Death and disability are topics most of us prefer to avoid. So, it’s no surprise that many business owners fail to prepare for the possibility of losing key personnel. Unfortunately, inadequate succession planning can jeopardize the survival of your business. The good news is there are steps you can take to protect your business if something happens to an owner or key employee.
What Is Succession Planning?
Succession planning is the strategy and process of transitioning key leadership roles in an organization to an employee or vetted outsider. Ultimately, a succession plan helps ensure a business continues to run smoothly after losing key personnel.
In most cases, succession planning is one part of a business owner’s overall exit strategy. However, proper planning can also help you avoid an interruption in routine operations due to the untimely death or disability of an owner or key employee.
Succession Planning vs. Estate Planning: What’s the Difference?
Succession planning and estate planning are similar in that they both document a plan for what happens when you’re gone. However, they differ in that they address two separate concerns: business continuity vs. personal property in your estate.
As a business owner, you likely use the income you earn from your company to support yourself and your family. If you become disabled or die, that income stops. However, you can purchase disability or life insurance to replace or offset that loss and protect your family’s lifestyle. These steps are part of a comprehensive estate plan.
On the other hand, the sustainability of your business may depend on your contributions or the contributions of others. If a key member of your company becomes disabled or dies, revenue, cash flow, or operations, in general, may be negatively affected. Succession planning helps ensure your business is protected in the absence of key personnel.
The Benefits of Proper Planning
Indeed, careful succession planning is often critical for the ongoing success of a business. Yet according to a study of 200 privately held companies by Wilmington Trust, 58% of small business owners don’t have a succession plan. Unfortunately, this lack of preparation can have dire consequences—not only for your business but for anyone who depends on your business for their livelihood.
On the other hand, having a formal succession plan in place has many potential benefits, including:
- Facilitates business continuity. The Covid-19 pandemic taught us that the unexpected can happen at any time. Losing an owner or key employee can be a major setback for a small business. However, a succession plan can help maintain day-to-day operations by creating backup procedures.
- Preserves business value. Without a formal plan in place, the sudden death or disability of an owner or key employee could result in forced liquidation of the business. If so, you or your heirs could potentially receive pennies on the dollar for what your business was previously worth.
- Identifies future leaders. Succession planning allows you to identify talented employees and put them on a path towards leadership.
- Promotes employee engagement. According to a recent Software Advice survey, 62% of employees surveyed said they would be “significantly more engaged” at work if their company had a succession plan. Meanwhile, nearly all employers (94%) reported that having a succession plan positively impacts their employees’ engagement levels.
- Saves time and financial resources. Having a plan in place can help you avoid the often time-consuming and expensive process of finding a replacement for key personnel.
- Establishes formal procedures. If you have multiple owners or key employees, succession planning can help you establish a formal process for replacing leaders within your organization.
How to Plan for the Loss of Key Personnel
You may want to enlist the help of a trusted advisor or attorney to develop and document your succession plan. However, you can begin the process by yourself or with your leadership team by answering a few key questions.
First, which of your company’s owners, employees, or contractors would you least want to lose for an extended period? Once you’ve identified key personnel, what steps can you take to replace them, either temporarily or permanently? And lastly, what would be the cost to the business? These three questions can help lay the foundation for an effective succession plan.
When you have a formal plan in place, it’s a good idea to communicate your strategy to key members within your organization, as well as clients and other stakeholders. This can help prevent departures or loss of business if the unexpected occurs.
Key Personnel Replacement Strategies
There are a variety of succession planning strategies that can help minimize the financial burden on your business if a key member becomes disabled or dies.
#1: Key Person Life Insurance
Key person insurance is a life insurance policy you can purchase for yourself, other owners, top executives, or other individuals you consider to be critical to the business. Each policy can be tailored to the individual’s value and estimated replacement cost.
Your business is the beneficiary of the policy, which provides a cash payout upon the death of the insured individual. You can use these funds as you see fit—for example, to cover associated losses or recruit a qualified replacement.
#2: Key Person Disability Insurance
Similarly, key-person disability insurance can help offset the financial liability of a key contributor becoming disabled. The policy may pay a steady income stream or lump-sum payment if the insured person is unable to work due to disability. This can be beneficial if you need to hire a temporary replacement or outsource responsibilities until the individual returns to work.
#3: Business Overhead Expense Insurance
If your business suffers a temporary financial loss due to the death or disability of key personnel, you still need to pay your expenses in the meantime. Business overhead expense (BOE) insurance can help cover basic expenses for up to two years after a disabling event. However, it’s important to note that BOE insurance only covers fixed business expenses. And unlike key-person disability insurance, it can’t be used to cover the disabled person’s salary.
#4: Buy-Sell Agreements
A buy-sell agreement is a legally binding contract that can help ensure business continuity when ownership needs to change hands for any reason. When executed, it requires one party to sell their ownership interest and another party to buy it.
Notably, a buy-sell agreement must be funded in accordance with the current value of your business. You can use life or disability buy-out insurance to fund the agreement. Alternatively, you can fund it with cash flow from the business or not fund it at all. However, leaving a buy-sell agreement unfunded can present additional financial risks if a transaction is triggered.
When It Comes to Succession Planning, Don’t Wait Until It’s Too Late
It’s not unusual for business owners to focus on day-to-day responsibilities and neglect succession planning. Unfortunately, failing to prepare for the unexpected can have a devastating impact on your business and the people who depend on it. In other words, if you wait until you need a plan, it’s already too late.
Oak Capital Advisors specializes in the financial planning needs of small business owners. We can help you develop a succession plan that supports your exit strategy and protects you, your family, and your business if the unexpected occurs. Please schedule an introductory conversation and request your complimentary retirement readiness assessment to get started.
