As a business owner, you know that your company’s financial success is closely linked to your own. Any risks faced by your company could pose risks to your personal financial livelihood.
That’s why it’s critical to consider various situations that could arise and find strategies for mitigating or managing the risks associated with them. With that in mind, here are four common “what-if” scenarios business owners should prepare for:
1. What if I don’t want to do this anymore?
You may be very passionate about running your business today. But a point will likely arise where you’ll be ready to exit.
Planning for your departure is crucial because you may not otherwise have a viable exit strategy, which could compromise the long-term value of your business. The most common exit strategies include: selling the business to a third party; an internal transition of ownership (whether to family members, your management team or your employees); and passive ownership (continuing to own your business while others manage it). Each strategy carries special considerations and potential advantages or drawbacks.
It’s important to start working on your exit plan at least a few years prior to your departure — and preferably sooner. You may need to reorganize your company or set up ownership transition programs that will help with the sale. For example, if you’re looking to eventually sell the business to your employees, you may want to establish an Employee Stock Ownership Program (ESOP) several years in advance. If you’re looking to sell to family members, it’s important to make sure that role clarity, compensation and your buyout terms are objectively designed. Most importantly, give yourself, your family and your business associates time to think through the emotional life adjustments everyone will experience when you leave.
2. What if I can’t do this anymore?
Unexpected things happen. If you experience a trigger event, like a premature death or career-ending illness, you’ll want a written succession plan that provides direction in a time of chaos. It may be only a few pages long, but your plan should cover matters critical to the successful transition of the business, such as who assumes top leadership roles; how key customers, banks, suppliers and employees will be informed and reassured; and where to find important documents and passwords.
Your succession plan will help ensure that the new leaders can step in and perform, which greatly reduces the odds that the business will go through financial turmoil due to your absence.
3. What if a key employee leaves?
Businesses often rely on a key group of executives or top performers who drive revenue, maintain customer relationships and perform other duties that are critical to the mission of the organization. If one or more key employees leave or get recruited away, it could be highly disruptive and very expensive.
A well-designed compensation package that aligns both company and employee goals can prevent this. Start by evaluating base compensation and benefits to ensure they’re competitive within your industry and on par with each employee’s roles and responsibilities. Review your company’s bonus system, which should be tied to predetermined goals and metrics. Companies should also consider longer-term incentives, such as restricted bonus plans, where a bonus is awarded annually but a restriction is placed on access for a five to 10 year period. The award is often tied to sales, profit or operational metrics.
A well-designed compensation and benefits program will motivate key employees to continue delivering exceptional results and incentivize them to stay long term.
4. What if cash flow is a problem in the future?
Just because your business generates cash flow today doesn’t guarantee it always will. Recessions and other economic factors cause businesses to lose money — and sometimes shut down for good — all the time.
It’s important to be ready and shield your personal finances from an unforeseen business problem. It’s important to find investment alternatives outside your business that minimize current taxation and give you downside market protection. There are several tools available to business owners to accomplish this. The assets outside your business should be diversified, so you’re not overexposed to company or industry risk.
Owning a business can be one of the most rewarding life experiences you will have. It’s also filled with many unexpected surprises. Working with your advisor to mitigate risk and tackle the “what-if” scenarios will help protect your family and your business.
The strategies mentioned in this article may often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. Investors' tax and legal affairs are their own responsibility and readers should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this document.
This article is presented as is.
©First Republic Investment Management 2017