July 2018 eNewsletter
5 Ways to Make Sure Family Runs Your Company in the Future
Business owners need to prepare themselves now for eventually handing over the reins to their successors
Steve Faulkner, Head of Private Business Advisory, JP Morgan Chase
Business founders typically devote years to building their companies. Many want their firms to continue beyond their lifetimes, managed by their children and possibly future generations. If this is your desire, then you will want to devote the same kind of energy, thought and planning that it took to build your business to help you successfully pass the baton and leave behind a sustainable legacy.
You'll need a well-thought-out plan to ensure all goals are accomplished: yours, your family's and your business's. A vital objective of making this multi-faceted plan is to set the stage for family harmony.
Developing a mission statement for the business is a great first step. This can cover the values of both the family and the business, providing a vision of what will be expected of the next generation of leadership. Knowing where you want to go helps you to get there eventually. It is therefore important to articulate what your goals are for your immediate family, for each extended family member and for the business. Only then can you assess where these various goals converge — and possibly diverge.
Businesses are more likely to succeed into the second, third, fourth and even fifth generations when they have prepared for these five critical issues:
- Sudden events: Successful legacy businesses have contingency plans for a sudden management change, just as they do for other catastrophic events. You must regularly review and revise these plans as circumstances evolve.
- Orderly transition: Even if the current owner's withdrawal from the business is not expected to occur for a decade or more, management needs to acknowledge and prepare for succession. This preparation entails having a formal succession plan, creating appropriate legal documents that can effectively make the succession plan a reality, formally training interested younger family members and integrating them into the business.
- Liquidity/estate taxes: The U.S. estate tax rate is 40 percent, and payment is usually due nine months after a person passes away. If that is not planned for, then this federal tax liability can be a tremendous burden on a business, severely limiting the possibility of reinvestment and distributions to shareholders. Even if the estate-tax payment can be deferred, the principal and interest due in later years can hamper a business's competitiveness. Many families are forced to liquidate a business to pay the estate taxes due on it — often in a hurry and for less than the business's full value. It's vital to take action now to help reduce the estate taxes that will be due.
Steve Faulkner is the head of private business advisory in the Advice Lab at J.P. Morgan Private Bank. This article was originally published in Crain’s Wealth.
Risk Financing Strategies: When to Transfer and When to Retain Risk
For companies of all sizes, the risk financing strategies available are numerous, but the decision in choosing the best program for an organization can be laborious. Advantages and disadvantages exist within each risk financing strategy. Businesses should make certain its program is consistent with its risk management profile to ensure the right level of cost certainty, cost efficiency, and control over its risk management program. A sound risk financing program provides that losses are paid in a cost efficient manner and that the assets and reputation of the organization are properly protected.
Risk financing is a continuum between total risk transfer (e.g. a guaranteed cost program) and total risk retention (e.g. self-insurance programs). Total risk transfer through insurance provides fixed cost certainty from a premium standpoint. The premium won’t change during the policy period, but total risk transfer makes sacrifices on cost efficiency and control over the program. Total risk retention offers the most cost uncertainty because severe and frequent losses will significantly impact costs; however, total risk retention offers greater cost efficiency and control because claims are not paid until they are incurred. It is important businesses strike a balance between risk retention, program control, and savings potential.
Factors to Consider When Deciding Risk Financing Options
To understand what risk financing program best suits a company, a detailed analysis of the business’s risk management profile, risk taking philosophy and appetite needs to occur. Critical factors to consider are the company’s size and type of operation, financial strength and resources, claim history and predictability of losses, and short and long term goals. These represent a fraction of the factors used to assess where a business falls on the continuum. With that data, the focus moves to achieving equity between the company’s ability to manage claims, retain risk, need for budget certainty, and potential for program savings opportunities.
Options, Benefits, and Considerations
Common risk financing options include, but are not limited to: guaranteed cost programs, dividend programs, deductible and self-insured retention (SIR) programs, and group or single cell captives. The advantages and disadvantages from these few program options are listed below:
- Guaranteed cost programs: premium cost is fixed but it offers no benefit from improved loss experience and cash flow is poor because the forecasted claims are assumed in the upfront premium cost.
- Dividend programs: a company can share with the carrier in the profitability of its account through the payment of dividends, in return for good loss experience, but cash flow remains poor because the returned premium via dividend is not realized until two to five years into the future based on good loss experience.
- Deductible or SIR programs: offers improved cash flow while allowing companies to retain a portion of each loss through a deductible or retention and to transfer on to an insurer losses in excess of that deductible or retention.
- Captives: an insurance company that is wholly owned and controlled by the businesses that fund it. Improved cash flow can be realized by lower premium costs from eliminating carrier profits and administrative costs and gaining dividends in the form of investment income and underwriting profits.
In addition to ensuring the desired level of risk retention and program control, the analytical process of evaluating where a business should find itself on the risk financing continuum can result in program savings of up to 45 percent of a company’s total cost of risk. Total cost of risk includes not only premium costs, but also all aspects related to risk including retained losses, loss expenses, risk control, and legal and administrative costs.
Ask for Professional Advice When Needed
While businesses constantly look for ways to fuel profit margin and cash flow, opportunities to do so through risk financing may not always be top of mind. Companies should consider risk financing alternatives as a mechanism to accomplish those objectives.
Companies should feel confident its program is best suited toward its approach to risk management and offers the lowest total costs of risk practicable. All businesses do not have the internal tools and technical expertise to determine the most advantageous risk financing program. For clarity on the matter, businesses should seek out counsel from experts in the field.
A comprehensive, actuarial-based analysis is required to determine where an organization lands within the risk financing continuum and the resulting strategic financing options that are most consistent with the company’s risk profile.