Death, divorce, disability and departure: they are unpleasant to consider, but when one of them befalls a business that doesn’t have a plan for dealing with the fallout, the result can be catastrophic. Disorganization, loss of business opportunities, loss of customer or market share, and a decrease in employee morale and productivity may be the least of the repercussions. Family or partner discord, heirs left unprovided for and the demise of the business are very real possibilities.
Death: Particularly in family businesses, the death of an owner can trigger a real business disaster. Death can leave the heirs financially unprotected. Hoping the surviving partners will ‘do the right thing’ may prove overly optimistic – especially where big money and personal interests are at stake. When a partner has died without leaving any written plan outlining their ownership rights and what was to happen to their stake, it’s not unusual for the surviving partners to cut the family out of the business without recompense.
Even where there is an agreement, if it hasn’t been properly structured to take into consideration all the contingent issues, then it’s as good as useless. Fatal disputation can arise around issues like:
Is the business required to buy out the heirs? If so, what price should they receive for their share of the business and under what terms?
Who is to be the purchaser - the business itself or the individual owners?
Personal matters can also arise. Are all partners amenable to working with the respective heirs of the other partners?
If a procedure for dealing with these issues hasn’t been nailed down in a formal agreement, or set of agreements, then legal action is a likely recourse by a disgruntled party which will inevitably eat into the value of the business. At death, a tax liability is attached to the market value of the owner’s share. If a method of minimizing this tax liability hasn’t been factored into a transition plan (for instance by willing shares to a spouse) then it can mean hurriedly trying to raise finance to cover the amount. But in many instances, banks aren’t prepared to come to the table when the business has lost its major asset – the owner. The business may have to be sold to pay the tax liability.
Simply put, an owner/partner needs to understand that failing to properly plan for what happens to their equity in the business after their death, such as with a buy-sell agreement, will have consequences for their family and any co-owners of the business.
Divorce: Rarely do you see divorce listed as a cause of business bankruptcy, but with nearly half of all marriages ending in divorce, in circumstances that frequently turn ugly, divorce proceedings have destroyed many privately-held businesses. In the absence of any type of divorce planning, such as a pre-nuptial and a buy-sell agreement, all assets may be legally required to be divided 50-50. To come up with the cash to pay the divorce settlement, owners have had to sell their business. However, that may not be the final, or worst part of the story. In a court-enforced sale, the owner may even have to accept a discount price for the business.
Disability: The chance of becoming disabled during one’s working life is anywhere from one in four to one in three - far greater odds than the probability of dying before retirement. Statistics show that a disability that lasts beyond more than a few months will likely continue for several years or longer.
Owners/partners need to think beyond simply replacing lost personal income because for them, there is more at stake, such as long-term obligations they have contracted into (ie: a lease). Forced retirement of a partner due to poor health can jeopardize the likelihood of continuing partners receiving their fair share out of the business or of preserving their interest in it. After a year or two, continuing to carry a disabled owner on the books becomes an unacceptable expense for many small businesses.
A disability buy-sell agreement can take care of these issues by specifying the types and amounts of insurance partners should take out to cover the contingency of health-related forced retirement. It can extend to specifying disability buyout insurance to provide a means for co-owners or an outside entity to buy the interest of the disabled owner, generally over a number of years, once it is evident they are not going to return.
Departure: Partners can decide to leave the business for a number of reasons. They may choose to take up another opportunity or simply to take life easier. Here the issues revolve around determining what is owed to the leaving partner and where the money to pay them out is coming from.
Without proper planning, it can be a real challenge for the retiring owner to extract, as cash, the value they have locked up in the business; and for the remaining owners to compensate for its removal without recourse to methods that could damage the business’ viability. An announced departure shouldn’t trigger panic – it should trigger the provisions that have been laid down to handle the situation in an established buy-sell agreement.
Planning For The Four D’s:
Unpleasant and emotionally charged as it may be to contemplate the four D’s, planning for them should be an integral part of overall business and personal financial planning for every business owner.
The last thing an owner needs is to be forced to sell their business in a hurry because of unforeseen circumstances or to leave their business or family in a dire position when they die. Though circumstances may occur unexpectedly, that doesn’t mean they can’t be envisaged and planned for, ahead of time. An estate plan, a buy-sell agreement, a pre-nuptial agreement – all can feed into an overall transition plan to protect the business and its dependents in the eventuality of one of the 4 D’s.
