As CPAs, we are frequently accused of being numbers people. This is good. But today, I believe that these skills have become table stakes. Behind the numbers are all of the other stuff that can go wrong to derail a client’s world, and that is the main focus of this article.

Your business clients live with risks that they gleefully look past as they grind it out day after day. I feel the most significant of these risks involve their succession plans — or lack thereof. I find it pure negligence when a CPA for a company doesn’t ask if the client has a written succession plan and then further review it to expose gaps. The succession plan needs to be considered from two points of view. One is with respect to the ongoing operation of the entity, and the other has to do with creating a favorable transition for ownership, including any purchase of shares that needs to happen.

Absent a clearly communicated plan, chaos often rules. It may be easy if your client has a well-defined corporate structure where people have job descriptions and everyone knows their role. But for anything other than a larger enterprise with many skilled people serving in specific roles, there is frequently a “Who’s on first?” kind of reaction as soon as the news settles in regarding the loss of their owner/leader. We see everything from power struggles to employees who see this as an opportunity to steal clients and open their own competing business. To prevent this isn’t easy, but it can be done with the guidance of a skilled business counselor.


One extra day

Begin by role playing with your business-owner client. The role play is that you, Ms. Business Owner, just passed yesterday but you get one more day to come back to establish a business continuity plan for your business to operate without you. Who would be the leader? Is it one leader or will there be multiple key people? What about ownership? Do you expect that the business will pass to your family and that your employees will remain loyal to the new owners as they were to the founder? Will any of your key employees become owners? Will the business be sold after your passing? Will you create any bonuses or other incentives for your loyal employees as they help the family unwind and sell the business?

Rather than a checklist of great questions, what you need to do as that business owner’s advisor is to have a conversation where all of these issues and whatever else is germane in that business are discussed. In most cases, the business owner is most capable of assessing talent and envisioning the business operating without him or her, but this is another area where advisors can help.

The conversation should extend to the key people that you think are a part of the continuity. Help your client decide on some of the significant financial issues regarding their succession. What will be the titles and compensation structure of those chosen to be a part of the leadership team after they’re gone? The conversation should cover pay increases or bonuses and any equity incentives that may be important.

This is also an opportunity for your client to memorialize this agreement through an employment contract that can lay out compensation and roles today and in the future. This agreement can provide some protection for the employer in terms of non-competition or non-solicitation language both now and after the owner’s passing.


The name on the door

Moving over to the transition of ownership, there are two possibilities. One is where your client is the sole owner and the other is where your client has partners. Business owners and professionals alike give little attention to the succession for businesses with one owner. If your sole-owner client doesn’t want to properly address this issue, you must do a few things. You must document your attempt to have the conversation, as well as the concerns that you have for the ongoing value of the business absent the owner. You also should ask about the client’s life insurance if the value of the business and its subsequent sale would be material for the survivors to continue to live in the lifestyle to which they are accustomed.

For a business with multiple owners, please do not get lulled into complacency if the owners have some sort of shareholders’ agreement that addresses the loss of an owner. In my experience, two things have consistently been revealed. One is that most do not have a written agreement. Second is that for those who do, there are so many gaps in the agreement that they may have been better served without any agreement at all.

You need to carefully review the agreement and see what happens if your client passes away, becomes permanently disabled, or wants out of the business.

The first issue we often find is an outdated valuation or an unreasonable formula to create a valuation. The best practice is to get a formal business valuation every few years and have that value ratified by the owners and updated between valuations by a vote at the annual meeting. The second issue is one of practicality and reasonableness. Many agreements have language about three valuations, blah blah blah …. Really? At a time of stress do you really want to pay for three valuations and battle it out? As stated previously, get your valuation and make that the number that is used. It is not practical to do the valuation post-mortem. Is the business worth more or less after the loss of a key owner?

This section of your client’s existing agreement also talks about the payment terms. Even if the value is accurate, I find that frequently the payment terms are untenable by the surviving business. It isn’t easy for an enterprise to pay out fair market value plus interest over five years after the loss of a key person. If the business needs to replace the services of the deceased or incur other costs to replace their value, that only compounds the difficulty of meeting the ill-conceived obligation.

Funding and format also play a significant role. The primary tools for funding would be cash in the possession of the surviving owners, life insurance or an installment buyout. In terms of life insurance, the issues include having an adequate amount of coverage, the right type of coverage, and the proper ownership of that coverage.

If the buyout is to be an installment sale, make sure that the terms are affordable by the business. Too many times this payment stream is equated to what the previous owner took for compensation. But making similar non-deductible payments to a survivor may not be affordable or recommended in all cases.

I understand that not all clients want to talk about their demise and the consequences thereof. But as their fiduciary, I feel that you must have these conversations — or find a competent professional who can.

John P. Napolitano

John P. Napolitano

John Napolitano, CFP, CPA, is chairman and CEO of U.S. Wealth Management in Braintree, Mass. Reach him through JohnPNapolitano on LinkedIn or (781) 849-9200.