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Businesses don’t want to be in the position of having to “turn the lights off” for good, but the unexpected loss of an owner could trigger such a scenario. In the event of your, or a partner’s, untimely death or severe disability, would your company face hard choices, maybe even some form of liquidation?
Or could it continue on as a “going concern”? That is accounting parlance for describing a company that can function without the threat of liquidation for the foreseeable future, usually defined as the next 12 months. A ‘going concern’ simply means that in the eyes of a professional, such as a CPA or certified business valuator, the company is expected to continue business without interruption and meet its financial obligations.
Candidate for liquidation?
So how do you determine if your business is a going concern or a candidate for a forced liquidation? Ask yourself, if you or your partner were unable to run the business for any reason:
- Would a spouse or other family member become owner and/or control company’s stock?
- Would a spouse or family member be liable for the company’s debt?
- Does a spouse or family member lack the executive experience needed to run the company?
- Would sales suffer in the short term?
- Would profits decline?
- Would key employees leave?
- Would you lose customers?
The more questions you answer “yes” to, the greater the chance your business could end up in a forced liquidation should something unexpected occur.
Determining your liquidation value
Another important question to ask yourself is: “If you died 90 days ago, what would your business be worth today?” How you answer that question will depend a lot on how you answered the questions above, but it could give you a sense of the liquidation value of your business.
Liquidation can often result in getting less than 100 percent of a business’s value. So, what do you do? First, understand that there are two basic types of liquidation:
- A voluntary liquidation is when a business is shut down at the discretion of the owner or shareholders and its assets are sold off in an orderly manner.
- A forced liquidation is the involuntary sale of assets to create liquidity in the event of an uncontrollable or unforeseen situation (you’ve heard the term “fire sale,” right?).
A forced liquidation often occurs when the business unexpectedly loses its rainmaker, most often the owner. Because the business is thrust into an involuntary transition, your partners or heirs may not realize the full value of the business’s assets, such as the collection of outstanding accounts receivables, inventory liquidation, or the sale of plant, property and equipment. Whether these assets have to be liquidated to pay off outstanding debts or simply to close the doors for good, the business you worked so hard to build could be sold for pennies on the dollar if the right planning hasn’t been put into place.
Proper planning can help avoid a forced liquidation
To help a company manage through the unexpected loss of an owner or key employee – and come out the other side as a going concern -- there are two areas where a business owner may want to focus their attention: having secure sources of funding and building a strong management team.
Looking again at the seven questions above, the first three questions may be addressed by having a secure source of funding already in place. For example, a fully executed buy-sell agreement could help ensure that company ownership passes seamlessly to the surviving partner or heirs.1
But this agreement should also be funded in accordance with the current value of the business to help provide the remaining or new owners with the funds necessary to help pay its financial obligations, rather than be forced to liquidate business assets.
MassMutual research shows that 54 percent of buy-sell agreements are not properly funded and nearly half are stale — making the funded, up-to-date agreement all the more important.
The remaining questions may be adequately addressed by the company’s employees.
- Does the company have a strong management team, one that can lead others through periods of difficult change?
- Is the company culture one where everyone will come together in trying times to provide the level of service customers expect?
- Is the team experienced enough so that one employee can step into the shoes of another without difficulty?
If your business is overly reliant on you, it could be difficult to survive an unexpected change in ownership. And, if it can run without you, it could be more valuable if it has to be sold.
Keep going
Secure funding and an experienced staff are a good start to help companies prepare to survive an unforeseen event that forces a change in leadership. Now may be a good time to take at look at what you have in place to help ensure there are no obstacles to a successful business transition. Your families, employees and community are counting on your business to remain a going concern.
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Frequently asked questions about business forced liquidation and continuity
Q. What is forced liquidation for a business?
A. A forced liquidation is the involuntary sale of business assets — often triggered by the unexpected loss of an owner — that can result in receiving far less than the company's full value. Unlike a voluntary liquidation, in which owners control the process, a forced liquidation is reactive and rushed, sometimes described as a "fire sale."
Q. What is a "going concern" in business?
A. A going concern is an accounting term for a business expected to continue operating and meeting its financial obligations for at least the next 12 months. It means the company can function without the threat of liquidation hovering over it — even if ownership or leadership changes unexpectedly.
Q. How can a buy-sell agreement help prevent forced liquidation?
A. A properly funded buy-sell agreement establishes in advance who can purchase an owner's business interest and at what price if a triggering event occurs, such as death or disability. When funded with life insurance, the agreement provides immediate liquidity so surviving owners or successors can complete the transition without having to liquidate business assets. (Related: Funding a buy-sell agreement for a business)
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Discover more from MassMutual…
Knowing the value of your business
Selling your business, planning for the proceeds
This article was originally published in July 2018. It has been updated.
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