Why Consider Business Continuation Planning?

Business continuation planning, also called business succession planning, is the comprehensive process of identifying all potential threats to the long term viability of an organization and implementing strategies to mitigate these risks. Owners of successful businesses must plan for contingencies that could negatively impact their company. Do you have a plan?

Why is business continuation planning so important?

A 2017 US Trust, “Wealth and Worth Survey” of high net worth business owners, with company revenues of $1,000,000 to $100,000,000 million annually found:

“More than half (52%) of all business owners—and, surprisingly, 65% of Millennial owners—plan to exit their current business within the next three years.

Despite having plans for the future of their businesses, a majority of owners (69%) have not crafted a formal exit strategy. Nor have they prepared for potential negative events. For example, 84% don’t have a plan in case of a decline in their own cognitive capacity. Eighty-three percent aren’t prepared to handle a substantial labor or wage lawsuit. Seventy-four percent aren’t equipped to manage a sudden business downturn.” A sound business continuation plan will thoroughly address all conceivable risks to the organization and employ strategies to respond accordingly. As the business owner, the process begins with YOU! Your goals and objectives for the company and your ultimate vision for the future drive the process. You have worked too hard to let the direction of your business be left to chance. It is time to get going!

Minimizing Business Risk

In strategic planning, “SWOT” analysis is the process of evaluating a company’s Strengths, Weaknesses, Opportunities and Threats. Business continuation planning focuses on “threats” to an organization’s existence and works to minimize the risk. An integral part business continuation planning is risk management. The focus is on identifying the perils that could disrupt a business or undermine its productivity and implementing the appropriate resolutions.

A few examples of potential risks include:

A death or disability of a key employee or executive:

According to the Small Business Administration

“Small businesses account for 99.7 percent of all businesses in the United States.”

A large majority of small businesses rely heavily on the knowledge and abilities of one or two key people for the bulk of the company’s revenue. In these cases, the loss of just one key person can undermine the existence of a small business. Examples of a key employee may include an inventor, scientist, exceptional salesperson, computer programmer, professional license holder, etc. In nearly every case, finding a capable replacement is challenging, time consuming and costly. In terms of key people, the company faces two potential dangers which could devastate the business: the death and/or disability of a key person.

Key man life insurance

Key man life insurance is a relatively easy and affordable way to cover the risk of a sudden death of a major contributor. This insurance provides instant cash to the business at a most crucial time. The insurance proceeds can be used to meet short term obligation as well as to recruit, hire and train a qualified replacement.

SAMPLE COST FOR KEY MAN LIFE INSURANCE

Ages	$250,000				$500,000.00
	Exam		No Exam		Exam		No Exam
	M	F	M	F	M	F	M	F
30	$107	$100	$154	$119	$155	$140	$210	$150
40	$127	$125	$187	$161	$195	$185	$273	$203
50	$275	$223	$312	$263	$485	$395	$525	$438
60	$663	$490	$785	$564	$1,225	$870	$1,463	$956
65	$1,105	$768	N/A	N/A	$2,110	$1,400	N/A	N/A

Key man disability insurance

Key man disability insurance, while not as readily available and a bit more difficult to obtain, can protect the business if the key person is afflicted with a serious illness or sustains a debilitating injury. The insurance provides a monthly cash payment to the business until the key employee recuperates and returns to work. Funds can be used for any purpose but normally are used for recruiting and training an equally talented replacement. Key man life insurance and disability is NOT just for employees. If an owner is also a key person, there is a strong likelihood that the business will need funds to recruit and train a capable replacement. Key man insurance is a foundational component of business continuation planning and should include both life and disability insurance policies for each key person. Many companies only consider key man life insurance and forgo key man disability coverage. However, buying one policy without the other is leaving your company exposed to devastating consequences!

Losing a key employee to a competitor:

While there is nothing to prevent a key executive from leaving your business for a better opportunity, there are strategies that you can take to make it a bit more difficult. Providing executive benefits to your top performers is an excellent way to endear them to your company and creates a barrier against losing them to a competitor because they feel underappreciated. Examples of executive benefit plans include executive bonus arrangements, non-qualified deferred compensation plans, salary continuation plans and supplemental executive retirement plans. These extra financial incentives are intended to encourage top executives and key employees to remain with the company for a stipulated period of time. Effective business continuation planning rewards top level employees and provides the perks to show them how much they are appreciated.

The threat of a lawsuit:

Anyone that has ever been involved in a lawsuit knows a couple of things for certain: anyone can sue anybody for any reason at any time regardless if it is justified and lawsuits will cost a fortune. What if, a customer, competitor or investor sues your company for a misrepresentation or breach of duty? Or, an employee sues your company for discrimination, harassment or retaliation?

Directors and Officers Insurance

• Directors and Officers insurance is mandatory to protect your business from the very real danger of litigation. These policies provide for payment of the defense of a claim as covered under the terms of the policy and can be the saving grace if your company gets sued.
• The average cost of a Directors and Officers policy is often under $2,000 a year with a zero retention yet the average cost of a claim is over $100,000.
• Director and Officer Boards can be sued by employees (prospective, current or former), the general public, third parties, clients, and/or government agencies.
• Directors and Officers lawsuits may involve a variety of issues related to the daily operations of the board including:
• Duty of Care – Requires Directors and Officers to act prudently and reasonably in regard to the management of the organization’s affairs.
• Duty of Loyalty – Prohibits Directors and Officers from using their position in the organization to further their own personal interest.
• Duty of Obedience – Requires Directors and Officers to ensure that the organization is run in accordance with its charter and bylaws, and that the organization complies with applicable laws
• Directors of Non Profit boards have the same fiduciary duties as corporate board members.

Errors and Omissions Insurance (E & O)

Errors and Omissions insurance, also called professional liability insurance, is designed to protect your company if it is sued due to perceived professional errors or if a client accuses your company of mistakes, careless conduct, or incomplete work. E & O insurance coverage may help pay for lawsuit expenses, including attorney fees, court costs, administrative costs, settlements and or judgments. Errors and omissions insurance policies usually cover the business owner, both salaried and hourly employees, and subcontractors working on behalf of the business.

Cyber Security Insurance

If your company stores sensitive client information or runs the risk of being “hacked”, there is a good chance you should consider cyber security insurance. This relatively new form of insurance protection generally covers liability for a data breach involving classified information, such as social security numbers, credit card numbers, account numbers, driver’s license numbers and health records. In today’s society, cyber theft is a real threat and likely going to get worse and the impact of an attack on your company could be disastrous.

Cyber security policies come in many various but may cover things such as:

• Recovering compromised data
• Repairing damaged computer systems
• Notifying customers about a data breach
• Identity protection for victims of identity fraud
• Virus Protection against damage caused by a virus or computer attack
• Cost of restoring and recreating data
• Business interruption resulting from a hack to your network
• Damage to the company’s reputation
• Lawsuits alleging trademark or copyright infringement
• Expenses related to cyber terrorism and extortion

The importance of guarding against the serious peril of a lawsuit cannot be overstated. One claim, real or unjustified, can sink a very successful business. Maintaining, directors and officer insurance, errors and omission coverage and a policy for cyber security is an essential piece to fundamental business continuation planning.

Planning for Ownership Contingencies

The most critical part of business continuation planning usually deals with how to handle the contingencies with respect to the business owner(s). In other words, what happens to the business if an owner suddenly dies, becomes disabled, decides to retire or just wants out of the business and decides to sell her stock in the company? Any of these events could undermine the long term stability of the business. Therefore, careful thought and consideration must be given to each of these scenarios for the succession plan to be comprehensive. A buy-sell agreement is a legally binding document that contains the plans for dealing with the contingencies of the business owner. It includes the detailed steps and procedures for dealing with a death, disabling injury or buy-out of a business owner. To cover the risk of death, buy-sell agreements are usually funded with life insurance. One strategy is for the business to purchase a life policy on each owner for the express purpose of providing immediate cash to buy-out the deceased partner’s estate. This concept is commonly referred to as a stockholder redemption plan or entity purchase. There are multiple business buy-out strategies available and working with a competent business attorney and certified public accountant is essential to identifying the best strategy for your business continuation plan. There are many advantages to using life insurance to redeem a deceased owner’s equity but the biggest is that the cost for a life insurance policy is relatively inexpensive compared to the alternatives to funding a business buy-out. Additionally, the proceeds of the life insurance are generally received tax free. 1 A disability buy-out insurance policy is the most effective solution to covering the risk of an owner’s accident or serious illness. The buy-sell agreement lists all of the triggering events for a disability buy-out including the purchase price of the disabled member’s shares, the terms of the transaction, the time frame for the triggering of the buy-out, etc. In many instances, the risk of a disabling injury is significantly greater than death. Failure to plan for a business owner disability could very well sink the business. Funding a buy-sell agreement with disability insurance has tremendous advantages. The biggest is that it provides tax free funds to the business and therefore takes a huge financial strain off of the business.

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Effective use of a buy-sell agreement funded with life insurance and disability income insurance on the lives of each business owner can provide peace of mind and assure that the owner’s desires are satisfied.

Maintaining Control of the Business

Another very big concern in business continuation planning is how to effectively maintain the respective ownership percentages of the remaining owner(s) at the exit of an owner. In other words, when an owner leaves the business for any reason, how do the remaining owners maintain control of the business?

Problem:

In many cases, when a business owner dies, their business interests are passed to their survivors through a simple will. In other words, the spouse or other family members end up inheriting the business. Without effective business continuation planning, including a buy-sell agreement, there is no road map to provide any direction. Chaos ensues and questions arise: If an owner dies or is disabled…. Who now owns the interest of the departing owner? In other words, who is the new business partner? Do they know anything about the business? How do the heirs continue to receive income from the business? What if they aren’t able to contribute to earnings? Can the business survive without the departed owner’s contribution? Can the business interest be purchased from the heirs? What is the fair market value of the company? Can a reasonable price be negotiated? How are the remaining owner’s going to obtain the funds to buy the business from the heirs? Can loans be obtained? What if there are multiple owners with conflicting views? These are just of few of the many complications that can and will arise without a plan.

Solution:

A well-structured buy-sell agreement allows the business owner(s) to maintain effective control of the business and therefore avoid the nightmare above. Upon a “triggering event”, whether death, disability or retirement, succession agreements typically guarantee that the former owner’s interest must first be made available to the successor owners. A time frame, for example 6 months after the triggering event, is normally stipulated in the agreement as well. Therefore, if a business owner retires, dies or is disabled, the ownership of the company can be effectively controlled without intervention from family members or other third parties. The business owner’s goals may not be the same as potential heirs or family members. The implementation of a business continuation plan effectively deals with the business transfer at a pre-agreed price which establishes the fair market value. Without an agreement in place, there will likely be disputes over valuation or control issues that may result in costly litigation and ultimately a liquidation of the company.

Summary

Business continuation planning is crucial if you want to adequately protect your business. A solid succession plan includes a comprehensive risk management strategy, protection against the loss of key employees and executives and most importantly addresses contingencies involving the business owner(s). Without clear communication and an effective written agreement in place, your company may very well experience tumultuous times at the exit of a business owner. ¹ Neither MEG Financial nor any of its licensed agents provide legal or tax advice. Please consult your CPA or tax advisor for tax questions relating to your specific circumstances.