Maritime tradition holds that captains go down with their sinking ships, but ships need not go down when their captains expire.. unless the “ships” are businesses whose captains/owners have not prepared their businesses to sail without them.
Years ago I created an estate plan for Hank Walker, the owner of a thriving general construction company. He was married with two young children. His company’s success was driven, in large part, by two key employees who managed all of the company’s projects. During our estate planning discussion, I suggested to Ralph that he consider doing something (from a lifetime planning standpoint) to ensure that these two key people would stay with the company for the long haul. Hank, with a wave of his hand, dismissed my concern. “I don’t worry about them leaving. I pay them plenty.”
Two months after signing his will Hank died. “Fortunately,” I thought, “at least his estate is in good shape.” The estate plan worked perfectly, but I was wrong. Three months after his death, the business and Hank’s estate were bankrupt.
Shortly after his death, Hank’s two key employees realized that the business was not going to survive without him. While they felt badly for Hank’s family, they decided that their first responsibility was to support their own families. They accepted jobs with new employers who had contacted them shortly after Hank’s death. Without their supervision, the projects Hank’s company had underway came to an abrupt halt. Lack of progress put the construction contracts into default, and the bond company eventually foreclosed on the company’s assets. The bond company then threatened to file suit against Ralph’s estate for the bond default.
In only 90 days the business and the value of Hank’s estate had evaporated. The one saving grace was the irrevocable trust we had created for the benefit of Hank’s family. It was funded with a significant amount of life insurance, but not nearly enough to replace the income stream Hank and Hank’s business produced every year.
The disaster that befell Hank’s family (and perhaps threatens yours) was entirely avoidable. You can avoid this estate planning disaster by asking three Exit Planning questions:
- If I walk away from my business today, never to return, will it continue with minimal disruption to its cash flow?
- Can I successfully transfer my business today to the successor of my choice?
- If I sold my business today for fair market value, would my family and I be able to maintain our lifestyle?
Had Hank and his advisors discussed what would happen to both his family and the business if Hank immediately left his business forever, they would have realized that the business could not continue without the key employees.
Exit Planners know that when a business depends on the owner’s active involvement, it has little or no transferable value. Estate planners see the same situation and know that the income that the ship (business) provided to the captain’s family (and all employees) disappears. That’s the best-case scenario. In Hank’s case, the entire estate, which Hank had used as collateral for bonding purposes, was also lost.
What could have been done? First, owners must ask and answer an estate planning question. Second, owners must construct an Exit Plan founded on a basic fact.
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