Contributed to EO by Saul Simon, a certified financial planner, a registered representative of Lincoln Financial Advisors and founder of Simon Financial Group. This article is the first in a series of three about having “The Talk” with your business partners, parents and adult children.
One important life lesson we learned from the pandemic is that we should all expect the unexpected. We also learned that it’s not necessarily easy to plan for the unexpected. And yet, most of us wish we had done a better job of it in at least some aspect of our lives.
Plan for unexpected outcomes
When it comes to business partnerships, it’s better to have a plan for unexpected outcomes and not need it, than to need a plan for an unexpected event and not have one in place.
That’s why financial planners recommend having “The Talk” with your business partner. It can be a difficult and somewhat sensitive discussion; however, it has significant implications that could impact you and your partner, the families of all the partners, your employees, and other stakeholders.
A worst-case scenario
Imagine this scenario: You and your partner are entering your late fifties, sixties or perhaps even seventies. You’ve been in business together for over 20 years. You have a successful, thriving company, plus you’ve enjoyed a substantial income as well as the benefits of owning a small- to medium-size business. Everything is going well―until disaster strikes: Your business partner suddenly passes away. Now everything that you’ve built together with your partner is in turmoil. All at once, you’re faced with handling an enormous number of details that must be addressed immediately, not to mention the emotion of losing a valued friend.
To begin with, you’ve just endured a personal loss and so has your partner’s family. Attention must be given to the emotional situation and the immediate actions that grieving families must deal with.
Then the chaos starts for you. First of all, if you had no plan in place, you may now have a new, previously unanticipated partner in your partner’s spouse and family. They can claim ownership of your partner’s shares in the business and make decisions with which you disagree, and that may not be in the best interests of the company. Plus, there is an additional financial drain on the business because you will need to hire someone to replace your partner’s role while continuing to pay a salary to your partner’s spouse. In other words, you now have a mess on your hands coupled with legal and financial matters to contend with that you didn’t anticipate and weren’t prepared for.
Sadly, this story is not unique and probably happens all too often to partners in business. In a multi-generational, family-owned company, similar scenarios may include inheritance issues and other tax implications.
If you are in a business with one or more partners, no matter your ages, you should have a plan in place for an eventual business sale, business break-up, business acquisition, or demise of any partner.
3 Essential elements to put in place
How can you protect yourself and your partner(s) from this scenario? There are three essential elements that can help avoid such a crisis:
- Buy-sell agreement. This lays out how ownership will transfer in the case of a partner’s death, disability or retirement. The agreement provides for the purchase of the departing shareholder’s stock by the company or the surviving shareholder(s).
- Funded life insurance policy. In order to have the money to buy the stock of a deceased partner’s estate, a life insurance policy is used to fund the purchase of the deceased’s shares.
- Business valuation. In the event one of the partners no longer wishes to be in the business, a valuation of the business will determine its market value. It must be agreed upon by all partners for a smooth transition based on the terms of the buy-sell agreement.
According to Gary Katz, a registered representative of Lincoln Financial Advisors, a buy-sell agreement and its proper funding may achieve several goals:
- Avoid liquidation of the business
- Facilitate an orderly continuation of the business
- Replace lost business income for a deceased owner’s heirs
- Set a purchase price that can fix the estate value of the decedent’s stock
- Provide evidence to customers and creditors of the firm’s stability
No matter what the circumstances, to be prepared for a partner’s retirement, a company break-up or the death of a partner, your business must have a plan in place of agreed-upon actions to take in such circumstances. The plan will protect not only the financial health of the company, but also the financial well-being of all parties involved.
I strongly suggest that if you are an owner of a closely held business with one or more partners or family members, and don’t yet have a buy-sell agreement and funded insurance policies in place, it makes sense to have “the talk” sooner rather than later before anything unexpected happens.
There are important conversations that need to take place between partners, with a substantial amount of paperwork involved. Having an objective financial advisor at the table, along with your attorney and accountant, can help make this “talk” less awkward, more productive, and more beneficial to all involved.
I hope you will not consider this information as only food for thought, but rather as fuel for action.