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Exit Planning

Buy-Sell Agreements that Overlook Challenges to the Business

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Buy-Sell Agreements that Overlook Challenges to the Business

In the previous article, Buy-Sell Agreements that Overlook Challenges to the Business: Part 1, we discussed the first challenge to a business—the loss of financial capital—that an owner’s death or lifetime departure causes if that owner guaranteed the company’s debt.

In this article, we tackle the second challenge to a business: the loss of personal capital that an owner’s death causes if that owner was the company’s rainmaker, relationship developer or COO. If no one is able to step into those roles, the business may be unable to survive.

The Loss of Talent
 

The loss of talent is a challenge that is easy for advisors to appreciate. It is a chief concern of many professionals who own their firms, and a major concern for their respective professions. Little wonder then that the prospect of the loss of human capital also impacts closely-held businesses. In both worlds, rainmaking or customer relationships tend to be the responsibility of a single owner, or in larger firms, two of the co-owners.

A properly designed and funded buy-sell agreement may, at the death of a co-owner, do an admirable job of transferring ownership to the remaining co-owner(s), yet the business fails or, at best, declines steadily in revenue, cash flow, and reputation. Ultimately, the business is sold, merged, or liquidated because it can’t continue without the deceased owner. The buy-sell agreement transferred ownership successfully, but little thought or planning went into whether the business could survive, let alone flourish, without the key employee/owner.

The Role of Transferable Value
 

Exit Planners understand that most businesses must grow significantly in value and cash flow in order to provide the financial resources required for a successful owner exit. Owners and Exit Planners spend a lot of planning effort and time on creating or enhancing “transferable value.” If a company has transferable value, its owner can leave, permanently, with minimal disruption to company cash flow. If, for example, an owner is the chief rainmaker, other employees or co-owners must eventually assume the responsibility of rainmaking. This need to successfully assume responsibility applies to whatever key function only one owner/employee can capably perform.

When a business’s value is thus transferable, the death of any owner—no matter his or her choice of lifetime exit path–does not permanently affect the company’s future performance.

The Exit Planning Solution
 

Exit Planning works really well when owners cooperate by not dying until both owners and advisors take the necessary actions to find, train, and motivate successor talent in the business. This doesn’t necessarily mean these successors-in-talent will be the successor owners as well. It does mean that when there are others who can capably perform key roles, the original owners are no longer central to vital business functions.

Exit Planning also works well (albeit slowly) when owners don’t cooperate and die before successor talent is in place. In other words, Exit Planning addresses the question of, “What happens when an owner dies or becomes disabled ‘too soon?’” (We define “too soon” as any point before the owner’s planned business exit.) What will happen if one of your owner-clients dies next month?

Should an owner die before you can create and execute his or her Exit Plan, you must:

  • Identify risks. Ask owners to describe the risks to their company if any one of them dies unexpectedly. For example, if the rainmaker dies, how can the business replace his or her essential talent and skill? Their answers will lead to recommendations such as: recruit new management or train existing management or key employees to assume part of the key owner’s responsibilities. This process is part of sound and necessary Exit Planning, but it takes time (usually more years than it takes a business to fail), to hire or train the necessary people and/or create the systems needed to replace an owner.
  • Create a replacement plan. When an owner/rainmaker dies “too soon,” the business, if it is to thrive, must replace that owner as soon as possible with one or more equally talented rainmakers. Highly talented rainmakers or other high-performing managers are typically not looking for new jobs. They are successful, well-compensated and perhaps even owners of similar businesses. They must be enticed to leave their current positions. Enticements include:
    • Working for a business that has a good reputation-brand in the marketplace.
    • A challenging position that probably offers a path to ownership.
    • An attractive, competitive compensation package. We suggest that “attractive” means compensation that is significantly higher than one’s current salary and bonus. The easiest, safest, and cheapest method of providing attractive compensation to a new rainmaker is insurance on the life of the former rainmaker. Remember, the death of the former rainmaker makes the remaining ownership justifiably concerned with the financial viability of the entire company. Also consider key person life insurance on all other key employees whose deaths would affect the cash flow of the company.

As you can see, buy-sell agreements transfer ownership, but they may not protect the on-going viability of the business.

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The Argument For Starting Now
 

In the long term, Exit Planning provides solutions to these challenges to the survival of a business at an owner’s death. It takes years to enhance the skills of existing managers or create new management, or develop systems and processes that lessen the responsibility or importance of key employees/owners. This is an important point to drive home as you explain to owners why they can’t postpone Exit Planning if their target departure date is within ten years.

In the short term, rapidly replacing the rainmaker with another of equal or greater talent may be the difference between the life and the liquidation of a company. Funds from life insurance (assuming the key player is insurable) enables companies to hire the best available replacements. It can also provide the funds necessary to maintain a business until the new person (or people) is able to fill the hole in the business’s operations.

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