health. wealth. life. | 8 |
life
B U S I N E S S
S U C C E S S I O N P L A N N I N G :
T O E N S U R E F U T U R E
A StrategyGrowth
| 9 |
Success can be defined and conceptualized in many ways. In
business, success is often associated with profit margins. A second
way businesses can be seen as successful is a sustained history of
accomplishments, innovation and preparation for the future.
Granted, there are plenty of companies that have proven success
without many decades to put behind their name. Twitter, for
example, would be enrolling in second grade if it were a person,
but in 2012 the company “hashtagged” its way to a reported $129.7
million in advertising revenue.
Both new and time-honored companies share the same need when it
comes to longevity - a plan for the future. In order to secure the
continuation of a closely held business at the death or disability
of an owner or partner, formal planning is necessary. The
unfortunate truth is that 70% of businesses fail before they are
transitioned to a second generation. Much of this failure can be
credited to a simple lack of planning.
An important component of business succession planning is the
use of a buy-sell agreement that plans for the sale of a business
interest upon an altering event, such as the death, disability or
retirement of an owner or key employee. The arrangement protects
the interest of the business owners and helps the continuation of
the business in the future. Life insurance is one of the best ways
to fund buy-sell agreements to ensure business continuity. It is
cost-effective, makes cash available at the time it is needed and
proceeds are not subject to income tax.
If a permanent life insurance policy is used, the cash value
accumulation in the policy can provide needed equity to buy-out a
business owner at retirement. In addition, special buy-sell
disability income policies are available to fund a buy-sell
agreement in the event of a total and permanent disability.
Typical buy-sell arrangements come in the form of either a
cross-purchase or an entity purchase.
Cross-purchase is an agreement between the owners of the
business to buy the business interest of another owner. Entity
purchase differs in that the arrangement is between the business
entity and individual owners.
In a cross-purchase arrangement, the owners pay the premiums,
which can be funded by the corporation through a bonus plan. The
business pays the premiums in an entity purchase. Entity purchase
works best for businesses with several owners because the business
will only need to purchase one policy on each owner. There are many
benefits of having a buy-sell arrangement. A buy-sell arrangement
provides a guaranteed buyer, creates
liquidity, sets a fair selling price, sets the valuation for
estate tax purposes and maintains harmony during a potentially
difficult time of transition.
One of the most important benefits of a buy-sell arrangement is
to fix a value for the business. Common ways of valuing a business
include specific fixed price, book value, capitalization of
earnings, formula or appraisal. A business valuation produces a
value to be used for federal estate tax purposes, as well as to
determine an amount of life insurance needed to fund a buy-sell
agreement.
Conducting a business valuation is not a one-and-done process.
It must be done at regular intervals to keep up with changes that
occur in revenue and business strategy. Once every two years is the
recommended timeframe for a business valuation.
A well-drafted and adequately funded buy-sell agreement is a key
component of a business owner’s succession and estate plan, and
should be taken into serious consideration in planning for a
company’s future growth.
Finally, key person insurance is an additional tool used for
business succession planning. Businesses purchase this type of
insurance on the life of an employee who is crucial to the
business’s success to provide the monetary resources needed in case
of sudden death or disability.
It’s never too early or too late to develop a plan to protect
the future of your business.
Life insurance is one of the best ways to fund
buy-sell agreements to ensure business continuity.
