Business Continuity Planning - Preparing the Business For Your Unexpected Departure
THE COUNSELOR
Volume 10 • Issue 5 • May 2020
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning and business planning issues. This month's issue will discuss emergency continuity planning for the small business owner. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
Preparedness
For all your days prepare,
And meet them ever alike:
When you are the anvil, bear—
When you are the hammer, strike.
-Edwin Markham
As the global pandemic continues to rage, small business owners are struggling valiantly to stay afloat in turbulent seas. One of the unique challenges that the Covid-19 crisis presents is the possibility that a business owner could be medically incapable of leading the company for a significant period of time or even permanently. While we are acutely aware of our own mortality in this current situation, the fact is this possibility has always existed. Comedian Steven Wright once said: “I intend to live forever. So far, so good.” The reality is probably more along the lines of what Charles de Gaulle reportedly said: “The graveyards are full of indispensable men.”
“Small businesses,” that is, those that have less than 500 employees, comprise 99.9% of all businesses in the United States. The owners of these businesses will, someday, exit their businesses due to retirement, incapacity, or death. Unfortunately, most are so busy working that they don’t slow down and think about business succession or estate planning issues and they definitely don’t spend much time planning for the continuity of their businesses if they are suddenly and unexpectedly unable to pilot the company.
Currently there is a massive disruption taking place across the globe. It is causing businesses to work in ways that they weren’t doing just 60 days ago. Some businesses were prepared to handle that disruption, others were not. Often with small businesses, the loss of the owner can devastate the business. Knowledge and know-how are lost. Customers and clients quickly disappear. The value of the business plummets. What are some steps you can take as a business owner to prepare your business for the day you may be taken away prematurely?
Organize Your Business in an Entity with Perpetual Existence. Many small businesses operate as sole proprietorships or general partnerships. While these can be easy to start and easy to run, the loss of the owner is often a liquidating event. This causes a disruption in the ability of the company to continue to function when the owner dies. Forming a limited liability company with perpetual existence as a business separate from its owner will allow the business to avoid mandatory liquidation and to continue without court intervention in the event you are no longer able to manage the same because of death or disability.
Have Your Estate Plan in Order. If you die or become disabled, who has the legal authority to step in and make decisions on your behalf? A good estate plan using trusts, financial powers of attorney, and health care directives will allow those you have appointed to step in and manage your affairs when you cannot and do so without court interventions.
Have Key Person Insurance in Place. One of the biggest problems with a disruptive event like losing an owner to death or disability is the lack of liquidity that happens almost immediately. With key person life insurance, a company buys a life insurance policy on a key employee, business owner, or executive. The company is the owner of the policy and pays the premiums. If the key person dies, the company receives the tax free death benefit. The money can be used to make up for lost earnings. It can also help cover some or all of the costs of finding a replacement and provide proper training. The money can buy time to address the transition in a more orderly fashion. Key person disability insurance works in much the same way, except that it provides funds to the business in the event the key person can no longer work because of disability. Note that this is different from a disability insurance policy that pays money to the disabled person to make up for his or her lost salary.
Devote Time to Establishing Great Systems and Processes. All successful businesses rely heavily on their systems and processes. The benefit of systems and processes is that they make the business less reliant on individuals who are finite. Individuals leave for a variety of reasons, including death or disability. If great systems and processes are in place, the lead time for the next person to get up to speed is significantly shorter.
Identify in Writing the Individual(s) Who Will Take Over In Your Absence. Warren Buffett once said: “in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.” Find good quality people, train them well, identify who will take over in your absence, and review regularly to see if performance meets expectations. This may be a single individual or it may be multiple individuals. In determining who these individuals are, ask the following questions:
Who is best suited to supervise business operations?
Who is best suited to make financial decisions?
Who is best suited to manage internal administration?
6. Have a Contingency Exit Plan. Business owners should always be looking at their exit strategy. Review annually your contingent exit strategy and leave written instructions to your successors that identify whether you believe the business should be sold to a third party, a key employee, or a family member. The written instructions should also identify individuals or companies who may be interested in purchasing the company.
7. Allow for Access to Information. One major problem that can exist in the sudden departure of an owner is the lack of access to information. This lack of access can be a result of secrecy on the part of the owner, but even if the survivors know where to find the information, it must still be accessible. Bank accounts, credit cards, vendor accounts, customer relationships - the more this information is unavailable or inaccessible to others, the worse it will be when that owner is no longer around.
Business accounts of any kind should never be in the name of just one person.
Provide guidance to successors on how to access crucial information.
Identify which professional advisors should be consulted.
Every business needs someone in charge in order to succeed. The business may be a sole proprietorship with a single person making all decisions or it may be run by a team of leaders. The loss of an owner or key decision maker can always create complications for a business. But, if the business leadership team consists of only one or two people, the unexpected loss of one of these individuals can be devastating. A business worth millions could turn into a business worth little or nothing almost overnight.
Working on the above items and reviewing them annually will help you build a stronger business, more capable of avoiding liquidation. This will allow the business to be sold or transitioned to new ownership, in an orderly fashion, and for a fair price, regardless of whether the business owner is available or not.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.