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According to Exit Planning Institute, an astounding 79% of business owners have no written transition plan and 48% have done no business exit planning at all. On top of that, roughly 50% of all business exits are involuntary and are forced by dramatic, unanticipated external factors.
A business typically represents 80-90% of an owner's total net worth — that certainly warrants succession planning attention! You need to have a well-thought-out plan of what should occur if something unexpected happens to you or someone in your family and directly impacts your business.
Dwight Eisenhower once said, "Planning is everything. The plan is nothing." A great succession plan provides the strategic scaffolding to respond to change and handle the certainty of uncertainty. Business exit planning should be active and always present tense.
Business owners need to plan for how they want to walk away from their business not only in a perfect scenario, but also in a worst-case situation. Researcher and author Jim Collins famously identified productive paranoia as a common leadership trait of top CEOs. By asking "What if?" and planning for unexpected change, business leaders can handle disruptions more easily.
Throughout the business exit planning process, it is critical to consider the following scenarios that can force business owners to exit their businesses abruptly, often leaving value on the table. Thoughtful contingency plans can help to protect and preserve business owner value. These contingencies are often referred to as the 5 Ds:
Let's take a look at each of the 5 Ds.
Imagine right now: You are in the middle of an intersection and are T-Boned.
What do you want your family, management team, and ownership team to know? What happens to your business loans? Are your beneficiaries correct?
Who should family and company management talk to for advice? Do you have a documented plan? What obligations does your business have to your estate for the value of your shares?
We often think that a will addresses the needs of a business upon the death of a business owner. But if your partner or spouse passes, do you have the ability to continue their job at the level they were performing it?
Without proper planning, a business owner's sudden death can create chaos and uncertainty for their employees, customers, and family members, potentially leading to the downfall of the business they worked so hard to build. A business exit plan that takes this contingency into account can ensure a smooth transition of ownership or management, preserve the value of the business, and provide financial security for the owner's family in case of an unexpected death.
Now imagine that you had a stroke and cannot talk or write.
Does your family know where your important papers are? Do you have a power of attorney for financial and medical matters? Will this event invoke a purchase of your shares? How will it be paid? Who has the right to vote your shares?
Similarly, if you’re put in a position where you need to stay home to take care of a suddenly sick or disabled family member, what will happen if you are forced to exit your business due to your inability to come into work?
A business exit plan that takes a disability contingency into account can help mitigate the risk of an unexpected long-term illness, injury, or disability that could prevent a business owner from running their business. Having a plan can also help ensure that the business continues to operate smoothly and that the owner's financial interests and those of their employees and partners are protected.
Imagine that your spouse announces that he or she has grown apart from you and now wants to end your marriage while the two of you are still friends. How will your shares be valued in a divorce? Do you have a prenuptial agreement? How will the changes in your finances impact the cash needs of the company?
Creating a business exit plan that takes a divorce contingency into account can help protect your business assets from being divided during a divorce settlement and ensure that your business continues to operate without any significant interruption or impact on its financial stability. This can help preserve the value of the business and safeguard the interests of the owner, their partners, and other stakeholders involved.
When multiple partners enter into a business, is it all roses and rainbows? Business partners rarely prepare for conflict with a productive exit clause. Like all relationships, business partners sometimes decide not to co-own a business. If there's a big disagreement, how will your interest in your business be valued? How will it be paid?
Planning for a potential business partner disagreement can help prevent a potential legal dispute or business disruption in case of a conflict. By outlining clear processes for dispute resolution and defining the terms and conditions of a buyout or exit strategy, the business exit plan can help minimize the impact the disagreement will have on the business and the financial interests of all parties involved. It can also provide a roadmap for a smooth transition of ownership or management in case one partner decides to leave the business.
The pandemic has taught all of us some painful lessons regarding business interruptions and external threats we could never imagine. Many businesses suffered disruption to productivity and the delivery of their products. What was the strength of your back-up system? What insurances did you have to cover business interruption?
Good contingency planning includes risk reduction strategies and policies to protect against everyday disaster situations, including data breaches, property disasters, supply chain disruption, work safety incidents, and critical employee loss.
It is important to run through the tough questions about what you want to happen to your business if you have to exit your business prematurely. Studies have shown that in the four years following a business owner’s death, sales declined 60% on average and employment fell 17%, resulting in a decline of the overall valuation of a business. Additionally, two years after a business owner’s death, firms are 20% more likely to fail or file for bankruptcy.
It is important to have a business succession plan in place to avoid these issues happening to your business in your sudden absence.
What do you want your family, clients, and management team to know? What do you want to happen if you die or become disabled? What should happen if you or your spouse wants a divorce? What happens if there is a disagreement between business partners?
An unplanned business exit can not only impact the day-to-day operations of your business, but also the tax and legal aspects of it, along with the value of your company. You need to create contingency plans for each of the 5 Ds to be properly prepared for any unplanned scenario.
While each of these unplanned events will undoubtedly be treated differently, an important step to take is creating and communicating the action plan for each contingency. This is done through a contingency letter, which serves as a playbook that is a shorthand to your operating agreement and your estate planning documents. Your contingency letter should outline what you, as the owner, would like to happen if you can no longer operate the business.
Have you planned for these contingencies? Part of the role a Certified Exit Planning Advisor (CEPA®) plays is to educate a business owner on how to de-risk their business. Collaboratively, risks can be identified and mitigated. If you want to start planning for the 5 Ds for your business and would like more information, contact our business exit planning experts today.