Many family businesses are run by a principal owner who is also the chief executive officer, the sole director or the manager. On loss or retirement of that principal, if the business does not have a comprehensive succession plan, the principal's beneficiaries and other shareholders may lose the value of their interests in the business while they try to establish new governance structures and ownership agreements.
A business continuation plan can be the first step toward creation of a succession plan that helps preserve business value when the principal dies or retires before the business is ready for ownership transitions.
1. The Problem. When a family business relies heavily on the leadership of one individual, the unplanned exit of that individual can be disruptive to the business which can lead to a loss of value and discord among family members. Even the most well intentioned family members may strongly disagree on how to proceed in such a crises.
2. The Solution. A business continuation plan will consist of a master plan that is updated from time to time. The planning process may also identify contracts that should be changed or renegotiated to allow successful implementation of the business continuation plan.
3. Corporate Structure and Ownership. Many businesses have a multi-tiered organizational structure involving a parent company and one or more subsidiaries. Some parts of the business or investments may be held by the same owners in a separate entity that is completely apart from the principal business operations. The key is to provide for a smooth and immediate transition of the business's voting control. This is accomplished by establishing a clear understanding of who has control of each entity in the business. The business continuation plan begins with a description of the entity structure and ownership.
4. Voting Control. The authority to elect directors or appoint managers, amend governing documents and approve a sale, merger or other disposition or restructuring of the business. If the principal dies or is disabled someone will need to vote the principal's shares on the company's board or as member or manager so that the entity can act for the business. Transition of voting control must be addressed separately for each company if there is more than one entity.
Making a business continuation plan identifies who will succeed to the principal's right to vote the controlling interests in each company of the business immediately after the principal is unable to to ensure continuity and prevent loss of income. Estate planning documents for the owner may need to be amended to accomplish this element of the business continuation plan. I have prepared the documents both ways--sometimes the business continuation plan is prepared before the owner's estate plan. Sometimes, the estate plan is prepared first or already prepared. However, the business continuation plan can still be tooled to or amended to work in tandem with your estate plan.
a. Upon Disability. The principal can execute a durable power of attorney that grants an agent authority to vote the principal's stock in the company. The POA should name a primary and secondary agent. If the stock is held in a revocable trust for estate planning purposes, the successor trustees will be able to vote the stock in the event of the principal's disability.
b. Upon Death. The shares or membership ownership can be titled to the revocable trust so that the successor trustee can vote them upon the death of the principal. The trust can be named as the transfer on death beneficiary. It is possible to separate voting rights from the beneficial or economic ownership of a company's shares or membership interest. In this way, it is possible to give voting control to the person best suited to exercise that control without compromising the principal's wishes about who should receive the economic benefit of owning the business.
5. Board of Directors or Managers. One issue that can happen with the loss or disability of a principal may create a deadlock or schism on the board. If the principal is the only director, the business continuation plan should provide for election of a full board or of members immediately upon the death or disability of the principal.
Other considerations are:
- how should management be constituted currently?
- should the company have outside directors or an advisory board?
- how will the new board be appointed or elected?
- how should be board or members be constituted immediately after the death or disability of the principal
- who should serve as chairperson of the board if the principal ceases to serve?
- how does the board make a determination that the principal has been mentally incapacitated?
- what rules will apply to board procedure immediately after the loss or change in duties of the principal?
- what will the successor's compensation be?
- what other executives need to be retained upon the loss of the principal and what stay incentives may be appropriate?
7. Contracts and Open Transactions. Whenever practical, contract terms should be renegotiated to allow a transition of leadership or change of control and the contract would be updated and may be integrated with the company's operating agreement or revocable trust.
Other considerations may be:
- would the principal's death or disability cause acceleration of any debt obligations or personal guarantees?
- would the principal's death or disability affect other contracts or constitute a triggering event or a change of control?
8. Notice. The loss of the principal may cause concern among parties who have an economic relationship with the business, such as employees, investors, creditors, vendors and customers. Who should receive prompt notice of the principal's death or disability and the resulting change in leadership? The business should keep a list of parties who should receive prompt notice of the loss of the principal. The notice procedure should identify one person or small team of individuals to control communications regarding the principal's death and the transition of leadership.
9. Cash Needs. The principal's death or disability could cause an impairment of contracts such as accelerations of debt or reduction of credit lines. Revenue could drop enough to cause liquidity problems. The business continuation plan should include a schedule of additional cash needs. How can the business obtain the needed cash upon the principal's death or disability? Appropriate levels or life or disability insurance on the principal, sufficient lines of credit to cover increased cash needs, assets that could be sold and contributions from the principal's beneficiaries or fiduciaries.
Questions to be addressed are:
- would the business have to increase dividends to meeting the principal's cash needs on disability or to meet the family's cash needs on death?
- does the principal have appropriate levels of disability insurance or life insurance?
- are there assets that the principal could liquidate?
- would the principal need to draw cash out of the business as a result of the principal's death or disability?
10. Leadership Crisis Plan. The business should have a coordinated, written, "leadership crisis plan" that instructs employees, officers, the boards and the fiduciaries voting the principal's stock how to promptly implement the initial stages of the business continuation plan. Parts of the leadership crisis plan will be incorporated into other documents of the business, such as bylaws, employment contracts, and policies and procedures manuals.
11. Beneficial Ownership. Transfer of beneficial ownership can be separated from transfer of voting rights. Transfer of the beneficial ownership of the business will be controlled by the principal's estate plan.
Questions to be addressed are:
- what ownership rights and restrictions should apply to ownership of the business after the principal's departure?
The business will operate more smoothly if management and ownership after the principal's departure are controlled by shareholder's agreements, buy-sell agreements and operating agreements that are established while the principal is alive. For example, transfer restrictions can ensure that the business stays in the family util it can be sold and provisions can ensure that a minority owner cannot veto the sale of the business. Other questions to be addressed are should the beneficiaries have an exit strategy that does not require sale of the entire business? How ill the rights of employee-owners differ from those owners who are not involved in the business? Who can decide when to sell the business?
12. Sale of the Business. It is possible that the principal's beneficiaries will want to sell the business sometime after principal's death if they can get the right purchase price and appropriate terms. The business continuation plan should make sure that the business is positioned to pursue the beneficiaries' most likely exit strategy.
Questions to be addressed are:
- what is the most likely market for the business?
- how can the business be best positioned for sale to the most likely buyer?
- can the business create its own markets for purchase of the business?
Once the above questions are addressed into a written plan and adopted the family business can continue profitable operations after the departure of the principal and a permanent leadership and ownership plan can take flight and flourish.
Please contact me at 307.200.1914 for a consultation regarding your business plan.