Planning for Success(ion)

My wife and I had our first child late last year. As any new parent quickly discovers, having a baby comes with an impressive list of things to worry about. Some are immediate and often. Is he eating enough and when did he last eat? Why won’t he sleep? Why is he crying? Does he like me? Is having the TV on really that bad for him? 

Others are considerably less immediate, but much more uncomfortable. What happens to him if something happens to me?

Having a child has a funny way of making you zoom in on your own mortality. I wrote a health care directive for the first time in my career the night before my wife gave birth. Suddenly, things like life insurance, wills, beneficiaries and estate planning move from “things responsible adults should probably get around to doing” to “things that I actually need to get done even though I don’t feel like a responsible adult.”

I’m not planning on going anywhere anytime soon, but my son depends on me, and that changes how I view my own life. His birth forced me to think about how things could change immediately. 

Entrepreneurs spend an enormous amount of time thinking about how to start a business. What product should we sell? How much money do we need? Who are our customers? How do we price it? How do we grow? How do we hire employees? How do we finance it? If everything goes according to plan, eventually the business becomes successful.

And yet, for many emerging businesses, there can sometimes be surprisingly little thought given to a fairly obvious question: What happens to this business if I’m gone tomorrow?

The $10 Million Business with No Plan

Imagine three friends start a company together. At the beginning, there doesn’t seem like there is much to plan for. The company has little value. The founders are young. Nobody has much money invested. Everybody is working toward the same goal.

Ten years later, things have gone remarkably well. The company now has employees, customers, equipment, contracts and real earnings. Maybe the business is worth $10 million. Then one of the founders unexpectedly dies. Her one-third ownership interest doesn’t disappear with her. So, who owns it? Perhaps her husband does (if she’s married).

There is nothing inherently wrong with that result, but it creates some questions. Does the husband want to own one-third of the company? Does he know anything about operating it? Do the two surviving founders want to be in business with him? Does he get a vote on major company decisions? Does he receive distributions? Can he sell her interest to someone else?

Maybe everyone agrees that the best solution is for the company or the surviving founders to buy the husband’s interests out. That creates another problem: where are they going to get $3.3 million?

Unless there is a life insurance policy with the company named as beneficiary, the company may have to borrow the money. It may have to pay the purchase price over a number of years. The surviving owners may have to contribute their own money. Or, worse, everyone may discover that nobody ever agreed on whether the ownership interest had to be purchased in the first place. These are difficult questions after someone dies.

They are much easier questions when everyone is 30 years old, healthy and sitting around a conference table starting the company that doesn’t have any value yet.

The Best Time to Plan Is Before You Need the Plan

Most business owners hear “succession planning” and think about retirement or death. In reality, succession planning is much broader. Disability, Divorce, Disputes or unexpected Departures can all affect ownership and leadership within a business. The question is not whether change will occur. The question is whether the business can handle it. That’s where good legal planning becomes invaluable.

A good succession plan doesn’t need to predict the future, but it should answer questions that become difficult once the future happens. Who can/should own the company? When does an owner have to be bought out and why? How is the company valued for this purpose? How will any buy-out be financed? 

Those answers can be built into operating agreements, stockholder agreements and buy-sell arrangements. Life insurance can provide liquidity if an owner unexpectedly dies. The particular solution depends on the business. What’s most important is that everyone agrees to the rules of these solutions while they are still hypothetical and nobody knows which side of a potential situation they (or their heirs) will be on. 

I didn’t update my estate plan and buy life insurance because I expect something bad to happen. I did it because someone now depends on me. In many ways, business owners are in the same position. As a business grows, there’s a number of people (e.g. investors, customers, vendors) with a vested interest in its continued success. Succession planning is simply acknowledging that success creates responsibilities. The best time to answer difficult questions about ownership, leadership, and continuity is not during or after a crisis. Just as I wanted to make sure my family would be protected if the unexpected happened, entrepreneurs should make sure the businesses they worked so hard to build can survive without them.