While running the day-to-day operations of a company can be time consuming, it is important for business owners to take the time to assess the organization’s future as well. Succession planning is essential for the continuity of a business for when an owner or key employee retires, becomes disabled, passes away or simply leaves the company. A good succession plan can help protect the interests of the other owners by proactively addressing such an event.
Three key issues a company should consider before any complications arise include: (1) what to do with regards to the transfer of shares or interest in the company; (2) how to address the financial impact the departure of a key person can have; and (3) whether it wants to provide its workforce with ownership interest in the company.
A Buy-Sell Agreement addresses the handling of an owner’s shares in the company when certain events occur. They are used to reallocate shares of a business if an owner dies or leaves the company for another reason. A Buy-Sell Agreement establishes the events triggering the buyout, who may purchase the departing owner’s shares or interest, and the price to be paid for those shares. When such an event occurs, the shares are often sold back to the company through a stock redemption agreement, or to the other owners via a cross-purchase agreement.
The terms of a Buy-Sell Agreement can help protect the remaining partners’ interests by restricting the departing owner from selling to outside investors without their approval. They can also can protect owners from fiduciary agents (such as lenders) from taking control of one owner’s shares in the event of a personal bankruptcy. Importantly, Buy-Sell Agreements set the terms for how owners assess the value of the company and will be used to avoid confusion down the line.
Buy-Sell Agreements are a great way for a company’s owners to dictate control over the future of the business. They help keep the business out of the wrong people’s hands while ensuring you and/or your heirs receive fair compensation when you exit the company. If you have business partners, Buy-Sell Agreements are important because they establish the rights and responsibilities each owner has with regards to the future of your business.
Key Person Insurance
Another way businesses can plan for the future is to obtain what is known as Key Person Insurance – a life insurance or disability policy purchased by the company covering someone essential to the company (usually an owner, but it could also be someone in senior management). Like typical life or disability insurance policies, the company purchases the policy, pays the premiums and is the beneficiary if the key person dies or becomes disabled. Businesses should consider purchasing such a policy if the absence of this person could have a serious adverse effect on the company.
The premium payments are not tax deductible, but the insurance proceeds received as the result of the death are tax-free. The company can use those proceeds for expenses until it can find a replacement for the key person, pay off debts, as severance for other employees, or however else it sees fit.
Key Person Insurance is not necessary for all companies. However, if your business relies on a few key individuals to succeed, it is a good way to protect yourself in the event that this key individual dies or becomes disabled.
Employee Stock Ownership Plans (“ESOP”) are a contribution employee benefit plan designed to provide the company’s employees with an ownership interest in the company. The shares are generally held in a trust until the employee leaves the company, at which point, the shares are then either bought back by the company for redistribution or voided. The plan can borrow funds or receive contributions from the company itself.
ESOPs can be used to provide a market for the shares for when an owner departs the company. The company can make tax-deductible contributions to the ESOP and buy out an owner’s shares or the ESOP trust can borrow money to buy the shares. ESOPs are also a good way to ensure that the participating employees to do what is best for the company since they are shareholders themselves.
Another major benefit of ESOPs from an owner’s perspective is that they create a ready-made buyer for the company once an owner moves on. It helps create a structure whereby a business can thrive after its original owners leave the company.
These strategies are great ways for companies to address future events that might have an impact on the business. There are other approaches, and the aforementioned plans might not be best for your company. The key takeaway however is that it is important to consider not only the present-day issues affecting your company, but also how to ensure that it continues to thrive in the future. For more information on business succession plans, contact the attorneys at Rock Fusco & Connelly, LLC.