Investing in an actual business is much different than investing in real estate or stocks of a larger public company. Much of the wealth that citizens hold is built upon owning a small to medium size business. The size of the business is all relative to the location and genre of types of business you are involved in. Regardless of the size, running a business takes time, effort and a skill that not all people have.
There is one aspect of running a business that most business owners often overlook; succession planning. I am often reminded of the vary scary scary fact that,
Approximately 90 percent of U.S. businesses are family firms, ranging in size from small “mom-n-pop” businesses to the likes of Walmart, Ford, Mars and Marriott.
Family businesses are also more successful than non-family businesses, with an annual return on assets that’s 6.65 percent higher than the annual return on assets of non-family firms.
Unfortunately, only a little more than 30 percent of family businesses survive into the second generation, even though 80 percent would like to keep the business in the family. By the third generation, only 12 percent of family businesses will still be viable, shrinking to 3 percent at the fourth generation and beyond.
These stats, provided by Mr. Leibell in an Article titled, Succession Planning, (March Trusts and Estates Magazine – Subscription Required) should be a wake up call to all those business owners.
What is a Buy-Sell Agreement?
a binding agreement between co-owners of a business that governs what happens if a co-owner dies or is otherwise forced to leave the business, or chooses to leave the business.It may be thought of as a sort of premarital agreement between business partners/shareholders or is sometimes called a “business will”.
When I am explaining a buy sell agreement to a financial planner or client I usually explain that it is a contract to proactively and preemptively take care of:
- Disagreement Among Owners
- Determination of Value
Why do Professionals have Additional Complications?
It seems like things may be changing soon but as of the date of this post, in the State of New York non-professionals are legally unable to own some professional companies. For example a non-lawyer is legally prevented from owning a law firm.
This obviously presents additional problems with Business succession planning which should be considered.
Funding a Buy Sell
You have no idea how many times I will read a buy-sell that has been in place for years and covers most if not all the situations above, but is unfunded. What do I mean by unfunded?
Lets say we are talking about death, and the document says that upon death of one of the partners/shareholders the surviving partner will buy the shares from the estate of the deceased shareholder for 20% down and 80% note…my first 2 questions are always:
- Does the business have enough cash to part with a 20% down payment? If not do they have insurance?
- Can the business operate with an amortized payment of 80%? If not, do they have insurance to increase the down payment?
A Buy-Sell can be funded with either a sinking fund (think of a super emergency fund) or life insurance.
The type and logistics should be secondary to the idea that one needs to prepare for Death, Disability, Dissolution, etc., and it should be done prior to the occurance of those events.
Do you have a Buy-Sell?