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Use buy-sell agreements to ensure business continuity
If a business owner passes away suddenly without a plan, it may lead to the business being:
- Sold
- Closed
- Taken over unexpectedly by family members
To avoid this scenario, it’s a good idea to have a buy-sell agreement in place.
What are buy-sell agreements?
This agreement, which a lawyer helps set up, outlines how the owner’s share of the business will be handled in the event of their death.
A buy-sell agreement can be between shareholders of a corporation, partners of a partnership, or a key employee and a sole proprietor. The agreement obligates the surviving business owners, key employee or the business itself to purchase the interest of the deceased owner. A lawyer will need to prepare the buy-sell agreement.
What are the advantages of a buy-sell agreement?
Among the benefits of having a buy-sell agreement in place are that it:
- Creates a continued market for the business interest
- Allows those interested in keeping the business going to do so without interference from the deceased owner's heirs
- Provides liquidity for the deceased owner’s estate by turning the business interest into cash
- Establishes the value of the business for federal estate tax purposes
Types of buy-sell agreements
A buy-sell agreement may be structured in one of three ways. Seek the advice of your tax advisors to determine which is best for you.
Cross purchase
This means the business owners (whether shareholders or partners) agree that if one owner passes away, the remaining owners will buy their share, and the deceased owner’s estate will sell it.
Entity
In this kind of agreement, the business itself agrees to buy the share of an owner who passes away, and the owner’s estate agrees to sell it. When the business is a corporation, this is often called a stock redemption agreement.
Wait and see
If you’re unsure whether to go with a cross-purchase or an entity agreement, you can choose a “wait and see” approach. This lets you keep things flexible by deciding only after an owner passes away whether the remaining owners or the business will buy their share.
Coverage in action
If the owner the business you work for dies unexpectedly, buy-sell agreements may help ensure the continuation of the business and your employment.
Where does the money come from to purchase the business interest?
Owners personal funds
Most businesspeople don’t keep large sums of liquid assets that would be needed to purchase the deceased owner's interest. Most money would be in their businesses
Sinking fund
The premature death of an owner may not give the business time needed to accumulate the purchase price.
Borrowed fund
A bank may not be willing to lend money to a business that has recently lost an owner or the cost of the interest of the loan may be excessive.
Installment payments
The heirs of the deceased owner may not get the sum or money needed to settle death costs and there are no guarantee future payments will be received if the business fails.
Life insurance
There are many advantages life insurance offers that the other options don’t:
- Life insurance annual premiums are often a small fraction of the death benefit
- Death benefits are available when needed, regardless of when the owner dies.
- Death benefits are generally federal income tax-free
A State Farm® agent can help you choose an insurance program that will meet your objectives.
What does business interruption insurance cover?
Business interruption insurance typically covers the following:
- Lost income: Compensation for the income a business would have earned during the period it was unable to operate due to a covered event.
- Operating expenses: Ongoing fixed costs such as rent, utilities, and employee salaries that continue even when the business is temporarily closed.
- Temporary relocation costs: Expenses incurred if the business needs to move to a temporary location to continue operations while repairs are made.
- Extra expenses: Additional costs necessary to minimize the suspension of operations, such as renting equipment or paying overtime wages.
- Contingent business interruption: Losses resulting from disruption at a supplier’s or customer’s location that directly impact the insured business.
Coverage specifics can vary depending on the policy terms and the insurer, so it’s important for business owners to review their policies carefully.
What’s not covered by business interruption insurance?
Business interruption insurance generally does not cover the following:
- Damage or loss not related to a covered peril: If the interruption is caused by events not specified in the policy (e.g., certain types of floods or earthquakes unless specifically endorsed), the loss may not be covered.
- Intentional closures: Losses resulting from deliberate business decisions to close or reduce operations are excluded.
- Pandemics and epidemics: Many standard policies exclude losses related to disease outbreaks unless specific coverage is purchased.
- Pre-existing conditions: Interruptions caused by issues or damages that existed before the policy was in effect are typically not covered.
- Losses due to utility outages without property damage: If a power outage occurs without damage to the insured property, losses may not be covered unless the policy includes specific endorsements.
- Losses due to cyber attacks: Business interruption caused by cyber incidents usually requires separate cyber insurance coverage.
- Non-physical damage interruptions: Situations where there is no physical damage to the property but operations are interrupted (e.g., loss of reputation or customer base) are generally excluded.
Because coverage can vary widely, it’s important for business owners to carefully review policy terms and consider additional endorsements if needed.
Frequently asked questions about business continuity
Both are crucial. Business continuity is the big-picture plan to keep all parts of the business operational during disruptions. Disaster recovery, a subset of business continuity, is focused on recovering technology and data. Together, they help businesses bounce back stronger and faster from any crisis.
Business continuity
- Focus: Keeping the entire business running smoothly during and after any disruption.
- Scope: Covers all critical business functions, from operations, communication, staffing and supply chains to customer service, and technology.
- Goal: Minimize downtime and maintain essential services, so the business can keep serving customers and generating revenue.
- Example: If a power outage hits, business continuity plans might include remote work options, backup power sources, and alternative suppliers.
Disaster recovery
- Focus: Specifically restoring IT systems, data, and technology infrastructure after a disaster.
- Scope: Deals mainly with technical recovery, from servers and networks to databases and applications.
- Goal: Get technology back online as quickly as possible to support business functions.
- Example: After a cyberattack or data center failure, disaster recovery involves restoring backups and fixing systems.
This answer was drafted with the assistance of Artificial Intelligence.
In business continuity planning, organizations should consider a wide range of risks and threats that could disrupt operations. Key types include:
- Natural disasters: Events such as earthquakes, floods, hurricanes, tornadoes, wildfires, and severe storms that can damage facilities and infrastructure.
- Technological failures: Hardware or software failures, power outages, telecommunications disruptions, and cyberattacks like ransomware or data breaches.
- Human-caused events: Accidents, sabotage, theft, vandalism, workplace violence, or terrorism that impact the safety of personnel and assets.
- Pandemics and health crises: Widespread illness outbreaks that affect workforce availability and supply chains.
- Supply chain disruptions: Interruptions in the delivery of critical materials or services due to supplier failure, transportation issues, or geopolitical events.
- Regulatory and legal issues: Changes in laws, compliance failures, or litigation that could impact business operations.
- Financial risks: Economic downturns, market volatility, or loss of key customers that threaten financial stability.
- Operational risks: Internal process failures, equipment breakdowns, or loss of critical personnel.
By assessing and planning for these varied risks, businesses can develop comprehensive strategies to maintain essential functions and recover quickly from disruptions.
This answer was drafted with the assistance of Artificial Intelligence.
Creating an effective business continuity plan (BCP) involves a systematic approach to ensure that a business can continue critical operations during and after a disruption. Key steps include:
- Conduct a Business Impact Analysis (BIA): Identify and evaluate the potential effects of disruptions on critical business functions, processes, and resources. Determine recovery priorities and acceptable downtime.
- Perform a risk assessment: Identify threats and vulnerabilities that could impact the business, such as natural disasters, cyberattacks, supply chain failures, or pandemics.
- Develop recovery strategies: Based on the BIA and risk assessment, establish strategies to maintain or quickly restore critical operations. This may include backup systems, alternate work locations, or manual processes.
- Create the business continuity plan document: Outline roles, responsibilities, procedures, and resources required to execute the plan. Include communication protocols, emergency contacts, and detailed recovery steps.
- Implement training and awareness programs: Educate employees about the plan, their specific roles, and how to respond during an incident. Regular training ensures readiness.
- Test and exercise the plan: Conduct drills, simulations, or tabletop exercises to evaluate the plan’s effectiveness, identify gaps, and make necessary improvements.
- Review and update the plan regularly: Continuously monitor changes in the business environment, technology, and personnel. Update the plan to reflect new risks, lessons learned, and organizational changes.
By following these steps, organizations can build a robust business continuity plan that minimizes downtime and supports rapid recovery from disruptions.
This answer was drafted with the assistance of Artificial Intelligence.
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