Protection And Planning Your Exit
Succession planning is usually thought about as a retirement question, which is why the version that actually happens often has no plan at all.
A planned exit gives everybody years to arrange finance, agree a price and transfer relationships. An unplanned one gives them a fortnight, during a crisis, with a business that has just lost the person who ran it and is therefore worth considerably less than the valuation everybody had in mind.
The gap between those two situations is money, and money is the part that can be arranged in advance.
The short answer
Most succession plans identify who should take over and stop short of arranging how they would pay for it. If your exit is unplanned because you have died or become seriously ill, the intended successor usually has to find the money at short notice, which is exactly when borrowing is hardest and the business is worth least, so the plan quietly depends on funding nobody has arranged.
What this changes
- Your shares or interest are an asset that will pass to your family on your death
- Your family may need the value in cash rather than a stake in a business they cannot run
- The intended successor needs funds at the point they are hardest to raise
- The business is usually worth less immediately after losing its owner than before
- Lenders are less willing to fund a buyout during the disruption that follows a death
- Without an agreement, nobody has a right to buy and nobody has an obligation to sell
The bit people miss
The valuation problem is the one that gets overlooked. People plan around what the business is worth today, with them in it. A business that has just lost its owner is frequently worth less, sometimes considerably, because the relationships, the knowledge and in some cases the reason customers stay were attached to that person. So the family expects the figure everybody discussed, the successor can only raise what the business is now worth and can only borrow against what it now looks like, and the two numbers do not meet. Insurance fixes this by putting an agreed sum on the table regardless of what the business is worth that month.
Selling To Your Management Team
Passing the business to the people who run it is a common and sensible plan, and it is the one most likely to fail on funding.
A management team is usually made up of capable people who are not wealthy. They may be entirely the right successors and still have no realistic way of raising six or seven figures at short notice, particularly against a business that has just lost its owner. The plan depends on them borrowing, and the moment they most need to borrow is the moment a lender is least inclined to help.
Policies arranged between the owner and the intended buyers, alongside an agreement setting out the terms, solve this by making the money available on the day rather than hoping it can be found. It also means the price can be settled in advance, so the team is not negotiating with a grieving family and the family is not trying to value a business they do not understand.
A Family Successor Is Still A Funding Question
Where a child or another family member is intended to take over, people often assume the funding question disappears because it is all staying in the family. Usually it does not.
If there are several children and only one is involved in the business, handing the business to that one is not an equal division, and the others may reasonably expect their share of the estate. Where does that come from, if most of the value is the business? Often the answer is that the business has to be sold or borrowed against, which is the opposite of the intention.
Cover can resolve this neatly by providing the money that equalises the position: the business goes to the child who runs it, and the policy provides for the others. That keeps the business intact and the family on speaking terms, which is usually the real objective. How it is arranged and taxed depends on your circumstances, so it is worth doing alongside your accountant and solicitor rather than in isolation.
What usually fits, and why
The usual mechanism where there are co-owners. Policies arranged so the funds exist for the remaining owners to buy your share, and your family receives its value in cash.
Protects the business itself through the transition, which is separate from funding the purchase. The new owner inherits a trading problem as well as an ownership one.
Your own family's position, which is not the same as the value of the business. If the succession plan leaves them dependent on a sale completing, cover gives them something that does not.
Common questions
What is wrong with just naming a successor?+
Nothing, except that naming somebody does not give them the money to buy you out or the right to do so. If your exit is unplanned, they need funds at short notice against a business that has just lost its owner, which is the hardest possible moment to raise money. The plan needs funding attached to it.
We plan to sell to the management team. How does that work?+
Usually through policies arranged between you and the intended buyers, alongside an agreement setting out the price and the process. That way the money exists on the day and the price is already settled, rather than a capable but not wealthy management team trying to borrow during a crisis.
My children will inherit the business. Is cover still needed?+
Often yes, particularly if only one of them is involved in it. Giving the business to that child is not an equal division, and the others may expect their share. Cover can provide the money that balances it, so the business stays intact and nobody has to sell it to settle the estate.
Why would the business be worth less after I die?+
Because a good deal of the value in an owner-managed business is attached to the owner: the relationships, the knowledge, sometimes the reason customers stay. Buyers and lenders both price that in. It is why planning around today's valuation can leave a shortfall at the point the plan is actually needed.
Do we need a legal agreement as well?+
Yes, for the same reason as any ownership transfer. Insurance provides the money and the agreement provides the right to buy and the obligation to sell, plus the valuation method. Without the agreement there is cash but no mechanism, which does not get anybody anywhere.
Cover that often goes with this
The gaps we most often find sitting next to this one.