The 6 L's of Small-Business Planning

Small-business owners pour their blood, sweat and tears into their enterprises, so it’s no wonder such dedication can cause a little tunnel vision. In being so focused on day-to-day operations, owners often fail to spend the appropriate time on personal planning. It creates a reality where those business owners under-insure and underinvest outside their own companies.

A successful business essentially becomes a security blanket, as owners don’t sufficiently plan for events that could change the course of their financial well-being. It’s incumbent on financial advisors to help them address the critical events that will disrupt everything personal and business. We run these fire drills (aka the six “L’s”), for all of our business owner clients annually by asking, “What’s the plan to deal with the following emergencies: liquidity, long-term disability, loss of life, long-term care, longevity and legacy/legal?”

• Liquidity: If a business owner has to write a significant check for something unexpected, like office repairs after a damaging storm, where will that $10,000 or $20,000 come from? Businesses typically don’t have substantial liquidity because so much of their capital is tied up in operations. As a result, lines of credit tend to be the most common solution for owners encountering this situation. When you run this drill, make sure there is access to cash in the short run should it be necessary.

• Long-term disability: Owners are often disproportionate contributors to their small company’s success. If they lose the ability to work, the whole organization can suffer, from sales to distribution, operations, and customer relationships. What’s the plan to protect against such a scenario? The first step should be to identify who can step into a leadership role for a short time period. But if the disability is long term, how might that impact the company’s value and succession plan? Solutions can include business overhead insurance or policies that offer income replacement. Stipulations can also be implemented that enable key employees to buy out the business owner.

• Loss of life: What happens if an owner, business partner, integral employee or investor suddenly passes away? Life insurance funding buy/sell plans and key-person coverage can be an effective tool in these circumstances. However, we find that business valuations are often much higher than people insure them for. We’ve also seen multiple-owner firms that don’t adequately protect against loss of life because one of the owners is a smoker or in poor health. The other business partners are wary about the cost of insuring that person, so they either purchase too little coverage or none at all. The biggest concern that business owners ignore: becoming forced partners with your deceased business partner’s spouse.

• Long-term care: Many baby boomers with substantial business wealth are starting to wonder what will happen if they need significant medical care. That’s a legitimate concern, but the elderly parents of business owners represent an additional consideration. If an owner takes time off from their company to help provide care for an ailing mother or father, the potential disruption to operations and revenue could be significant. Consider where the capital is going to come from to offset the cost of long-term care for family members — we don’t want forced liquidation of business assets.
• Longevity: What will it mean for a business if the owner has an unusually long life? Has that person contemplated how their role will change, as well as who will succeed them through phases of potentially decreasing interest and capacity? Does the owner expect to be provided with an income for life? If they live to be 100, that could result in a huge expense for the business and significant burden for the succession team. If the owner lives 30 to 40 years in retirement, can they presume the business will remain viable for decades? Would annuities or pensions be a sensible option for diversifying their retirement income? These are all important long-term cash-flow questions to consider.

• Legacy/legal: What does the business owner envision as their legacy for the next year, 10 years or 100 years? Is it important to an owner for their company to last another century? It might be if they preside over a third-generation family business. Various types of trusts, gifts and legal structures can be utilized to help ensure the business won’t be decimated by taxes when ownership is passed to a son or daughter. This type of planning requires estate and tax professionals to make sure that the local laws and documentation is aligned.

The key takeaway for advisors is that serving the best interests of clients can sometimes mean asking uncomfortable questions. An annual review should go far beyond performance, allocation and fees. Point out potentially disruptive scenarios like those described above and create plans to address them. At each review, revisit those plans to determine if they can still be effective responses to the six “L” financial fire drills.