As we all adjust to a new way of life in the midst of the COVID-19 pandemic, it’s never been more apparent that having a continuity plan is vital. At its core, succession planning is a strategy for passing on leadership roles in the event of either an unanticipated or an inevitable life event.
While knowing to whom a role will pass in the wake of one of these events is key, it’s not sufficient. There is a financial aspect that must be addressed in order to ensure that the firm will be able to maintain operations going forward.
To that end, there are three main categories of succession events your firm should be prepared for: voluntary departure (i.e., retirement), death and disability. In a complete succession plan, you firm must address each of these categories and their corresponding financial needs.
This is succession planning in its purest form. There are many items to be address in a voluntary departure, but from a financial perspective these items are relatively simple. The departing partner will need to be able to replace their income in order to leave. The firm’s role in this part of the planning centers on 401(k), profit-sharing, and top-hat plans to assist in preparing for the departure.
Transfer of ownership interest also needs to be addressed, as well as any potential residual income from client relationships that were developed by the departing partner. The firm should also detail these items in the partnership agreement well in advance of an actual departure to ensure everyone knows what will happen at the separation date.
The unexpected passing of a partner causes a host of issues that need to be dealt with at a time when the survivors are often emotionally compromised. Planning for these events in advance will help alleviate much of the stress.
From a financial perspective, the firm must replace the income previously generated by the deceased partner, as well as potentially fund a buyout of the individual’s ownership interest and equity position. This is most often addressed with life insurance.
Your implemented plan can help preserve the loyalty and support of employees, clients and creditors during and after the ownership transition — an incalculable value that will certainly affect the firm’s financial future immeasurably.
There are many types of life insurance that can be used, each with benefits and drawbacks. We recommend using the services of a life insurance agent who is familiar with the ins and outs of succession planning to avoid making mistakes in setting up the policies ― both in providing the correct amount of insurance and the administrative setup. The most common error we see when implementing these types of life insurance policies involves not setting up the ownership of the policies correctly. An incorrect setup can cause the proceeds of the policies to be taxable, whereas a proper setup will make the proceeds tax-free.
Many of the same issues associated with the passing of a partner exist in a situation where a partner is disabled and no longer able to perform their duties. The financial concerns surrounding disability are typically funded with disability insurance. There are several types of disability policies, including:
Once again, the ownership of these policies is key, as well as a separate buy-sell agreement in the case of an equity buyout to avoid tax and other common pitfalls.
Protecting the firm financially means ensuring that the equity partners who remain following a succession event can not only retain control of the firm but also maintain financial viability without interference from a departed partner’s family or estate. A solid succession plan will allow you to enact a prompt transfer of the departed partner’s interest at a fair price.
Moreover, beyond the immediate financial needs a succession plan should address, your implemented plan can help preserve the loyalty and support of employees, clients and creditors during and after the ownership transition — an incalculable value that will certainly affect the firm’s financial future immeasurably.