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Business succession planning: The day after disaster strikes

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Getting the attention of business owners is hard — they are busy running their business every minute of every day. Even their regular advisors may have difficulty getting time to discuss routine financial and legal matters.

So how does a financial advisor get the business owner’s attention to talk about business succession? One way is to get the conversation started is to talk about the day after disaster strikes.

Disaster can occur in a variety of ways. Fire, flood or earthquake can put the physical place of business out of commission for an extended time — often with the loss of important business records. And the scale of the problem is often underappreciated: the Institute for Business and Home Safety estimates that 25 percent of small businesses affected by a major disaster never reopen. In these situations, the business owner is around to pick up the pieces and deal with customers. But what if something happens to the business owner?

The question for the business owner is simple: “What should your employees do tomorrow if something happens to you tonight?”

The question is usually framed in terms of the owner dying, but it could be equally applicable to a situation where the owner is disabled for a time — for example, as a result of a major vehicle accident or a disabling medical incident like a stroke. The owner’s response is likely to be that the employees will just carry on and everything will be fine in the very short run — and maybe it will be — but practically, that stability is not likely to last.

Consider what all these different groups are thinking and what they need to be told about the future of the business:

  • Employees are very concerned about the future of the company – will the business continue? Who will run the business? What changes will be made? Should I look for a new job now or adopt a wait-and-see approach? Everyone knows that these questions will be the subject of continuing office speculation until a definitive message and plan can be delivered.

  • Customers have a similar outlook. Are we going to get the goods and services that are on order at the time we expect? Will the company honor the recent discount/deal that was just negotiated with the owner? Will the quality be the same? Should we look for a back-up supplier or should we cancel now? Customers may also be thinking about whether they need to pay the recent invoice if the business is not going to be around. At best, they are likely to delay payment, which could cause cash flow problems.  

  • Suppliers are also thinking about whether they will get paid. A likely scenario is a change of payment terms, where the goods are now cash-on-delivery. This may cause cash flow problems for the business.

  • Creditors are also reviewing their options. The bank may be looking at the line of credit and could decide to end the facility and, perhaps, demand immediate payment of outstanding loans. They will probably be able to do so under the material change of management clause.

  • Finally, and perhaps most importantly, the family may be wondering how they will pay their bills.

Many of these issues, questions and concerns can be successfully addressed if the business has a succession plan.  With a succession plan, employees know what to do in the event of a disaster or know if there is additional cash flow to cover short-term shortfalls in the business.

A succession plan that includes a short-term business contingency plan — outlining what personnel are to do, who is to contact customers, suppliers and the bank —can make a significant difference. The plan will give confidence to everyone that the business will continue and will help employees, customers and creditors know that their interests are being considered.

For this interim period, having adequate cash is critical to maintaining the business because it will ensure that the employees are paid, that suppliers can be paid upfront if necessary and that the business has cash to ride out delays in collecting accounts receivable and ensure the family is taken care of.

The easiest way to provide this short-term cash can be purchasing a life insurance policy on the owner of the business. This is essentially a “key person” policy.

The cost to cover the cash flow need can be relatively inexpensive. Depending on the age of the business owner and when he or she expects to retire from the business, a term policy may be appropriate if the term extends to at least a reasonable estimate of when the owner intends to retire or turn over the business to the next generation.

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If, like most business owners, he or she does not intend to retire, then a permanent policy may make more sense. This policy might also be used to fund a buy-sell arrangement or could be over-funded as part of retirement planning.

While small business owners may not like the idea of creating a contingency plan because it seems like “more paperwork,” the business owner owes it to his or her family. The family depends on the business owner for their support and if the business disappears one day, they could face severe financial difficulties.

If family doesn’t persuade them, then perhaps discussing the survival of the business beyond the working life of the business owner is more important to them. They have spent their working life creating the business and they would like to see it continue.

This is an issue for all small business owners, including those who don’t necessarily identify themselves in this group such as attorneys, accountants and other professionals. Everyone should think about these issues and producers can use this as a wake-up call for their existing and prospective clients.

See also:

LTCI Watch: Succession planning

How to best serve your clients: Reflections on a long career

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