Stanley - Small-business financial tune up

Chances are, your business has a "business plan," a plan that describes your products, distributions channels, marketing strategy, and revenue goals among other things. A business plan helps you maximize the profitability of your business.

Whether you are aware of it or not, you also have a "business succession" plan for your business. A business succession plan is a roadmap for the transition of ownership and/or management of your business following disability, retirement or death. While a business plan maximizes the profitability of your business, a well-crafted business succession plan maximizes the value of your business at the time of transition.

The challenge is that in the absence of thoughtful planning, the value of your business at the time of transition is likely to be much less than you hoped. Also, without a well-planned transition, there is a risk that your business interest will end up in the hands of someone other than intended.

Triggering events

Events such as disability, retirement and death are often referred to by professional advisers as "triggering events." That's because these events are so dramatic they trigger change -- planned or unplanned. Understanding the natural consequences of these triggering events is often a prime motivator in developing a formal business succession plan.

Disability

Many people fail to recognize that a long-term disability -- a disability lasting six months or more -- is much more likely to occur during the working years than is death. In fact, according to the Health Insurance Association of America's (now America's Health Insurance Plans--AHIP) Source Book of Health Insurance 2002:

· Nearly one in four men and women under age 40 will become disabled for 90 days or longer prior to retirement.

· Each year, one in 13 workers suffers a disabling injury or illness.

· The probability of a disability occurring during one's working years is two to three times greater than the risk of early death.

Disability of a small business owner impacts not only the financial well-being of the owner's family, but also the continuity of the business. In most cases, the owner is also a key employee. If an owner becomes unproductive due to disability, there may be insufficient cash flow to continue his or her salary.

Even if the business is financially able to continue salary, court cases have held that in the absence of a pre-disability salary continuation plan, payments to disabled owners may be considered non-deductible dividends rather than deductible compensation.

But, even deductible salary continuation payments to a disabled business owner are likely to create a strain on the business in the long-term. Healthy business owners may become resentful as they search for a replacement for their disabled colleague while struggling to grow the business in his or her absence.

If it becomes apparent that the disabled owner is unlikely to return to work or return to work at full strength, the healthy parties usually negotiate a purchase of the disabled owner's interest. Unfortunately, a disabled owner with dwindling resources is hardly in a position to drive a hard bargain. And, the healthy owners may face difficulties getting financing for the buy-out if revenues are down.

Retirement

The retirement of a small business owner creates parallel concerns. Unless a pension, profit-sharing, or 401(k) plan is in place, the owner cannot count on an employer-sponsored retirement plan as a source of retirement income. Also, because the net worth of most business owners is tied up in their business, the owner is unlikely to have substantial personal savings and investments to rely on in retirement. Consequently, it is often necessary to sell the business to achieve retirement income goals.

Unfortunately, although small businesses are often cash cows while the owner is healthy and working, finding a buyer that understands the business well enough to continue it profitably and pay fair market value for it, can be a challenge. Potential buyers include competitors, other owners, employees, and family members who are active in the business.

But, just as in the case of disabled business owner, a retiring owner who has not negotiated price and terms ahead of time is at a bargaining disadvantage. Also, if the sale is to a family member, things are likely to go more smoothly if the buyer has been groomed for the job and positioned properly with management and other family members.

Death

At the death of a business owner, the business interest becomes a probate asset similar to marketable securities, real estate and household items. If the owner has a will, the business interest passes to the named beneficiary or as part of the residual estate. If the owner lacks a will, the business interest passes to his heirs under the laws of intestacy. A common disposition pattern calls for a portion of all property to pass to the surviving spouse and children.

One concern is that following the death of an owner, surviving family members usually need cash -- not stock certificates evidencing ownership in a small business that probably does not pay dividends to inactive shareholders. Again, finding a qualified buyer -- one with financing or cash who is willing to pay a fair price may be difficult.

Another concern is that the business interest, although not cash producing in the heir's hands, may have a significant value for death tax purposes. This can translate into a significant tax bill that is due and payable within months of death. Heirs forced to sell the business quickly to raise cash for taxes are unlikely to receive the best price.

Bottom line

Whether the transition is triggered by disability, death or retirement, in the absence of a formal business succession plan, the "plan" is uncertain income continuation for the owner or his or her heirs, uncertain tax consequences to the business, and diminished business value.

A business succession plan

With a formal business succession plan you decide whether your business interest is to be retained for the benefit of family members, sold to the other owners, or sold to outsiders -- well in advance of the triggering event.

If a family member is slated for succession to your interest, you can position and groom the successor for the challenging task ahead. Also, arrangements can be made for the payment of death taxes associated with a bequest of the business interest. Often, this means the purchase of life insurance to assure that the cash is available at the precise moment it is needed.

If a sale is contemplated, price and terms can be worked out in an environment where both parties negotiate at arm's length and on an equal footing. Often insurance is the solution to the problem of where to find the cash to complete the buy out in the event of death or disability.

The lesson is that you can choose a business succession plan, or have one chosen for you. You can be in control, or be driven. A financial professional working in concert with your tax and legal advisers can help ensure that you call the shots and maximize the value of your business interest.

Sharon Stanley is a representative of The Prudential Insurance Co. of America in Cape Girardeau. (334-2603 )