Finance Monthly - May 2022

CASE STUDY Business partners expanding their business, initiating a succession plan, and taking on debt for the right reasons. The common scenario we help our clients with is simple risk management when it comes to partnerships. The file fact pattern is this – two business partners own a manufacturing business. Partner one, John, owns 75% and partner Bill owns 25%. John is older and eventually wants to retire so he is selling 24% more to Bill. To purchase the 24%, Bill needs to come up with $3,000,000 which he does not have in cash. John has no other buyers so he needs to work with Bill and knows the company is more valuable with Bill since he has worked there for 20 years. The operating company is currently debt-free and worth about $12,000,000. This is oversimplified for this case study purpose, but financing was put in place inside the operating company and the $3,000,000 was given from the operating company to John’s holding company. Now the operating company is holding new debt and the share split is 51% John and 49% Bill. So where is the risk in this situation as it applies to if one partner dies? Well, the company now has debt, it would also lose a key contributor to the business which likely would affect the company value, which affects the families of both the deceased partner and surviving partner (who by the way now needs to pick up the slack of the partner who died). Since the goal is to sell this business to a third party within 10 years, the simple solution was to take out 10-year-term life insurance on both partners for the amount of their respective share ownership. In this case $6,000,000 each. The question really was: John or Bob, if you died, would you want to be partners now with the deceased partner’s wife? Both answered no, so the question was how do we buy out the surviving partner’s wife as quick and easy as possible and know there is near sufficient cash to do so. Taking on large or more debt in the near future was not desired by either partner. We then discussed if they would like to extinguish the debt at the same time if a partner died. They felt this extra $3,000,000 each was not needed since they usually carry around $2,000,000 in the bank account as afloat. We also discussed having a policy slightly above the value now to account for growth. They felt that if the company grew in 5 years, the debt would likely be a lot less and they would use new financing at that time to solve any shortfall the insurance didn’t provide. The shareholder agreement was also adjusted, and the life insurance was noted in the agreement. space. And looking at your own business, practice, real estate holdings, invest in yourself. Invest in what you can control. Have you cleaned up your own kitchen as best you can before exploring investments outside of your own world? Liquidity is a concern or an area that I think many business owners are vulnerable in. A large part of their net worth is tied up in the value of their operating business. We help people findways to extract the value out of their business but still keep the business a solid going concern for decades to come. And we help them to engage the management team in the process. Some of the key lessons the past year has taught me is time goes by very fast. Returns for equity in 2021 for the most part were very good depending on your exposure. In late 2020 the world was unsure if it was opening up or closing down. Then 2021 was full of lockdowns, variants, some friends getting ill but not dying. And if a person watched the news, it was very bad. It was negative, scary, anxiety-ridden and not centred around wellness by any means. Yet the market roared double digits plus percent up. So, one may conclude if you are only watching the market you could have made a lot of money, but if you were watching the news you stayed out of the market. This is a key lesson that I learned over the last year - the good news is hard to find. If you set goals that need positivity then be aware of your news sources and the amount of time you consume. Think: Does what I am doing right now serve me and my goals? Finance Monthly. Bank i ng & F i nanc i a l Se r v i ce s 39

RkJQdWJsaXNoZXIy Mjk3Mzkz