A good military leader grooms his replacement.  Likewise, the sooner you, as the owner, start planning for your exit, the more you can get.  You should put strategies in place about 5+ years before retiring, because you need time to find, then groom a replacement, put in new procedures, marketing to bring a higher value to the business, thus a higher price for you.

[This is the third in a series of 4 Sunday guest posts. Today’s guest blogger is Del Hegland, who, in addition to being an extremely knowledgeable insurance professional, always has a smile for you! Read more about Del at the end of this post.]

There are two kinds of owners: 

you are the business: you are performing the service, e.g. appraisals, a painter, a plumber, horse trainer, masseur, realtor.  You have the knowledge, the relationships with customers and suppliers.  Staff, if any, is there to organize your day, order supplies, arrange meetings.  But you leave, the business ceases.  You retire, the value of the business = the furniture, your customer list (maybe);

you have staff and you are involved in much but the staff can operate without you: you take a vacation and the business can keep going.

If you are (2), your business can have value when you go, thus can supplement retirement by selling the business and keep staff and clients going.  Your focus now is solidifying the value of the business and includes many factors, including:

• Setting Exit Objectives
• Determining Business Value
• Determining potential buyers/ owners: including family, staff (e.g. an ESOP), competitor, outside party;

And: Challenge: The Loss of the business’ #1 talent—You!
A Solution: A Buy/Sell Agreement plus a Key Employee policy

The key man/ woman:

For many or most small businesses the loss of a critical person – a great sales person/ controller/ buyer/ assistant/ partner/ inventor/ financial backer can mean a serious, even fatal setback: business is lost, accounting is inaccurate and late, etc., especially if the loss is unexpected and sudden.

One owner, “Joe”, had two key staff that had been with him for years, “Jim” and “John”.  Jim had been with him for 18 years, knew all the potential problems and how to fix them, and knew all the key clients well.  At 47 yrs. he fell off a ladder at home, broke his neck. A $70-$120/mo. term life-insurance premium would have given the owner a $500,000 benefit to cushion the financial blow and buy him time to rebuild.  A bit more and the wife could have had an additional $250,00o

What if the key person (KP) who died was Joe?  Without proper grooming and job structure in place and adequate liquidity (life insurance is often the most cost-effective) to buy time for the business to recoup, the business will often collapse.  Consider this likely scenario: staff promptly starts looking for new jobs, customers don’t return,suppliers switch to COD, creditors, and the bank, call in their debts and liquidation follows.  A life insurance policy can be a business savior.  However, if no one is trained and willing or is available to run the business, the death benefit might best be used to close the business, pay off debts, donate to loyal staff, etc.

A Buy/Sell (BS) Agreement: 

A BS agreement is simply an agreement for A to transfer ownership to B or B to A under certain circumstances, such as A wants to retire or quit, or becomes permanently disabled and can’t work, or he/ she dies. It provides a valuation and a means of payment set up when there is no duress and a means or formula to update the valuation.  Parties and spouses, if appropriate, all sign off.   It should be updated when circumstances change, e.g. the business value changes, there’s a divorce, etc.  In the case of death, the simplest solution is having a life-insurance plan on each relevant party.  If A dies, B gets the life-insurance benefit but must hand that to A’s spouse by contractual agreement,.  This is really relevant when there’s a partnership.

The inadequacy of a BS is that, while, if A dies and B now gets the business free and clear, B now has to do A’s work as well and maybe B can’t add that or doesn’t have the skills, etc.  I recommend adding a KM policy to make up for the lost business until the business is restructured or a replacement is finally found.

A One-Way Buy-Sell: 

Here, the provision can be for a key person, say John, to replace the owner, say Joe, if Joe dies.   Again, I’d add the KP.  Say there’s a $1 mil. policy on Joe.  Joe dies, John, who has insured Joe, gets the funds which he must hand to Joe’s wife.  John is the new owner and, because of an additional $500,000 KP policy on Joe, the business is liquid enough to keep paying bills, staff, product, etc. and to make up for lost business for some time.  Banks are comforted as are the creditors and staff.  If there’s been proper grooming, John is already familiar with the accounting, legal, marketing, service &c. of the business.  BUT, you need time for finding and grooming the right person.

About Del Hegland: I have three jobs; (i) to help others get a better grasp of what is often a complicated financial world; (ii) to help ensure that their decisions are acted upon; (iii) to keep their strategies up-to-date. Business owners, professionals and families – very busy people who struggle for time to really focus on their insurance and financial goals – are my clients. And I work with other advisors, or can suggest some. Contact me at: 805-563-1000, or email me at dlhegland@ft.newyorklife.com