Businesses were once formed and operated with a smile and a handshake. However, modern-day operations have become so complex that a lack of proper business planning can be crippling, especially in these uncertain economic times. Good advisors can assist companies in identifying, minimizing and managing certain business risks. This article addresses several common business risks that, if not managed properly, can lead to substantial economic losses.
The buy-sell agreement serves as a legal guide to protecting ownership interests in the event of death, disability, voluntary or involuntary termination, sale, divorce or personal credit proceedings. In an owner-operated business, this is probably one of the most critical documents, and yet it is often one of the most overlooked. The lack of such an agreement can result in disputes that can distract other owners from activities critical to creating value in the business. A properly drafted agreement will dictate the terms for how an exiting owner’s interests are to be valued and liquidated, ensuring that control of the business remains in the hands of the other owners and unintended parties.
Covenants not to compete
In many businesses, employees gain knowledge of many intricate details of a company’s operations that, if used improperly, could cause significant damage. For instance, many employees have access to key customer information, including the nature of products and services purchased, as well as pricing and other pertinent terms. Additionally, many employees have deep knowledge of research and development activities, proprietary production or delivery techniques, as well as other forms of intellectual property that are critical to the value of the business. When a key employee exits a company, it is difficult enough to locate and retrain a replacement, without having to worry about the threat of stolen intellectual property or customer relationships. A once good employee can often become a now good competitor. A covenant not to compete signed by key employees will establish legal boundaries regarding the activities of employees for a defined time, which can help limit the risk of irreparable damage to the value of the business.
As state and local governments are experiencing more and more bud-get constraints, they have come under increased pressure to find other means of generating revenue. Many state governments have generated additional revenue by identifying unregistered businesses that are generating some form of taxable revenue within their jurisdiction by conducting audits of compliance with state income or sales tax regulations, and assessing substantial fines against businesses for noncompliance. Worse, in some cases, statutes of limitations do not restrict how far back a tax authority can audit, exploring companies to substantial risk. Additionally, aside from the monetary impact of tax assessments, the effort required to deal with the substantial audit effort can distract teams from addressing other issues critical to the performance of the business. The advice of a good professional, whom is well versed in state and local taxes, can assist in the identification of potential exposure, the development of processes to ensure compliance, as well as the negotiation of settlements with tax authorities for past non-compliance. By entering into settlements or voluntary disclosure programs, companies can some-times avoid penalties and limit the number of years subject to govern-mental examination.
Insurance, like financing, is hardest to get when you need it the most. Insurance not only plays a crucial role in protecting the company and the owner’s assets, but also in providing a vehicle for funding buy-sell agreements, payment of estate taxes and reimbursing costs associated with replacement of executive management. Underfunded insurance might result in unanticipated expenses that have to be borne by the company; yet overfunded insurance can result in lost profits and decreased business value. To mitigate these risks, a comprehensive review of a company’s insurance policies should be conducted at least annually and possibly even more frequently if a business is experiencing rapid growth or decline.
It is important to understand that risk doesn’t discriminate based on whether the economy is strong or weak. However, in difficult times, an unmitigated risk can turn a bad situation into a catastrophic one. As a result, while managing risk does require a commitment of time and resources, it may end up being one of the best investments a company can make.
Steven E. Staugaitis can be reached at Email or 215.441.4600.