How to Plan for the Future of Your Company
If you’re a business owner, chances are you’ve been so focused on building your company in the present that you haven’t thought quite enough about the future – specifically, business succession planning. Even if handing over the reins seems like a distant moment, it’s a smart idea to start your planning today. If you want to properly plan for the future success of the business you’ve given your blood, sweat, and tears to, you can’t afford to ignore the issue of planning for the company’s future without you.
Read on to find out the information you need to create a business succession plan that accomplishes your goals.
Picking a Successful Successor
When you’re ready to move on from your business, you have choices. You can simply choose to sell your business to the highest bidder and use those funds to fuel your next steps. However, many owners are more comfortable thinking of their hard-built business continuing on when they’re gone.
That’s when picking a successor becomes critical. It could be as easy as appointing a relative or high-performer to take your place. However, sometimes it’s not so simple: there could be several people who fall into each of those categories, each of which is worthy of consideration. If you make your choice, the remaining folks who aren’t chosen could harbor resentment that can have a lasting impact on you or the success of the business.
A partner is certainly a logical choice, though sometimes they don’t feel like they need or want an outside party coming in to help them run the business in your absence. In that scenario, they may elect to sell their portion of the business to the other party-in-charge in a buy-sell agreement.
Know Your Company’s Value
If an owner decides to cash out (or if they pass away and don’t have a choice in the matter), the business will need to be assessed and a set dollar value determined. You may believe your business is priceless—and in emotional value, you’d be right!—but to assess the actual value of your business, it’s best to get the help of a professional like a certified public accountant.
Alternatively, you can set up an arbitrary agreement between all individuals, if you have partners. If all the business’ stock is publicly traded, then it’s a bit more straightforward: the valuation of the owner’s interest will be determined by the stock market’s current value.
Protect Yourself and Your Business Partners
If you have business partners, after you’ve determined how much your business is worth, it’s time to make sure that all parties are adequately protected in case of an emergency. No one likes to think about what could happen when the unexpected strikes, but in the event that one of the partners passes away before they can retire, life insurance is often the best way to protect the interests of everyone involved.
If all partners in the business agree to purchase life insurance based on the dollar value of the business, the death benefit proceeds can be used to buy out the deceased partner’s share of the business when they pass. The two basic arrangements for this—cross-purchase agreements and entity-purchase agreements—serve the same end, but are usually used in different situations.
Cross-Purchase Agreements
Cross-purchase agreements are set up so that each partner purchases, owns, and manages a policy on each of the other business partners, functioning as both owner and beneficiary on the policy. When an insured partner dies, the policy held on the deceased partner is paid out. The proceeds are then used to purchase the business shares held by the deceased partner, at a price agreed upon when the insurance was initially established.
It may sound a little complicated, so here’s an example. If a business is worth $6 million, and there are three partners involved, each partner’s share is valued at $2 million. If they agree to a cross-purchase agreement, each partner must take out a $1 million policy on each of the other two, so if and when one partner passes, the remaining partners will each be paid $1 million. The combined $2 million is enough to purchase the deceased partner’s shares.
Entity-Purchase Agreements
Imagine for a moment a business with many more partners—a cross-purchase agreement could still technically work, but it would be prohibitively impractical for each partner to maintain multiple policies if there are more than a handful of partners. Cross-purchase agreements can also be inequitable if there is a significant age gap between partners—the cost of a policy on a 65-year-old is significantly different than the cost of a policy on a 35-year old.
That’s where entity-purchase agreements can help. In this scenario, the business itself acts as the policyholder and beneficiary, purchasing a single policy on each partner. When a partner passes away, the business uses the life insurance proceeds to purchase the late partner’s shares.
Business Succession Planning: The Wrap Up
There are many benefits to having a smart business succession plan, one that can protect the business and add value for years to come. Not only can it reduce stress if the unexpected happens—agreeing on a valuation beforehand means you don’t have to worry about that during a difficult time—it can also help ensure a smooth transition and see that your business wishes are carried through.
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