1 in 5 start-up businesses don’t last past the first year. And only 28% survive to their tenth year! The reasons for these frightening statistics are many and varied.

However, the Insolvency and Trustee Service (Ministry of Economic Development) who gather and publish data on Insolvency and Bankruptcy, consistently report the following to be major reasons:

Excessive use of credit facilities

Domestic Discord

Ill Health or Lack of insurance!

Loss of Income

Adverse Legal Action

How long could your business survive if a key person died or become incapacitated through illness or injury?

Succession Planning

The development and implementation of a Business Succession Plan (BSP) containing Preservation and Exit Strategies can be critical to the survival of the business (and therefore the family) and the realisation of its equity value during a sale should this occur.

Business Succession Planning provides a predictable and certain outcome for the business, shareholders and their families.

A well constructed BSP:

Protects the value of the business

Creates creditor confidence

Ensures a fair value for the blood, sweat and tears that has been put in

Maintains profitability

Ensures liquidity

Protects the family

Without a BSP, a likely scenario of a shareholder dying without the correct insurance could be:

The Estate owns the deceased’s shares in the business with no cash at hand

The Estate is pushing for settlement (Your share in your business is more than likely your biggest personal asset.)

The business partner has a new equity partner – immediately (The Executors or Trustees principal duty is to get the best value for assets for the Estate.)

The business value will decrease.

Without guaranteed funds where does the cash come from to purchase the deceased shareholders shares? Do you really want to sell other assets? Or ask the bank manager for a loan increasing your personal risk? Or accept a new business partner not of your choosing?

But what if the shareholder does not die? A likely scenario could be:

The person suffering the illness is alive and owns shares but no cash

The person who is sick is pushing for settlement

The business partner is around but now a non-productive equity partner

The non-productive partner still has equity and voting rights

The business value will decrease.

And further effects could be:

Downturn in revenue

Loss of Profits

Inability to service and repay debts

Replacement Costs

Competitor Attack

Loss of Key staff

Preservation Strategy

This is designed to cover additional expenses – e.g. recruitment, salaries, contract fees, accountant, and lawyers.

Also to stabilise cash flow to ensure entity can meet its fixed outgoings and maintain gross profitability.

Exit strategy

This is to create capital to release personal guarantees and debt, pay staff redundancy, cover most legal and accounting expenses, clear out creditors which will stop the fire sale of assets, and to help clean up any taxes that may be outstanding.

The risks are such as:

Loss of profitability normally generated by the key person.

The additional costs and disruptive downtime incurred in securing and integrating a suitable replacement to the business.

Important customers and/or valuable contracts that may be lost or unable to be completed.

Loss of market share as competitors take advantage of the situation.

As a Business Owner What Are Your Obligations?

If you are a sole trader or a member of a partnership, you are personally liable to an unlimited extent for obligations (including loans) incurred in the normal course of business.

Directors can be personally liable if they cause or allow the business to be carried on in a manner likely to create a substantial risk of serious loss to company creditors.

As part of the Companies Act 1993, a company must be able to pass the Solvency Test immediately after a distribution is made. This means:

Liquidity Limb – Company must be able to pay its debts as they fall due in the ordinary course of business.

Balance Sheet Limb – Company has assets greater than all its liabilities including contingent liabilities.

Therefore it is imperative that you also cover debt

As a general guide, the amount of insurance required depends on the guarantee. Most bank loan or overdraft guarantees are joint and several. This means that each guarantor is liable for the full debt, not just a proportionate share.

Business debt could be to:

Banks / lenders

IRD – Tax bills or arrears

Landlord

Staff (outstanding holiday pay etc)

Creditors

Suppliers

Shareholder Protection

What might happen to control and future ownership of the business if one of the partners or shareholders should die or become seriously disabled?

Do you want to be in control of who you are in business with?

How important is it that your estate and dependants receive a fair price for your shares or business interest?

These are all key questions that need to be answered so that appropriate shareholder protection is provided to create the cash required in the unexpected death or serious disablement of a partner or shareholder, to enable the purchase of their shares or business interest.

How much shareholder protection is required?

There are three questions we need to answer:

Who are the shareholders and what is their share of the ownership?

Do you have a Buy/Sell Agreement to create a certain outcome in case of an unplanned exit from the business?

How is the business valued and, what is the value of your business today?

Buy / Sell Agreements

are legally binding contracts between business owners / shareholders that set out the agreed process should a predetermined event occur to one of the parties, such as: Death or Terminal Illness, Total and Permanent Disability, Critical Illness.

Unfortunately it appears that many of these agreements have been poorly written and in some cases not even executed! It is critical that an expert in drafting these agreements is involved and that it is reviewed yearly along with the BSP, so as to ensure the intention of the agreement, business value and insurances remain relevant and sufficient.

Summary

The most relevant Business Succession Plan helps you protect the personal wealth that you’ve worked so hard for.

It enables you / your family to extract the best value of the (probably) biggest asset they have for their Estate. With the freedom to make all the decisions they have to when they need to and the ability to move forward.

No other funding alternative is guaranteed to be available when they need it.

It’s all about providing you with Control, Cash flow, Certainty.

The Last Word

As individual circumstances vary, always seek advice from an Authorised Financial Adviser before making any changes to your existing insurance plans, or taking out new insurance policies.

Vaughan is an Authorised Financial Adviser who specialises in Insurance and Mortgages. And he has also been recognised within the industry as a leading adviser with awards in 2009 and 2010. http://www.insurancebrokerschristchurch.co.nz

Vaughan is an Authorised Financial Adviser who specialises in Insurance and Mortgages. And he has also been recognised within the industry as a leading adviser with awards in 2009 and 2010. http://www.insurancebrokerschristchurch.co.nz

Author Bio: Vaughan is an Authorised Financial Adviser who specialises in Insurance and Mortgages. And he has also been recognised within the industry as a leading adviser with awards in 2009 and 2010. http://www.insurancebrokerschristchurch.co.nz

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