The 5D’s of Worst-Case Scenarios

Aug 22, 2022

When we are looking at exit planning and value building, we work to mitigate against the “5D’s” worst case scenarios. These are major risk areas for the continued success of a business.

According to the Exit Planning Institute, 79% of business owners have no written transition plan, and 48% have done no exit planning at all. In addition, about 50% of all business exits are involuntary and are forced by unanticipated external factors. If you think about your own business, it will likely represent about 89-90% of your total net worth. You want to make sure you are maximizing that worth with well thought-out exit planning of what should occur if something unexpected happens to you or someone in your family that will directly impact your business.

You need to plan for how you want to walk away from your business not only in a perfect scenario, but also in a worst-case situation. With well thought out plans for unexpected change is crucial for handling these disruptions more easily.Throughout the exit planning process, it is critical to consider the 5D’s that can force you out of your business abruptly, often leaving value on the table. These 5 scenarios are:

  1. Death.
  2. Disability.
  3. Divorce.
  4. Disagreement.
  5. Distress.

Death

We often think that a Will addresses the needs upon the death of an owner. If your partner or spouse passes, do you have the ability to continue their job at the level they were performing it? What do you want your family, management team, and partners to know? Where will your loans go? What about life insurance and beneficiaries? If you are gone, who does your team turn to for leadership, guidance and advice? Do you have a documented contingency plan for your (or a partners) death? These are all considerations we will look at, and more, to best protect your business in this unfortunate event.

Disability

If you’re put in a position where you need to stay home to take care of a suddenly sick or disabled family member, what will happen if you are forced to exit your business due to your inability to come into work?Imagine that you had a stroke and cannot talk or write. Does your family know where your important papers are? Do you have a power of attorney for financial and medical matters? Do others have essential passwords that enable them to pay your bills or interface with customers, vendors, etc.? Will this event invoke a purchase of your shares? how will it be paid? Who has the right to vote your shares?

Divorce

You and your spouse have decided to end your marriage while the two of you are still friends. What does this mean for your business? How will your shares be valued? Do you have a prenuptial agreement? How will the changes in your finances impact the cash needs of the company? Do you know your options on how to create a non-adversarial process to make the decisions needed to unbundle your financial affairs at the end of a marriage and mitigate the impact on your business?

Disagreement

What happens if there is a disagreement between business partners? When multiple partners enter into a business, is it all roses and rainbows? They rarely prepare for conflict with a productive exit clause. Like all relationships, business partners sometimes decided not to co-own a business. How will your interest be valued? How will it be paid?

Distress

2020 has taught all of us some painful lessons regarding business interruptions and external threats we could never imagine. Many businesses suffered disruption to their businesses productivity and delivery of their products. What was the strength of your back up system? What insurances did you have to cover business interruption? Good contingency planning includes risk reduction strategies and policies to protect against everyday disaster situations, including data breaches, property disasters, supply chain disruption, work safety incidents, and critical employee loss.
It will be smart to assess what you currently have in place that “de-risk” the negative impacts of these events. Understand what will happen in each of these scenarios, what you may need to do as your systems grow and change, and review this process annually.

Exit Planning Process for the 5D’s

It is important to run through the tough questions about what you want to happen to your business if you have to exit your business prematurely. Statistics have shown that in the four years following an owner’s death, sales declined 60% on average and employment fell 17%, resulting in a decline the overall valuation of the business. Additionally, two years after an owner’s death, firms are 20% more likely to fail or file for bankruptcy. It is important to have a plan in place to avoid these issues happening to your business in your sudden absence. An unplanned exit can not only impact the day-to-day operations of your business, but also the tax and legal aspects of it, along with the value of your company. You need to create contingency plans for each of the 5 D’s to be properly prepared for any unplanned scenario.

While each of these unplanned events will undoubtedly be treated differently, an important step to take is creating and communicating the action plan for each contingency. This is done through a contingency letter, which serves as a playbook that is a shorthand to your operating agreement and your estate planning documents. Your contingency letter should outline what you, as the owner, would like to happen if you can no longer operate the business. These are the 5D’s worst-case scenarios.

Have you planned for these contingencies? Part of the role a CEPA plays is to educate the business owner on how to de-risk the business. Some of the largest risks to the business can be planned for and some cannot. These are events that are usually out of your control and can ruin the value of your business.