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On March 13 Yours Truly had the privilege of being a guest on the URBusiness Networks Business Exit Strategy show ‘Exit This Way’ with Kerri Salls. We had an opportunity to talk fundamentals of insurance; what both buyers and sellers should consider during their transition.
There is never a time on my SMG team that we don’t look at things wholistically. This article is no exception. So we begin truly at the beginning.
ALL business owners current and future must have their personal financial house in order. That means will and testament, healthcare proxy, life coverage, disability and other solutions administered by quality insurance, legal and financial professionals.Image may be NSFW.
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For buyers: I’d also consider the firm’s workers compensation, pollution, environmental and other applicable insurance experience. It may point to symptoms of poor management that may be an indicator of lackluster processes, poor safety records, bad reputation amongst consumers, etc.
Buy/Sell Agreements
You must ensure you know what to do if an owner(s) die or no longer have capacity or will to run the company. There are two typical buy/sell agreement structures. Most business owners implement one of two plans.
- Cross-purchase plan – Each business owner purchases a life insurance policy on each of the other owners. When an owner dies, the surviving owners use the death benefit to purchase the deceased owner’s share of the business. A cross purchase plan is typically limited to cases where there are only two or three owners.
- Entity purchase or stock redemption plan – In an entity redemption plan between owner-employees, each owner enters into an agreement with the business for the sale of their respective interests to the business. As a part of this agreement, the business will purchase separate life insurance contracts on the lives of the owners. The business will pay the premiums and will be the owner and beneficiary. When an owner-employee dies, his or her share of the company will pass to the heirs of his or her estate. The business may use the proceeds from the policy to purchase the interest from the estate.
What are the business benefits of a buy/sell agreement?
- Provides money to create a fair market value exchange.
- Promotes equitable and orderly transfer of wealth, ownership and management.
- May offer tax advantages.
- Guarantees heirs a buyer for assets they may not know how to manage
- Provides heirs with cash to pay estate debt, expenses and taxes.
‘Key man’ Insurance
This insurance coverage is often used in conjunction with other incentives for keeping essential professionals in place before, during or after transitions or for funding their transition. In an age where your currency is your IP (intellectual property) you need to protect yourself against the loss of the source of that stream of innovation.
Who is insured Business is insured in the event we loose a key person.
How it works Your business would pay annual premiums and be the beneficiary under the policy. If a key person unexpectedly dies, the company would receive the insurance payoff.
How much insurance do I need what the budget allows versus how much money the company would need to survive while bringing a new person up to speed.
- What would happen in the event of an unexpected loss of any key people?
- How much income or revenue could you lose in the time it would take to replace them?
- Would appropriate candidates be available to replace them? Would you have to fly them in from other locations?
- Remember: Term insurance (limited time policy is active) is generally cheaper than a whole life policy.
How the money is used The money can pay off debts, distribute money to investors or cover day-to-day expenses. You could also split the premium and death benefit between the firm and the spouse of the key person “Image may be NSFW.
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162 Plan ‘Golden Handcuffs: Company pays premium directly or indirectly on employee owned whole life policy through means of a bonus. Tax deferrment on income for employee, tax deduction now on income for employer, creates goodwill w/ employee, part of a package of incentives which may also include other incentives.
ESOP (Employee Stock Ownership Program)
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The recent sale of Clinton, MA based NYPRO highlights the benefits of an ESOP when used in the right situation. Employees are indirect holders of company stock through a trust established on their behalf. ESOPs are generally for larger firms (50 or more employees and certainly more than $5mm in sales, generally companies are much larger). The sales of NYPRO to Florida’s Jabil Circuit, Inc. was a $665mm USD deal that fulfills the promise made four decades ago by former NYPRO owner Gordon Langton while ensuring the company’s $1 billion in annual sales will not only continue but grow exponentially.
My final advice: When thinking transition ensure all parties are at the table, fully capable of transparency in communication. Secondly, consider your team made up of your insurance broker, legal counsel and accounting firm. Having the right team will increase the likelihood the transition is a success.
Scott Graves is passionate about helping business owners. Tune in to his show ’The No Boundaries Radio Hour’ with co-Host Dennis Mannone on the No Boundaries Radio Network. Meet him at the crossroads between strategy and innovation at scott@smgravesassociates.com or twitter @smgcreative.Image may be NSFW.
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