THE BEAT A quarterly publication from Tamura Insurance Services

Cheating Fate. . . Real stories from the files of The Insurance P.I.

An insurance specialist is like a private investigator. We gather facts and data to help uncover and then solve mysteries. Recently, my investigative crew and I worked on a particularly enticing mystery. What follows is a fictionalized account of our investigations...

The thrill that day was realizing our client had cheated fate with an inordinate amount of luck. My palms were sweating as I pondered what might have happened had their lucky steak ran out.

The goal . . . develop a multi-generational business succession model. The challenge . . . how to achieve the goal even if key partner were to die or become disabled.

To protect confidentiality, our client has been disguised as ABC INC. a thriving law firm. ABC INC. has three partners. Two are the original partners, who are now in their eighties, and the third is the lead practicing attorney who is now the controlling partner. The business is in the last year of a very expensive cash funded buy-out of the two original partners. Besides the current lead attorney, there are two new attorneys who are being offered partnerships in the firm.

WHAT COULD TOPPLE THIS FIRM?
ABC Inc. did not have a savings plan in place for the eventual buy-out of the original partners. They’d been quite fortunate that neither partner died during their active revenue-generating tenure nor during the buy-out phase (which has one year left). What would have happened to ABC Inc. had one of the firm’s partners died or become disabled? More importantly, how would they handle these challenges in the future to ensure the goal of maintaining a multi-generational business? I knew my team had to find a way to strengthen the firm’s weak links – and fast!

JUST THE FACTS
 The firm is valued at just over $4,000,000 and has 6 core employees, plus a host of independent contractors, all of whom depended on the firm’s continued growth.
 All partners are married, which means their families also depended on the firm for their well-being and to maintain their standard of living.
 None of the partners (retiring and new) had any business insurance in place when we met. Are you beginning to see how lucky they were?

TIME FOR A REALITY CHECK
Our task was to find a way to help our client face the realities of their precarious situation without causing them to run away in fear. We decided the best course of action was to ask a series of questions designed to help them understand their dilemma.

#1 What happens to a controlling partners shares if he or she dies while still holding company stock? The surviving spouse gets the shares of course!
#2 Will the surviving spouse think the value of the stock is high or low? Odds are the spouse’s opinion on the value of the business is much higher than that of the surviving partners who now have to face replacing a trusted friend, partner and key revenue generator.
#3 How can a business survive such a devastating loss? Without a plan in place that provides a road map for navigating the unthinkable, the odds of coming out with the firm in tact are pretty grim.

SO LET’S GET TO THE POINT
What comes next? You guessed it! The lawyers from both sides would be tasked with finding a price for the stock that both parties could agree upon. Not only is this typically a long and potentially volatile process but also very expensive. As a law firm, ABC INC. is well aware of the potential high costs of such an endeavor. So how do they avoid this catastrophe? ABC Inc. knows that continuing on with only a hand shake agreement is simply no way to run a business. Change was positively required! While any change can be tedious, it’s nothing compared to the pain of not having a well thought out and executable plan.

Step one: Get a professional valuation of the business.
Step Two: Use the valuation number (agreed upon by all partners) to create a buy-sell agreement with an experienced business attorney. At the heart of that plan there must be provisions for all the possible current and future challenges of an eventual buy-out of the existing partners/shareholders. The common considerations are death, disability and retirement. All of these have the potential to take a thriving business and run it into the ground.
Step Three: Fund the plan. While this is often overlooked, it’s critical to have funding mechanisms in place to address all the common considerations listed above.

PUTTING THE CLUES TOGETHER
The hair on my neck stood on end thinking about the possibility of a partner dying: Where would the money come from to pay the spouse the pre-determined price for the shares in the company? If a partner suffered a permanent disability and could no longer perform his daily duties, how would the firm fund the search for a replacement and buy out the partner’s shares – there just isn’t enough money in the world nor time in the day? And, what if a partner neither died nor becomes disabled, but instead is ready retire.

We had to make sure they’d have the capital to buy-out the exiting partner at retirement without causing havoc on the firm’s capital reserves as was done with the original partners? We assembled the clues needed to solve this case and we found there were multiple possible solutions that could work, given enough time and money. But only one would work today, tomorrow and on into the future – can you guess which?

1) Assuming you have the current capital, pay it out from the corporation’s capital accounts. Although this is an option, it is unlikely a business can sustain such a withdraw all at one time.
2) Create a sinking-fund where money is allocated on a regular basis to build toward the resources needed. While this is recommended, it does not provide all the funds required until the account matures, which may be somewhere near the retirement age of the partner.
3) Buy life and disability insurance to guard against current and future losses – this solution may also offer potential opportunities for increasing capital accounts that can be used for a variety of business scenarios.

CASE CLOSED

ABC INC. now has a buy-sell agreement in place along with the appropriate insurance to ensure their Future success. We have an agreement in place to review their plans every two years and make adjustments as needed. We’re all sleeping like babies now!

What adventure could be more meaningful then alleviating worries of the unknown? If any of ABC INC.’s story hits home for you and your organization, don’t waste another minute. Contact us for an investigation of your business!

Let us sweat the details so you can relax and enjoy your meaningful adventure. Tamura Insurance: 925-335-9749 or tracy@tamurainsurance.com