Creating an Exit or Succession Plan for Your Business
Posted on Wed, Dec 28, 2011 @ 02:00 PM
Peggy Hoyt, JD
The Law Office of Hoyt & Bryan, LLC
Member of WealthCounsel
It has been said that seventy percent (70%) of Americans have done no estate planning. I would suspect this number may be even higher among business owners when it comes to creating an exit or succession plan for their business.
One of my clients was the exception to this rule. Three businessmen were very successful in the construction industry when the economy was booming. They understood the importance of having a plan that would address what would happen to their respective business interests if any of them became disabled or died. They engaged my services for the purpose of educating themselves about their planning options, developing the strategy for the plan and then implementing the plan through the creation of legal documentation. And, they were even diligent enough to fund the plan with life insurance they felt would be sufficient to meet the liquidity needs of the business in the event a buy-out was required.
Time went by. The construction industry experienced a decline. Some partners made personal loans to the company to keep it solvent. The unexpected happened in more than one way – the business became unprofitable and one of the key partners became terminally ill. Ultimately the business partner died. The remaining partners reviewed the terms of the carefully prepared plan. What were their obligations regarding the deceased’s ownership interests in the business? Would there be sufficient life insurance to redeem the personal loans made to the company? How much, if any, would be owed to the heirs of the deceased partner?
In all things, expectations – right or wrong – rule the day. The surviving business partners expected to be reimbursed for the personal contributions to the company. The surviving spouse expected to be compensated for her husband’s interest in the company. Ultimately, each side made a compromise.
The fair market value formula agreed upon by the partners assumed the business would be a profitable ongoing concern. The life insurance proceeds would be used to provide liquidity to purchase the deceased’s interests and avoid the possibility of an “unexpected partnership” with a surviving spouse. The surviving spouse would receive the value of the business in exchange for the ownership interest of the deceased. Reality, as it ultimately does, set in.
The company owed more than it made. From an accounting perspective, it was completely insolvent and therefore, without value. The surviving spouse believed she would receive the insurance proceeds because during his last days her husband reassured her there was a life insurance policy to buy his interest. The surviving partners needed to be repaid for the personal loans made to the company and the liquidity provided by the insurance proceeds should be used to accomplish that goal.
This was a situation ripe for litigation. Fortunately, not all business agreements end up in court. Instead, the parties followed the intent of the written agreement, the spirit of the partnership and reached an agreement where all concerned both won something and lost something. In the end, the plan accomplished its intended goal.
Editor's Notes:
How do you create lasting legacies for your clients?
70% of Americans fail to do estate planning because they lack awareness as to why they should. In an effort to change this alarming statistic, WealthCounsel launched the Creating Lasting Legacies campaign. Watch Peggy Hoyt's video on how she helps create lasting legacies with her clients.