In a recent survey, 95% of business owners agreed that having a transition strategy is important for their own future and the future of their business. But only 42% of the owners had a formal written transition plan. This lack of preparation is particularly concerning since approximately 50% of all business exits are involuntary and are prompted by dramatic external factors. (This data was presented in the 2023 National State of Owner Readiness Report prepared by the Exit Planning Institute [EPI]).
Wealthpreneur Lesson
Stephen Covey Begins With the End
In The 7 Habits of Highly Effective People, Stephen Covey wrote, “Beginning with the end in mind means starting with a clear understanding of your destination. It means to know where you’re going so that you better understand where you are now and so that the steps you take are always in the right direction.”
No matter where you are on your Wealthpreneur journey, I recommend you carefully consider this advice. For Weathpreneurs, beginning with the end in mind means understanding that at some point in time, you will transition the ownership of your business.
Planning for the future is key to reaching your business, financial, and personal goals. Will your transition be proactively voluntary or reactively involuntary? It depends on whether or not you prepare.
Revealing the 5 D’s
Successful Wealthpreneurs thoughtfully plan their ownership transition – both in a perfect situation and a worst-case scenario. To prepare for an uncertain future, de-risking your company is a pivotal first step. You may think you are many years away from exiting, but circumstances can change unexpectedly.
While planning your ownership transition, consider common scenarios that force business owners to exit their business hurriedly. These situations often cause business owners to leave significant value on the table and inflict irreparable financial harm upon their families. These value-destroying factors are frequently referred to as the 5 D’s.
- Death
- Disability
- Divorce
- Disagreement
- Distress
Will your business die with you?
An owner’s death can significantly reduce a business’s value. You may have skills and expertise that are critical to your company’s operations and success. Without its owner, a business may experience a decline in revenue, profitability, and overall value.
Protecting against premature death
- Put a Key Person policy in place in case of a premature death of you or a co-owner. Proceeds from such a policy can provide tax-advantaged funds to hire someone with similar talent to fill the role.
- Create a wealth transfer plan well in advance of your anticipated exit. This will mitigate income and wealth transfer tax implications and potential legal difficulties for your family. Remember to update your wealth transfer plan regularly to reflect changes in circumstance.
- Develop strong structural capital and document crucial processes. This will encourage continued success in the business, even after an owner’s death.
Break glass in case of disability
Unfortunately, unexpected disabilities and illnesses are part of life. But an illness, disability, or other medical concern would not just affect your personal life – it can also impact your business value. Without proper plans in place, a sudden medical emergency could plummet your business value.
Do Your Health Homework
- Carefully design a Buy-Sell Agreement. Implement appropriate plans for disability insurance and life insurance. Consult with a Certified Exit Planning Advisor (CEPA) to determine which policy ownership structure will work best for you and your business.
- Execute medical and financial powers of attorney. This will limit stress and confusion if a disability or medical event impacts your ability to manage your finances and business.
- If an owner or employee has a degenerative disability, strongly documenting business processes limits the negative impact on business value and operations when they ultimately exit.
Will a divorce break up your business?
If you and your spouse are in business together, a divorce will impact your business. You can limit the potential damage to your business value by having proper legal agreements in place if a divorce occurs.
The Marriage Dissolution Scenario
- Draw up a signed and detailed pre-nuptial or post-nuptial agreement. This document should dictate how assets will be divided if you and your spouse separate.
- Do not use collateral in your home to invest in your business. This can cause confusion over what belongs to whom during asset distribution in a divorce settlement.
- Your spouse may have a pivotal role in the day-to-day workings of your business. If they decided to quit due to a divorce, would your team be able to handle their responsibilities?
Disagreements can be dangerous
A disagreement with a business partner could lead to a creative solution. But it could also create a business problem – or even cause the company to crumble. Conflicts may arise from differences in your leadership approaches, financial strategies, or communication styles.
Agree You May Disagree
- During a disagreement, effective communication is key to ultimately resolving the conflict.
- Review your Buy-Sell Agreement annually to ensure it reflects the most up-to-date business valuation. Confirm each owner’s business, financial, and personal factors are considered.
- Clearly define roles, responsibilities, and desired actions for each owner to reduce the likelihood of a disagreement.
SOS, I’m in distress
Part of good contingency planning is implementing policies to guard against events like data breaches, property disasters, supply chain disruption, work safety incidents, legal battles, and critical employee loss. World events can also impact your business value. In the last 20 years, we experienced terrorist attacks on U.S. soil (2001), the Great Financial Crisis (2008-2009), and a global pandemic (2020). The importance of planning for distress cannot be understated!
This Is Not a Drill
- Make financial contingency plans in case your business is impacted by an unforeseen financial decline. Consider raising your core capital target to further reduce risk.
- In your contingency plan, include risk mitigation measures for legal issues, data breaches, supply chain issues, and more.
- Review your insurance policies. Is your business adequately covered for possible business interruptions and key employee risks?
Planning for a happy ending
What will happen to your company if you must exit prematurely? On average, four years after an owner’s death, sales decline by 60% and employment falls 17%. Two years after an owner’s death, companies are 20% more likely to fail or file for bankruptcy.
A contingency plan can reduce the risk of a financial catastrophe due to the 5 D’s. By de-risking their businesses, Wealthpreneurs can best position themselves for business success.
