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Business succession planning: Look to life insurance

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If you’re looking to expand your client base and the range of services you provide, there may be no time better than now to educate your customers and prospects on the use of life insurance in business succession planning. With 28.2 million small businesses in America, according to the Small Business Administration (SBA), and with four of every 10 grappling with a transfer of ownership issue, the market seems primed for outreach.

A recent MarketWatch article explains that “as much as planning for retirement can be a complex and confusing process for working Americans, it’s a whole other ballgame for those who are small-business owners. Not only do they have to manage their company’s day-to-day operations, develop and meet their sales and business goals, and provide for their employees, they also have to figure out what will happen to their business when they’re ready to move on.”

That’s not always easy, particularly when family dynamics and squabbles come into play. For example, the business owner may wish for one adult child to take over the company, but another child may be financially disadvantaged in the process. The proprietor may not be aware that a life insurance solution can be utilized to help equalize inheritances among children. Perhaps the process of succession planning just seems too overwhelming.

The perceived burden of succession planning may be among the reasons why 56 percent of family business owners either don’t have a succession plan at all, or still have one they’re unhappy with, according to a recent survey by The Alternative Board.

Furthermore, even though some business owners have a written succession plan, not all of them have funded it (or funded it appropriately). Another possibility is that they have outdated or exaggerated notions about the value of their company that render the existing plan unrealistic, and make them appropriate prospects for a discussion about the exit process – one that may lead to a life insurance sale.

Let’s take a closer look at the market. While America’s small businesses employ nearly half of America’s private-sector workers, 72 percent of the establishments are sole proprietorships, according the SBA. A recent Forbes article pointed out that 60 percent of small business owners are baby boomers.

Their businesses may include legal and financial services firms, real estate agencies, and health care services, among others. Other boomer-owned establishments that may benefit from an appropriately funded exit strategy include staffing agencies, transportation and warehousing businesses and construction companies, to name a few.

The needs of the owners may include helping a retiring partner transition from the business or, as mentioned earlier, transferring the business to a family member. Sadly, however, in the absence of a transition plan, the company may not even remain viable. Less than one-third of family-owned businesses survive transfer to the second generation, 12 percent to the third generation, and only about 3 percent to the fourth generation, according to the SBA.

Meticulous business succession planning, therefore, is of the utmost importance in facilitating the successful transfer of small businesses, and providing peace of mind to the legions of Americans who have worked hard at them for years in pursuit of a more secure financial future for themselves and their families.

Unfortunately, for many business owners I’ve met, their company is their “retirement plan.” The process of creating and growing a business requires capital – and often, profits are largely reinvested in the company. Business owners who have not allocated sufficient dollars to a transition plan may not be able to retire when desired; contend with a disability, catastrophic personal or family illness; or address other needs. They may not even be able to retire at all.

Small businesses, their proprietors, the owners’ family members, and our industry can all benefit from increased awareness about the role life insurance can serve, including if the policyholder becomes stricken with a chronic illness, disability or severe cognitive impairment. Traditionally, however, the talk about life insurance in exit planning has focused on needs that may arise from the business owner’s death. 

The opportunity for agents and advisors focused on offering innovative solutions is significant. Small business owners can avail themselves of life insurance solutions that can provide cash for a buyout in the case of death or chronic illness, or may provide access to cash at a pre-determined age if neither chronic illness nor death occurs.

A properly structured and funded buy-sell arrangement can offer access to life insurance cash value to assist in buying out a business partner upon his or her death; access to an accelerated part of the death benefit may also help to facilitate a business owner buyout or cover other needs; or provide for periodic withdrawals after as few as 15 years, irrespective of the cash surrender value within the policy.

How might you talk with a small business owner about exit planning? Based on my experience, asking a series of key questions is helpful. Number one, does the owner know who he or she wants to transition the business to – whether someone in the family, or an outside party? If not, you may be a valuable resource for the business owner in helping to identify a potential successor.

Are there key employees who are essential to the continued success of the business? The answer to this question may lead to the identification of additional needs for which life insurance is potentially a solution. Retaining key employees who can positively affect the marketability and value of the business is essential. It may be wise for the current owner to create a retention plan by funding for each of the key employees – contingent on their agreement to stay with the business for a set number of years. A permanent life insurance policy that has a robust cash accumulation feature may be a potential solution. This type of strategy may be an effective incentive for valued staff to remain.

As establishing realistic expectations about the potential timing of a business transition is critical, another question to ask is: “When would you like to exit the business – and do you want to get out completely, or remain involved to some degree?” If the owner wants to disengage fully, the next question is: “Does your prospective successor have the financial capability to buy you out?”

Unfortunately, from what I’ve seen, the answer is often “no” – so it’s important to assist the owner in identifying the means by which the prospective successor can buy the business. Typically, this is facilitated through the establishment of a formal business succession plan. The plan, often a buy-sell agreement, will identify the triggering events that will result in the transition of the business. It will also provide details as to the timing of the transition, how the business will be valued, and ultimately, the price at which the business will be sold.

For example, a succession plan may call for a key employee to buy the business at the death of the owner or at a fixed future date if the owner is still alive. In my experience, such an agreement is not uncommon. The funding mechanism, however, to ensure that the plan is in fact implemented is less common. Such an agreement could be funded with permanent life insurance with the appropriate living benefit riders. Funding the agreement in this manner provides a greater likelihood that the succession plan will be effective by ensuring that the financial resources will be available either at death or at the agreed-upon transition date. Regardless of the specific insurance product that is used, the plan must be flexible enough to retain relevancy even if the value and needs of the business evolve.

The tax consequences of a business buyout that’s funded through life insurance may vary depending on several factors, including the type of business involved. Generally, the policy benefits can be accessed free of income tax and will be available for the down payment, either through a loan against the policy’s cash value or as a living benefit. In keeping with industry best practices, let owners know at the onset of the planning process to pursue independent tax and legal advice when considering their own circumstances.

In addition to coordinating with an attorney and a tax advisor, make sure that a business valuation expert and a CPA are consulted, as the company’s current value and its future growth expectations must be assessed. It’s essential, as well, to establish a timeline for the planning team to re-evaluate the succession protocols and terms regularly, and determine whether the face value of the life insurance policy is still appropriate, based on any changes in the status of the company.

More careful consideration is starting to go into the succession planning process, and more focus on the need to plan for the multiple contingencies that may trigger a business succession. It wasn’t all that long ago that an agent or advisor assisting with an exit plan might have been thinking mostly about the death benefit of a life insurance policy.

Now, I believe we’re seeing a trend that, while emerging, centers on leveraging life insurance with living benefit riders to help business owners address other contingencies in succession planning, such as retirement, chronic illness and longevity. The more educated that clients and prospects become about the value proposition that innovative life insurance solutions offer for managing potential triggering events such as these, the more we’ll see the trend grow.