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Does the Death of a Business Owner Mean Death for the Business?

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The death of a business owner, though tragic, does not have to equate to the death of the business. Sometimes, after an owner’s death, we speak with successors who note that the deceased owner created strong Exit and Estate Plans but failed to provide any guidance about how to coordinate the two. Thus, it is important for you, as an Exit Planning Advisor, to ask your clients, “Will the business live if the owner does not?”

In theory, almost all businesses can survive the death of their owners. If owners create a strong buy-sell agreement (which governs the transfer of ownership) that establishes a transfer to a capable successor or co-owner, there should not be any problems. Good buy-sell agreements provide a successor with (1) a binding obligation to purchase the business at a predetermined buy value, (2) cash in the form of life insurance proceeds, and (3) on occasion, a salary-continuation agreement.

However, up-to-date, properly funded buy-sell agreements are not sufficient to guarantee business continuation by themselves; any owner who thinks they are is a bit too hopeful. Such buy-sell agreements guarantee that an ownership transfer occurs according to its terms, which does not guarantee a continuation of business. As Exit Planning Advisors, we must inform our clients about two other issues that are important to know and manage.

Issue 1: Debt and Capitalization
 

When an owner dies, one of the key issues that accompanies the death involves debt and capitalization. Specifically, successors, buyers, and Exit Planning Advisors must ask whether the business can survive without the decedent’s personal guarantee on debts, leases, surety bonds, and so on. If the surviving owner does not have a balance sheet strong enough to satisfy lenders, someone else’s balance sheet will need to be used in its place.

Older owners tend to have stronger balance sheets than younger owners and also tend to die sooner. Thus, they must assure that they have a plan in place to guide the business after their deaths. While younger owners may have the drive and ability to run the business, they may not have the capital available to support the business’ credit needs. This can cause the business to fail, especially if the business relies heavily on lines of credit or performance bonds.

The best way to combat a lack of successor-owner capital is to purchase a life insurance policy for the well-heeled owner for an amount that will satisfy the business’ bank. If the well-heeled owner is uninsurable, you, as an Exit Planning Advisor, must work with owners to find an appropriate alternative. For instance, in family-owned businesses, you may be able to provide a continuing guarantee or loan for the business in the deceased owner’s Estate Plan. If that is not possible, consider suggesting to your client that he or she consult lenders immediately to craft an appropriate plan.

Issue 2: Management Must Replace the Owners’ Skills and Leadership
 

Many successful co-owned businesses hinge on their co-owners’ different skills and aptitudes: A co-owner who is excellent at managing employees but terrible at finances may work with a co-owner who cannot manage employees at all but whose financial skills are outstanding. You may find yourself advising businesses whose older owner provides financial capital while a younger owner provides the drive, talent, and active leadership for the business. In such a case, the unexpected death of the younger owner, and vicariously his or her talents, could spell disaster for the business’ future performance.

The best way to cover for such talent gaps is instruct owners to groom capable successors for each owner as a hedge against the unexpected. In other words, we, as Exit Planning Advisors, need to focus on the most important Value Driver: assuring that our clients have capable, committed management in place for after the owner exits. If you are working with a business in which that Value Driver is a work in process, we strongly recommend that you suggest that the business owners purchase key person insurance on business-active owners to provide the cash necessary to hire top-level replacements if necessary.

Addressing the less-considered issues involved in business continuation is a hallmark of trained Exit Planning Advisors. BEI Exit Planning Advisors have the training to not only ask their clients probing questions about their goals and aspirations but also discover flaws or gaps in owners’ Exit Plans that may cause them to fail, both during an owner’s lifetime and after death

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