Year end is a time of planning for many business owners. Right now, your borrowers are strategizing about ways to grow, minimize tax and budget for the year ahead. An important part of this process is succession planning and preparing the next generation of management for what lies ahead.
You, of course, have a vested interest in your borrowers’ successors. After all, how will your borrowers repay their debt if no one is there to take over the reins — or if the next generation is unqualified to run the show?
You Don’t Need to Be Retiring for Succession Planning
Succession planning isn’t just for business owners nearing retirement. Many small businesses rely on the skills and knowledge of a few key individuals — or maybe just one “rainmaker.” They may be unprepared if something were to unexpectedly happen to a key person.
Ask your borrowers which individuals are expected to eventually take over the business. Then meet with the anticipated successors to gauge their qualifications. Beware of borrowers who expect their children to run the business without providing the requisite on-the-job training.
If a borrower has been gifting business interests to family members, ask whether heirs will take an active role in the business or serve as passive investors, perhaps with a seat on the company’s board of directors, after the current owner leaves the business.
Don’t Forget Insurance
Many borrowers purchase key person insurance to bridge business interruption losses or fund buyouts after an owner’s death or disability. If a borrower has insurance, inquire whether coverage is based on formal metrics — such as projected revenue decline, business value and replacement costs — or merely gut instinct.
For uninsured borrowers, consider revising your loan covenants to require coverage. Key person insurance provides an influx of cash, which can be used to service debt after a key person dies.
Have a Buy-Sell Agreement in Place
Every company with multiple owners can benefit from a buy-sell agreement. The agreement spells out the terms under which ownership interests will change hands when an owner leaves the business.
Even with an agreement in place, a shareholder dispute could arise if, for example, the agreement hasn’t been followed in the past or contains an outdated, oversimplified valuation formula. A valuation professional can review what’s currently in place to ensure its adequacy.
It’s never too soon to ask your borrowers about succession planning. If they haven’t started the process or put the details in writing, refer them to professionals who can help bridge any gaps and plan for business continuity.