business partners started an office supply store many years ago. The store prospered, and both partners were enjoying the fruits of their labors. Then, tragedy struck. One of the partners became disabled. He was no longer able to participate in the day-to-day operations of the business, leaving the entire burden on the shoulders of the healthy partner. Even though the healthy partner was doing 100% of the work, he only received 50% of the profits because the other 50% continued to flow to his disabled partner. Finally, the healthy partner made an offer to buy out the disabled partner. They agreed on a sum, and the healthy partner took out a substantial loan to finance the buy-out. The healthy partner struggled for years to make ends meet while paying down the loan. To make matters worse, soon after the buy-out, a large chain office supply store opened up down the road. Despite all of these challenges, the healthy partner remained in business and eventually paid off the loan, although his expected retirement and quality of life were significantly postponed and diminished.
This is a true story that was told to me by a disability insurance professional. He used it to illustrate how this situation could have turned out very differently had proper planning been in place. Many of us think that something like this will never happen to us. “I don’t plan on dying any time soon.” “My kids get along great. They’ll never fight over the business.” “That will never happen to me.” Sound familiar? The truth is, many businesses fail or at least suffer great financial loss because they didn’t plan for the inevitable challenges of life. So, what is a business continuation plan and how do you create one?
The Six “D”s
The six “D”s are events or circumstances that could quickly destroy a business if there isn’t a good plan in place. They are Death, Disability, Debt, Dispute, Disaster, and Divorce. Let’s talk briefly about each:
Death- This is the one everyone thinks of (but few do anything about). If you die prematurely, who will take over your ownership? Who will pay the employees during the transition? Are there systems and processes in place to the extent that someone could quickly take over your role as owner and preserve the value of the business? What would happen to your business if it had to go through probate (a process that could take years)? If you have a plan, is it funded with capital or with proper life insurance?
Disability- The story at the beginning of this post illustrates the importance of planning for disability. In the above example, had the partners established a buy-sell agreement and purchased a disability policy on one another, the healthy partner would have been able to avoid debt, and the terms of the buy-out would have already been established ahead of time. He would have been spared years of stress and financial hardship. If you are the sole owner of a business, appropriate powers of attorney should be in place that specifically address the needs of the business in case of your incapacity.
Debt, Dispute, and Disaster- I lump these three together because all deal with cash flow. Every business should have proper insurance, proper asset protection (legal structures that protect both the business and the owner’s personal assets in a lawsuit), and money set aside for emergencies. Whether there be an economic crisis that cuts revenues, a lawsuit against your business, or a natural disaster that interrupts business (hurricane, earthquake, etc.), even a very profitable business could crumble due to lack of financial reserves.
Divorce- Unfortunately, we live in a society where close to 50% of all marriages end in divorce. How many of you would like to have your partner’s ex-spouse step in as a new owner of your business? How hard would it be for a business owner to come up with the funds to buy out his or her spouse? Even in a strong, healthy marriage, it is important to clearly define what would happen to a business in case of divorce.
Exiting the Business
Most of us hope to one day sell our business or pass it on to our children. One business owner might sell his business for $1MM, but take home $500k. Another might sell her business for $1MM and take home $900k. The difference? Planning. Should you sell your business to your kids or gift it to them? Should you transition the business while you are alive, or leave it to your family in a trust? If you plan to sell your business to a third party, how do you find a buyer? How do you maximize the value of your business in a sale? How do you minimize taxes? You would be surprised how many options are available to someone who begins to plan months or even years in advance.
Begin to plan now. Every business owner should have powers of attorney in place. Many business owners would benefit from trust planning. If you have partners, buy-sell provisions are essential. If you want to attempt planning yourself, just be sure to have an experienced professional look over it to point out any gaps. Most business owners would be better off using an experienced attorney and financial professional to help them create a solid business continuation plan. If selling or transitioning the business, it is always a good idea to have an experienced tax professional (one who truly understands tax strategies for the sale of a business) talk through some options with you.
This article is meant to provide general information and should not be construed to contain individual tax or legal advice. Feel free to contact me at 801-923-8350 or firstname.lastname@example.org with any questions or for more information.
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