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Death and The Life Of The Co-Owned Business

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This is our third article in our series on death and the business owner. In the first we met Ralph, an owner who died with an up-to-date estate plan, but absolutely no coordination between that plan and his business Exit Plan. We recommended that Exit Planning advisors ask owners—and see that they answer—four questions, the first of which we discussed in the second article Death And Family Security. Today we tackle the second question:

Will the business continue if one of the owners does not?

Of course a business can continue if own owner dies: there’s a buy-sell agreement in place (governing the transfer of ownership) and a perfectly capable surviving owner still in place. What’s the problem?

Isn’t one of the great benefits of having both a capable co-owner and a current buy-sell agreement that they enable the business to continue when one owner dies? Doesn’t the buy-sell agreement provide a successor owner, a binding obligation to buy at a determined value, cash in the form of life insurance proceeds, and perhaps a salary continuation agreement?

Yes, but. . .

Contrary to all-too-popular belief (or possibly wishful thinking) simply having an up-to-date, properly funded buy-sell agreement isn’t sufficient to ensure the continuation of a business. It just ensures that ownership transfers according to its terms. As advisors, we must introduce owners to, and manage, two other issues.

Issue 1: Debt and capitalization

Can a company continue without the decedent’s personal guaranty on debt, leases, surety bonds and the like? If the survivor owner doesn’t have a sufficiently strong balance sheet (to satisfy lenders), someone else’s balance sheet will have to replace the decedent’s balance sheet. Chances are the older co-owner will both die first and have the stronger balance sheet. The younger owner may be capable of running the business, but usually lacks the financial strength to support the company’s credit needs. This can cause business failure, especially when the company is dependent on lines of credit or performance bonds.

The easiest and cheapest replacement vehicle is the purchase of life insurance on the well-heeled co-owner in an amount sufficient to keep the company’s bank happy. If the co-owner is uninsurable, explore alternative solutions now. One such possible solution in family-owned businesses is to provide a continuing guaranty or a loan in the parent/co-owner’s estate plan. If that is not possible, you may wish to suggest that your client meet with any lenders now to develop a plan acceptable to them.

Issue 2: Managers must replace skills and leadership of the owners.

Many co-owned businesses are successful because the co-owners contribute different skills and aptitudes: each fills the gaps in the other’s list of strengths. For example, one owner might be a great manager while the other (a terrible manager) is terrific in sales or operations or leadership, or just provides the investment capital and financing. You may represent businesses, for example, in which the older owner provides the financial support necessary (as in the first example above) and a younger co-owner provides the talent, drive, active management and leadership of the company. If the younger co-owner dies, the company loses those strengths, and that loss can pose real problems for the future performance of the business.

The best solution to that loss of talent is to have, in place, capable successors to each owner. This is yet another reason to focus on the most important of all value drivers: having capable management who stay when an owner leaves. If creating that value driver is a work in progress, you can suggest that the company purchase key person insurance on the lives of the business-active owners to provide the cash required to hire a top-level replacement.

Addressing the less obvious issues involved in business continuation is a good example of how Exit Planning advisors are trained to ask probing questions of their clients to discover their goals and aspirations but also, as is the case here, to discover any vulnerabilities or deficiencies that can cause their exits to fail—whether during lifetime or death.

In our next article, we’ll look at the same issue—business continuity—for sole owners.

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