Why De-Risking Your Business Succession Plan Is Key For Owners
For many business owners, succession planning is one of the most important business discussions that never seems urgent until it is.
That’s because it forces owners to contemplate uncomfortable scenarios: What happens if I die unexpectedly? What if I become disabled? What happens to the people I’ve spent decades building this business with? And, perhaps most difficult of all, what happens to the business I’ve worked so hard to build?
Beyond the emotional considerations, many owners delay succession planning because they worry it will divert time, capital, and attention from growing the business.
But postponing the conversation can cost more in the long run.
As business owners begin mapping out their budgets and strategic plans for the upcoming year, evaluating how their succession plans are funded is a critical task. A buy-sell agreement may establish what happens when an owner dies or becomes disabled, but that’s hardly sufficient. Owners may be left with little more than a promise on paper if there’s not a capital plan in place, too.
Financial professionals are often well positioned to help business owners evaluate the risks associated with an unfunded succession plan. Owners should be able to confidently answer one critical question: If I have a succession plan, can I actually afford to execute it?
A Plan Is Only as Strong as Its Funding
A buy-sell agreement can provide a framework for transferring an owner’s interest in the event of a death or disability, both of which are known as “triggering events.” More often than not, this agreement will establish who will purchase the interest, how the business will be valued, and how the transaction will occur.
But then comes the question that actually determines whether the plan works in practice: Where does the money come from? A business might theoretically fund a buyout through any of the following: existing cash, future cash flow, a sinking fund, installment payments, or borrowing.
Each approach, however, carries its own challenges. Consider a business that suddenly needs to purchase a partner’s interest after an unexpected death. The value of that interest may be substantial. Using operating cash to fund the transaction could leave the company with less capital for payroll, expansion, or other business needs. Alternatively, taking on debt could add another obligation at the very moment the company is navigating a major transition.
One way or another, an unprepared business will be forced to choose between funding the succession plan and funding the business. That is why unfunded risk should be a priority for every owner — and their financial professionals.
Turning an Obligation Into Liquidity
Insurance can be one way to address the liquidity needs that arise when a succession plan must be executed unexpectedly.
These arrangements can be structured in multiple ways, including:
● Cross-purchase agreements: This is when owners purchase life insurance on each other. In the event of an owner’s death, they agree to use the proceeds to purchase the departing owner’s interest.
● Entity-purchase arrangements: In this case, the business owns policies on its owners and uses the proceeds to fund the purchase of an owner’s interest.
● Disability buyout agreements: The financial implications of disability for a business can often be just as significant as those of a death. This is where disability buyout insurance can play an important role. Unlike life insurance, which can provide liquidity following an owner’s death, disability buyout coverage is designed to provide funds when a qualifying disability triggers a buyout.
A comprehensive succession plan should account for both death and disability outcomes. The appropriate structures often depend on factors including the number of owners, the organization’s structure, and the broader tax and estate-planning considerations involved.
That’s precisely why the conversation shouldn’t begin with a product, but a dialogue about risk. What is the business worth today? What would an owner’s interest be worth if a triggering event occurred tomorrow? Who is obligated to purchase that interest? And where would the money come from?
Once those questions have been answered, licensed financial professionals can help determine whether insurance may be an appropriate tool for creating the necessary liquidity.
Bring the Business Plan and the Wealth Plan Together
For many owners, their business is more than a source of income. It may be their largest asset and the foundation of their retirement and legacy plans. In these cases, business succession events can have consequences far beyond the company’s balance sheet.
That’s where a trusted financial professional can put together the pieces. They can ask the right questions to move succession planning from being thought of as a legal document to a financial strategy, such as:
● If an owner is counting on the eventual sale of the business to fund retirement, how should the timeline change if there’s an unexpected buyout?
● If the owner’s family is expected to inherit wealth from the business, what happens if a poorly funded transition forces the company to take on significant debt?
● If the owner’s estate is expected to receive proceeds from a sale or redemption, has the plan been coordinated with the owner’s broader estate strategy?
● Would using cash, borrowing, or future business income put pressure on the company’s operations?
● Does existing life or disability coverage provide enough liquidity?
● Has the funding strategy been reviewed since the last change in ownership or valuation?
● Does the succession strategy align with the owner’s retirement, estate, and personal wealth goals?
Licensed financial professionals can play an important role in helping owners identify and address these risks while aligning business succession decisions with broader financial objectives.
The Details Matter
It is tempting to think of succession funding as a simple equation: determine the value of the business, purchase enough insurance, and move on. In reality, the plan needs to evolve alongside the business. Business valuations change. Ownership structures change. Partners come and go. A buy-sell agreement drafted years ago may no longer reflect the business it was designed to protect.
The goal isn’t to predict exactly when a transition will happen. It is to make sure the business is financially prepared when it does.
The Bottom Line for Financial Professionals
For financial professionals, the upcoming budgeting cycle provides a natural opening to revisit the conversation. Is the client’s succession plan current? Is it funded? And is it still aligned with the personal wealth goals that the business was built to support?
If you’re looking to build or strengthen a multidisciplinary planning approach, AIMCOR EIG can help. Our team works alongside financial professionals to identify gaps in insurance, succession planning, and other wealth strategies.