THE VALUE OF PERSONAL TRAUMA INSURANCE IN BUY SELL ARRANGEMENTS
We are often asked why personal trauma insurance is required alongside trauma cover used to fund buy-sell arrangements.
There is plenty of evidence to support the fact that the most likely event leading to a business owner wanting to sell his assets in the business is a traumatic or critical illness such as a heart attack or cancer.
Serious ill-health may cause us to reflect on our lifestyle, goals and work habits and to decide that we need to change direction. Or medical advice leaves us no alternative!
In such circumstances we may want to sell our interest in the business to realise funds, or be obliged to do so as we can no longer contribute at a desirable level.
Trauma insurance will provide the funds to support the buyout of business equity in a timely manner when needed (provided that the critical illness is a specified condition in the policy).
But what if the critical illness is one where relatively full recovery is achievable and you can return to good health and full work capacity?
This is likely to result in a desire to reduce debt and a need to meet medical and other substantial expenses, however you don’t want to be under pressure to sell your business interest to meet cash needs. You see a bright future in remaining in the business and want to retain equity.
This is where personal trauma cover makes the difference. It provides much needed cash to meet personal needs and avoids the ‘pressure’ to sell business equity to fund the financial consequences of your critical illness.
The right level of personal trauma cover is not duplicating your protection. It is complimentary to the buyout strategy where trauma cover is used to fund purchase of equity, and fosters the harmonious and anxiety free continuity of the business as well as the stability of the affected equity holder’s personal financial situation.
Business Succession for Sole Proprietors
Many sole proprietors don’t appreciate the fact that when they die their business may die at the same time!
Being the sole proprietor of a business doesn’t mean that you can’t have a succession plan. If you have a business that has a value, or one where value can be created, then you could gain benefit from planning your succession.
All business owners will exit the business at some stage either by way of a planned strategy or through ‘default’ succession where the destiny of the business is determined by factors that are not controlled by the owner. Planned succession can make the difference between an exit being with dignity or with disaster.
If you recognise that your business has a value, and especially if that value can be increased by appropriate development strategies, then it makes sense to ensure that this value can be realised to supplement retirement funds or to form part of your legacy to your beneficiaries.
A sole proprietor has six main succession or exit options:
- Do nothing (succession by default)
- Sell to an external purchaser (i.e. competitor)
- Planned sale by the executor of your estate on your death
- Management succession - sale to employees
- Family succession - sale to family members
- Managed succession - developing partnerships, arranging mergers or acquisitions
If you choose to do nothing about succession then you choose acceptance that one day you will need to sell the business, quite probably in circumstances favourable to the purchaser, or that the business will be sold by the executor of your estate on your death. When your executor sells the business they might also be its “executioner” as their responsibility is to liquidate assets as soon as possible. With no plan in place the business loses its “going concern” value and its forced sale is likely to achieve only a fraction of its former value. Your business dies with you.
A sad destiny for a business built on the back of hard work and commitment.
In these circumstances an owner is well advised to build wealth outside the business and protect that wealth through appropriate financial risk management strategies.
Sell to a competitor
You may see the benefit of turning your business into cash at the right time; however, for a variety of reasons finding succession from within the business is not a preferred or appropriate path.
Under these circumstances a “friendly competitor” strategy may be the answer. This involves identifying a business, probably in a similar area as your own, whose owners might be interested in buying your business on your retirement or in the event of your death.
This strategy includes selection of a friendly or approachable competitor, agreeing terms including the purchase price of the business based on valuation, implementing a comprehensive agreement and establishing a Crisis SuccessionTM plan which provides a buyout mechanism and funding in the event of the death of the vendor business owner.
It is important, as part of this strategy, for the business owner to develop and increase the value of their business, and to implement business continuity strategies to protect the business against unplanned events such as the disability of the proprietor.
It is also important to affect an estate plan including a Will reflecting the existence of the friendly competitor strategy.
Planned sale by the executor of your estate
This strategy can be used if other methods are discounted, and as a short to medium term strategy to be implemented on the premature death of a business owner whilst a planned sale to other parties is still being developed. It leaves the responsibility of selling the business to the executor of your estate, however, the obligation is assisted by a documented plan, reducing the potential for the death of the business.
For example you may select a keen employee within the business to be developed for succession in the future, however, until such time as this is ‘workable’ you establish a life support system for the business to “keep it breathing” in the event of your death until such time as an external purchaser is found. This assists in ensuring that a realistic as opposed to a ‘fire sale’ price is attained. The strategy involves systemising the business, funding its continuity through employment of suitable personnel and implementing a Will that reflects the structural sale of the business by the estate executor.
The managed succession strategy is perhaps the most rewarding whilst at the same time being possibly the most challenging and time consuming.
It involves the selection of employees who demonstrate the qualities of a succession candidate, and a process to develop that person to a point where they possess the competence and skills to purchase equity and ultimately assume control.
The succession process is likely to take time and should be merged with Crisis SuccessionTM which provides a succession solution in the event of the premature death or disablement of the owner. (This may not involve the chosen candidates).
The Corporate Will Company’s six step process for managed succession is demonstrated in The Corporate Will Succession PyramidTM
At a point where an employee or employees have the competency to assume control, a Crisis SuccessionTM plan would involve the chosen candidates (see Succession ConvergenceTM).
A family succession strategy is similar in many ways to management succession but involves family members.
For this strategy to succeed the business owner needs to recognise the different expectations and needs of family members, and to ensure that the business is run in accordance with sound business principals as opposed to being operated solely for the benefit of family wants and needs.
The family succession plan adopts valuable guidelines that accompany and compliment the basic principles of management succession.
Managed succession can work well for a sole proprietor who is unable to find an appropriate candidate and/or prefers not to develop succession from within.
They seek like minded individuals who may wish to buy-in to the business, forming a partnership and enabling the transition to a multi-owner business which facilitates succession through sale to a partner. Alternatively the business owner may merge with or acquire a similar and/or complimentary enterprise to provide similar opportunities for buyout strategies to be developed.
The first step
The first part of The Corporate Will Company succession process is to spend time identifying and articulating the sole proprietor’s vision, together with their strengths and competencies which assist in determining the most appropriate succession strategy.
Once a suitable strategy is determined, the process relating to that strategy can be implemented and monitored to achieve the required outcomes within an appropriate time frame.