The secret to a successful succession strategy

You’ve gotta love those infomercial one liners “Death occurs often these days!” Really? I had no idea! “And, it can come unexpectedly”. No – are you sure?

It seems we are bombarded with insurance infomercials these days (if you happen to have the TV on long enough during one of your numerous days off as a hard working entrepreneur). Regardless of how annoying and painful they are, well, sorry the good old ‘She’ll be right mate!’ or ‘It’s in God’s hands now’ just won’t cut it.

The hard facts

If you do have a business partner (regardless of the fact you have a corporate structure or not) or several key members of staff, not having a formal “involuntary exit” succession plan, put simply, could be a disaster waiting to happen.

Not having one could potentially mean the other partner having to ‘stump up’ with enough cash to buy out the deceased partners share, and with the credit markets in ‘thanks, but no thanks’ mode at the moment it’s really just not an option.

Look at it this way

Say you have a business that’s worth 1.5 million dollars. Split say between two partners 50/50 that’s $750,000 each.

If one of the partners should pass away (remember death happens often and without warning) or should become permanently incapacitated, it’s more than likely the other partner will have to come up with enough cash to buy out the other partner.

More than likely this will have to be financed, 750k to buy out the other partner (Yes, good, I’ll just go and see what’s under the mattress!).

If you are lucky enough to obtain finance of 750k to fund the buyout, at an average finance cost of say 8% that amounts to $60,000 in yearly interest cost alone.

What’s more, any loan taken out by the surviving business partner will seriously stall future growth and expansion plans.

If both partners structured a legal succession agreement with life policy coverage of $750,000 each to buy the other partner out and the yearly premium for the cover amounted to $4,000, then they could fund approximately 10 years (allowing for stepping premium increases) of life premium with just one year’s potential interest payment.

This strategy also gives certainty to the departing partner’s family and leaves the other surviving business partner to get on with the business worry free.
Any debts or overdrafts attached to the company may also be called up by the bank or financier (depending on the loan agreement) as a result of the departing partner. However, even if this is not called, the executor of the estate won’t be able to wind it up until the guarantee is extinguished.

The succession strategy proceeds will repay the debt and extinguish any guarantee(s).

In good faith

In the absence of an agreement the old axiom “But we trust each other” might work in theory, but when they are not there to back it up don’t take the risk if you have no policies in place and you have not formulated a legal agreement.

Often you will be left with the departing partner’s family to deal with, who might not be so accommodating and like-minded when it comes to sharing your business goals nor possess the necessary skills.

Worse still, they may even sell out to a competitor to release the cash to fund the loss of their spouse’s income.

The upshot… yes there is one

The upside to a formal succession plan is it forces the owners to make a formal valuation of the business and provide each party with certainty around a reasonable price being paid for each owners’ share, with funding already taken care of.

Don’t leave it to chance – it’s just not an option.

A qualified financial adviser and planner (it’s important to check these credentials are held) in business succession planning will organise the plan and ensure it all comes together. Engage a specialist succession solicitor and accountants for tax matters and valuation. Then determine the level of covers required and draft the arrangements in a plan and structure it to avoid the costly mistakes often made by DIYer’s such as cross-owned and corporate owned policies.

Then it’s their job to carry this through to completion, including medicals and financial information that may be required, with regular reviews for any increases in business valuation.

Nick Christian is a Financial Adviser and planner and authorised representative of Millennium3 Financial Services.

The views and opinions expressed within this letter are those of the author and do not necessarily reflect those of Millennium3 Financial Services Pty Ltd.

The above is general in nature and should not be acted upon without seeking the advice of a professional licensed financial planner.