A Costly Mistake for Business Owners
What's the Worst Case Scenario?
Most business owners are so busy worrying about a million tasks that they fail to really plan for a lot of different things, but today I want to talk about something that should never be neglected or put off if you own a business. This is especially true for business owners who are in a partnership.
I am going to lay this out in a very simple manner for everyone to understand the importance, but in reality it might be a lot more complex, or it could actually be this simple.
Two Best Friends
5 years ago, two best friends started a small business selling their bathing suits online. The girls were 30 when they started and had no idea what to expect, but in the last 5 years their business has grown and is now worth $2,000,000. They are 50/50 owners and as their business has grown and their roles have been defined. Sally concentrates on design and Melanie focuses on marketing and sales.
Both girls are married and have 2 young children and their husbands stay at home and take care of the kids, because the girls have a successful business. Their friends think they are losers for staying home, but the guys are set and they play video games while the kids are napping and golf every Wednesday, when they're at daycare, because they need a break and they deserve it.
Even though the guys pretend they care about the bathing suit business and they like that their wives are building a successful company, they wouldn't have a hot clue how to operate the company if they had to.
Worst Case Scenario
One morning, on the way to work, Sally is killed in a car accident. Everyone is absolutely devastated to say the least and even though she doesn't want to, Melanie has to get back to work. She has employees and customers to worry about, but what are the implications of not having Sally around?
There are 2 Main Concerns
The first major problem is that Sally's husband is now a 50% owner of the company, which sucks for Melanie, because he doesn't know anything about designing bathing suits and he doesn't want to be there. The business is going to struggle without Sally and having him around is making things even worse. If she could, Melanie wishes she could just buy out his shares for $1,000,000 and now be the 100% owner.
Her problem is that they never had anywhere near that amount of money on hand as everything went back into the business and now that Sally is gone and sales are declining, it doesn't appear that lenders are comfortable giving Melanie a $1,000,000 loan to buy the shares.
This leads to the other issue. Melanie has her hands completely full with everything and she was never the designer. How is she going to continue to grow or even stay in business if she doesn't have any new designs? She's going to need to hire a new designer, but that's expensive and she barely has any capital to do anything, especially since she's trying to find a way to buy the other half of the shares.
What's the Solution?
It's actually quite simple. First the girls are going to need to draw up a USA (Universal Shareholders Agreement) with a qualified lawyer. This will lay out how they would like things to happen should there be an event like this.
Next, they email Kent at K4 Financial and fill him in on the details of their business and he will show them a few insurance options that they have. In this case, it would have been really important for the girls to each have at least $1,000,000 in coverage on their lives for coverage of a buy-sell agreement and an additional amount to cover Key-Woman protection. In this case, let's say $500,000 was placed, so they each had a $1,500,000 insurance policy on their lives.
When Sally died, "S&M Bikinis," (I honestly didn't pick their names so that I could name their company that, but now I'm happy I did), was paid out a tax-free lump sum of $1,500,000. Melanie took $1,000,000 of this to pay Sally's husband for his shares. Melanie is now the 100% owner.
Now Melanie has an extra $500,000 in cash to recruit and pay a new designer as well as cover a lot of the other lost revenue that will come with losing such a crucial piece of the business, but chances are she will be able to keep in business.
What's the Cost?
The cost to Melanie would have been $1,000,000 plus dollars, if she could have found a way to round it up. If not, it probably would have resulted in a lawsuit, a loss of a friend and then a sale of her business at a reduced price, but let's look at the cost, since everyone always wants to know.
First off, there would be the legal costs associated with this. I assume that the girls have a lawyer and their lawyer probably charges $5,000 a phone call or something silly, but the legal costs will be whatever they are.
As far as insurance is concerned, there are a million options when it comes to life insurance coverage and it all depends on the ability to fund the coverage and the need. However, if they just wanted to pay as little as possible for this, both of the girls could have life insurance coverage on their lives, worth $1,500,000, for less than $50/month each.
For $100/month they could protect their business from the worst case scenario. What bothers me is that I know that every business owner pays thousands a year in premiums to protect from theft, fire, liability and so much more, but fail to really consider covering the most important asset the company has.
The reasons why an individual owner should have coverage is a little bit different, but that doesn't make it any less important.