How Can You Plan For a Rainy Day if You Are Denying Reality?

By Jack Lyons, Mergers & Acquisitions Advisor and Certified Exit Planning Advisor (CEPA)

Let’s face it – these are tough times for most of us. Unfortunately, many business owners are still in denial about two very important matters: the true state of their businesses and their own mortalities. What has happened to the economy in the past nine months has weakened most companies. Many are at the point of insolvency and their owners are denying it. Their banks are imposing stricter lending covenants and are pricing risk profitably. Many companies have already lost their financing. As the recession continues, many more will join this unfortunate group as commercial lenders continue to demand larger amounts of collateral than can be offered by companies who need working capital. Financially stressed companies will become increasingly challenged over the next six months and the rate of business closings will escalate.

Many business owners refuse to admit that they are insolvent until they either must close the doors or go bankrupt. A little planning might have been able to prevent this scenario, or at least have made it easier. This is especially true if the business is taxed on a cash basis. What good does it do to have more cash when accounts receivable have been collected if you forget the tax liability on collected receivables? This oversight can force some companies out of business.

It is imperative to pay attention to both what has happened and what might happen to your business in the near to midterm future. Are you experiencing recurrent operating losses, negative cash flow (don’t forget about taxes that are due), adverse key financial ratios, payables growing in number and aging, trouble meeting payroll and/or denial of trade credit? Does it seem to be getting tougher for you and your company? If you are struggling, now is the time to get out of denial. If you act decisively, you may be able to minimize the consequences for yourself, your employees and your creditors.

Let’s go back to the second point of the opening premise: denial of your own mortality. There probably isn’t anything worse for a business than to have its owner suddenly die – especially if it’s you. As we will see in the following scenario, there are many things that can happen when an owner dies abruptly.

Dave White and Gary Gray were owners of a successful $10 million consulting company. Both were fifty years old and had hoped to sell their company in a mergers & acquisitions transaction to a third party in the next twenty-four months. When they first started the business, Dave and Gary had agreed that if either of them were to die, the other would take over. Unfortunately, Gary was the primary driver of the business and Dave operated as a consultant. They neglected to update their agreement based on their subsequent roles within the company. Before they could put their merger & acquisition plan in place to sell the company, Gary was killed in an automobile accident.

Upon Gary’s death, an individual life insurance policy paid Gary’s widow the $5 million face value of the coverage. Gary’s wife and family were fortunate to have this policy and were well taken care of as a result of it. Soon after Gary’s death, a number of key employees left the company for jobs with more certain futures. They were afraid that without Gary’s leadership the company wouldn’t be able to continue. They knew that Dave was a consultant and had never run the business.

Because of Gary’s death and the departure of the key employees, the company experienced a decrease in revenue and went into default on a number of contracts. This exposed the company to significant liabilities. A number of long-term customers were uneasy with what they saw happening in the company. They saw the company as a rudderless ship and took their business elsewhere. The company’s bank became nervous and called the company’s credit line, which had been personally guaranteed by both Dave and Gary.

I hope you can see why business continuity planning isSuccession Planning important for you and your company – without a survival plan, the consequences to employees, customers, families and estates are ominous. Fortunately, business owners can implement a number of plans to avoid the type of business collapse experienced by Dave and Gary’s company. Three plans come to mind:

First, the company could have chosen a different management arrangement. They could have spread the responsibility by having Dave join Gary in the management of the company or by hiring someone else to fill that role. Having a second, experienced manager ready to take over would have made the company less likely to experience failure by easing customer, employee and bank concerns. The company also could have had a key-man life insurance policy on both Dave and Gary, so that if one of them died, the company would have operating capital to better weather the ensuing shocks to the business.

Second, the company could have taken any number of steps to keep key employees on board after Gary’s death, such as part-ownership, additional compensation or bonuses for key employees. Compensation or bonuses could have been tied to the company’s continued success and profitability, which not only would have given the employees incentive to stay, but might have motivated them to help retain the customer base. Insurance could have funded the additional compensation or stay bonuses if the company had thought to have them.

Third, the company did not have a succession or contingency plan that took into consideration the first and second items mentioned  above. If it had, the various negative consequences of one owner’s death could have been dealt with prospectively. At a minimum, the plan should have covered how the business would be run successfully if something happened to either Dave or Gary: whether the business should be sold, continued or liquidated in a M&A transaction; how the surviving owner and the deceased’s heirs should interact with each other; and with whom to consult following a triggering event.

Have you been in denial about either the true state of your business or your own mortality? If you have been, take the first step and decide to begin to change this. There will never be a better time to begin than right now.

Jack Lyons is a Mergers & Acquisitions Advisor, a Certified Exit Planning Advisor (CEPA) and president of Lyons Solutions, LLC. He can be reached at 203-642-4141 or at jlyons@lyonssolutions.com.

Copyright 2010 Jack Lyons. All Rights Reserved.