Skip to main content
LaunchPad

How to Set Up a Contingency Plan for Your Business

β€” Alexandra Ardelean

A guide for small business owners

Josiah is a 50% partner in an automotive repair business in Ole, Pennsylvania. The business employs a team of five and boasted gross revenue of approximately $550,000 last year. This year, the goal is to increase gross revenue to $800,000. Josiah is wise to want a contingency plan in place should something happen to him or his partner.


Assessing the Situation

The business is structured as an LLC. Josiah needs legal advice on how to structure the business so that if something happens to him or his partner, the business can continue without any issues.


Hiring an Attorney

The first step is to hire an attorney. Josiah should have a budget of no more than $1,000 for this attorney. The attorney will draft two documents: a general partnership agreement and an LLC agreement with similar features.

Drafting Agreements

These agreements need to address the "D's": death, disability, drug use, default, disinterest, and divorce. For example, if one partner passes away, the remaining partner should have the right to purchase the deceased partner's share at a pre-established price. In the unfortunate event that one partner becomes disabled and can no longer contribute to the business, there should be a provision in place outlining how their share will be bought out.

Terms of the LLC can include restrictions on who can own stock in the event of divorce. For example, if one of the partners gets divorced, their spouse should not automatically become a 50% owner in the business.

Valuation and Buy-Sell Agreement

A buy-sell agreement is recommended. This agreement includes term life insurance for both partners. The amount of insurance should be enough to buy out each other's shares at a predetermined valuation.

A formula for valuing the company upon death should be included in the buy-sell agreement. A suggestion for this formula is four times net profit after all salaries are paid.

In the event of a partner's death, the other partner is required to use the life insurance payout to buy out the deceased partner's share at the agreed-upon valuation.

If the business owns property, a similar agreement should be made for its buyout in case of death or disability.

My own estate plan involves buying out real estate at 80% of appraisal value.


Financial Preparations

Life Insurance

Whole life insurance is not recommended as it is costly and unnecessary for most individuals. I suggest opting for 20 or 30-year level term insurance through Zander Insurance Group instead.

This type of insurance provides coverage for a specific period (e.g., 20 or 30 years) and pays out only if you die during that time frame. It's much cheaper than whole life insurance and is sufficient for most people's needs.

Life Insurance Requirements

  • Both partners need term life insurance policies on each other.
  • The amount of insurance should be enough to buy out each other's shares at a predetermined valuation.
  • In case one partner dies, they are required to use their life insurance payout to buy out their deceased partner's share at that valuation.

Additional Considerations

Long-Term Disability Insurance

Long-term disability insurance is recommended but may be costly for blue-collar workers such as mechanics. This type of insurance can offer monthly financial assistance if one partner becomes unable to work due to illness or injury.

The LLC agreement should address what happens if a partner can no longer participate in the business due to disability.


Conclusion

Contingency planning is crucial for any small business owner. By taking these steps now, Josiah can ensure that his business will continue to thrive even if something unexpected happens to him or his partner.