Recommendations for Common Holes in Business Continuity Plans

Ignores Threats to Business Continuity

Buy-Sell Agreements that deal with the transfer of ownership at an owner’s death (and sometimes permanent incapacitation) only ensure that a surviving owner owns all of the company and that the deceased owner’s estate receives fair value, in cash, for the transfer of ownership. It does not ensure that the business will continue.

Recommendations

1. Owners and their advisors should address business continuity risks resulting from an owner’s departure. These include the losses of the personal guarantees, collateral and talent provided by the departing owner that are essential to the business’ continued success.
2. Owners and their advisors should consider including two key documents in their Exit Plans: (a) a document that releases existing and contingent debt obligations and (b) a document that requests written assurance from lenders that adequate insurance or replacement capital will satisfy the removal of the deceased owner’s guarantees.
3. As soon as possible, owners and their advisors should create a plan to mitigate the loss of a key employee/owner by hiring and training others in the organization whose talents can offset the loss. Key-person insurance should also be considered for owners who are key to the ongoing success of the business.

Ignores Common Lifetime Exits

An owner’s incapacitation, divorce, bankruptcy, termination of employment, or retirement, along with business disputes among owners, can trigger the need to transfer ownership and are more likely to occur than the death of an owner. Most Buy-Sells fail to consider these conditions. Failing to provide for these events can wreak havoc for all parties, including the company.

Recommendations

1. Owners and their advisors must understand that ownership transfer issues are much more likely to arise from a lifetime triggering event than death. This understanding often motivates owners to update, revise, and expand the scope of their Buy-Sells to stave off an unexpected triggering event.
2. Advisors should explain to owners the advantages of discussing and agreeing on provisions relevant to involuntary lifetime transfers (including business valuation) before they apply to any of the owners. When owners don’t know whether they will be the buyer or the seller, the focus is on creating a fair deal.
3. Advisors should proactively recommend an experienced attorney who (a) knows whether the law precludes certain approaches to ownership transfer and (b) can draft provisions that protect all of the owners.

Neglects the Decedent’s Family

Most Buy-Sell Agreements focus exclusively on the benefits they provide to the surviving owner rather than on providing for the needs of the decedent’s family. Even if the deceased (or incapacitated) owner’s family receives Buy-Sell proceeds for the full value of their loved one’s business interest, that amount is rarely enough to support the family at the same level as did their loved one’s lifetime income.

Recommendations

1. Owners should be able to explain to their advisors what their families’ plans are if they were to die or become incapacitated. 
2. Owners should include their spouses (especially non-business-active spouses) in initial planning meetings to alert them about the consequences they and their families will face should their business-owning spouses exit their businesses by death or otherwise.
3. Owners and their advisors must determine whether a gap exists between the financial resources available at an owner’s death (including the money received from the sale of ownership pursuant to the Buy-Sell Agreement) and the financial resources the surviving family will need to maintain its lifestyle should the owner die.

Isn’t Up to Task

Many Buy-Sell Agreements don’t consider the complex natures and relationships of the owners who sign them. For example, the Buy-Sell may not consider the consequences of having two owners, one who is insurable and one who is not.

Recommendations

1. Owners and advisors must understand how different ownership scenarios create different sets of considerations regarding the optional or mandatory purchase or sale of an ownership interest.
2. Advisors should use Buy-Sell discussions as an opportunity to engage owners in a deeper conversation about their thoughts on whether, under various scenarios, the buyer must purchase the seller’s ownership or have an option to do so, and whether the seller must sell or have the option to sell.

Uses a Cookie-Cutter Valuation Formula

The valuation methodology (e.g., agreed-on value or book value) is too simplistic. While such a formula may be adequate when a business first forms, it does not adjust sufficiently to account for business growth.

Recommendations

1. Advisors must recommend a business valuation that fulfills three criteria:
   1. Is appropriate based on the purpose of the valuation
   2. Matches the sophistication of the business
   3. Matches the owners’ willingness to pay for the recommended valuation
2. Owners should consider their advisors’ suggestions and voice any concerns about the type of valuation their advisors suggest.

Is Outdated

Owners rely on Buy-Sell Agreements to manage emotionally charged situations, and if those agreements don’t account for changes in the business, they cause huge problems for everyone involved.

Recommendations

1. Owners should make reviewing the Buy-Sell an annual event, perhaps part of their fiscal year-end reviews.
2. Owners and their advisors should confirm that they are reviewing the signed Buy-Sell in their reviews, not an unsigned draft.

Conclusion

A Buy-Sell Agreement, if triggered, must achieve the goals of both the remaining owner and the departing owner. Taking the time to thoroughly review an owner’s business continuity planning from an Exit Planning perspective ensures that the business owners have the best chance to exit their businesses in style.