Chapter 5
Contingency & CONTINUITY Planning

IN This Chapter
Setting exit limits
Selling your business
Succession planning
Estate planning
Retirement planning
Business failure and bankruptcy
Managing risk

Introduction
It may sound odd, but the same day you begin your business you should start preparing your exit strategy, which means defining the circumstances under which you will consider leaving your business.
This chapter discusses scenarios in which you may need to shut down your business and move on. It also describes a variety of risk management tools, including continuity planning, which will allow your business to survive major disruptions like fires, floods and other disasters.
Setting Exit Limits
Exit limits are a safety net against personal and professional loss. They look something like this:
If my business experiences the following, I will seriously consider calling it quits:
Overdue bills exceeding $25,000
Annual sales below $500,000
Over $100,000 in long-term debt
Profit margins below 12 percent over four consecutive quarters
If my business experiences the following, I will call it quits:
Overdue bills exceeding $35,000
Annual sales below $200,000
Over $150,000 in long-term debt
Profit margins below 10 percent over six consecutive quarters
You might also set limits for your involvement in the business once it reaches a certain level of sales, customers or employees. This might be your signal either to hire a full-time manager, or to bail out and start your next business.
There’s no need to carve these limits in stone. In fact, it’s wise to revisit them often as your business grows.
Selling Your Business
The most common and easiest way of selling your business is through word of mouth. If you talk to people in your network, you might be surprised how quickly you can find a buyer.
If you want to approach things more methodically, you can hire a professional business broker. Business brokers operate locally, regionally or nationally, and often specialize in an industry or location.
States have various laws governing the transfer of ownership in a business. Also, taxes can seriously affect the structure of the transaction. Before you sell all or part of your share in a business, get help from an experienced tax attorney or lawyer.
Valuing Your Business
Most buyers will value your business primarily on the basis of its cash flow and significant tangible assets. Other indicators of value include sales growth, historical profitability and industry market conditions. For more information, see Chapter 30, Valuing and Buying a Business.
Evaluating Buyers
If you choose not to work with a business broker, you’ll have to evaluate prospective buyers yourself. Ideally, your accountant should assist you in this process.
Often, buyers pay a small portion of the price in cash and pay the remaining installments from business earnings. Therefore, you must assess the buyer’s ability to run your business profitably, based on criteria like these:
Size and financial strength
Type of industry
Reputation and experience
Knowledge of your industry and market
Geographic location
Ownership of the company (privately or publicly held)
Degree of synergy between the businesses
Some buyers will ask the seller to stay on and teach them the business. The buyer benefits from the seller’s experience, and the seller guards the value of the business, which is especially important when the purchase is financed out of cash flow.
…
Todd Crafton spent three years as a pool serviceman for Desert Spring Pools and Spas in Las Cruces, New Mexico. While he made his rounds, customers often asked him about alternatives to chlorination. He’d heard of alternative water purification systems, but he didn’t know very much about them.
When he asked his boss, Carl Schmitt, if these systems were viable, he got a very negative response. Alternative disinfectants were a “fad,” according to Carl. They were also “expensive” and “dangerous” and “stupid.” The only people who bought them were “hippies” and “treehuggers,” all of whom were “anti-progress.”
In other words, Carl had no plans to offer alternative purification systems.
Carl had a strong opinion, as per usual. But I didn’t feel like his opinion was relevant to the issue of whether this market was viable.
And besides, I’d talked to these people face to face. They didn’t look to me like radicals of any kind. They were just ordinary people, living in ordinary houses in ordinary neighborhoods.
The only thing that was even slightly unusual about them, as far as I could tell, was that they didn’t want chlorine in their pools.
And since they were spending their own money on their own pools, I didn’t see why they shouldn’t be able to use whatever system they wanted.
I figured that if Carl wasn’t going to sell these customers what they wanted, someone else would. Why shouldn’t it be me?
…
Succession Planning
Although many entrepreneurs hope to build a successful business that they can pass on to their children, surprisingly few of them take the time develop a coherent succession plan.
Worse, some of them don’t adequately consider these basic issues: Are your children capable of running the business properly? Can they work together? Do they want to? Are you comfortable giving up some control before succession, or will you feel driven to micromanage things? Will your successors have the space they need to make decisions and learn from mistakes? Or will all decisions go through you?
If you neglect to include the younger generation in the planning process, and fail to give them increasing levels of responsibility, they will have little choice but to accept the business as it was left to them. Planning that includes the younger generation’s ideas and goals helps to ensure that the responsibility for your business will be shared rather than imposed.
Outside advisors and consultants can help by providing an objective view of the skills and experience successors will need. An informed judgment from non-family advisors may lessen the disappointment of those who are passed over for succession. This can also spare parents from the painful dilemma of having to choose a successor from among several children.
Succession and Retirement
If you will depend on the business for your post-retirement livelihood, you need a succession plan that provides the necessary safeguards for yourself, while giving the younger generation sufficient operational control. Some retiring owners do this by transferring their voting shares to children over a period of years. In other cases, seniors receive preferred stock with fixed dividends, or retain company real estate with a long-term lease to the company.
Planning for the post-management years is often just as important as planning for succession. Things usually go more smoothly when seniors have something to occupy their time after leaving the business. Before retirement, they should cultivate outside interests and experiment with different hobbies or activities.
Seniors who wish to be involved in business may choose to stay on as an advisor or consultant, or launch a new career. If the family has created a charitable foundation, philanthropic giving is another option.
Estate Planning
Although often overlooked by entrepreneurs, estate planning is a vital part of business planning. It can help your business continue and prosper for generations to come. But more important, it can protect your loved ones and make a difficult time much less stressful for your survivors and beneficiaries.
Avoiding Probate
If you don’t have a will when you die, the state writes one for you under the probate statutes. The state’s will (also known as intestate succession) usually provides that your surviving spouse receives half of your estate and the remainder goes to any surviving children.
In most states, your business is sold and the cash is distributed. Legal documents disclosing your assets will be filed at the courthouse as public records. Filing fees, administration expenses, attorney fees and accounting fees are included in this procedure, which can take anywhere from six months to several years.
Obviously, this process is unlikely to result in the best outcome for your family or your business. Therefore, our first and most important recommendation is that you discuss the preparation of an estate plan with your lawyer.
Avoiding Estate Taxes
The federal estate tax applies to cash, real estate and other property that passes from deceased persons to their legal heirs. Very few estates are subject to this tax due to its large exemption: As of 2015, the exemption is $5.43 million for an individual or $10.86 million for a married couple; the tax only applies to sums over this amount.
Estate tax is not assessed on any property that is donated to a tax-exempt charity. Also, under federal law, you may leave any amount of assets to your surviving spouse without paying estate tax. Thus, the time to plan is while both spouses are alive and able to utilize their estate tax exemption. Simply splitting an estate into two entities can save several hundred thousand dollars.
Some small-business owners anticipate taxes owed with an insurance policy, which will prevent liquidation of business assets. You must not own the policy yourself, however, or it will be included in your estate. Either the business or a third party (e.g., your children) should own this policy.
Some states also collect estate taxes, though rates are generally much lower than those imposed by the federal government. As with federal taxes, property left to a surviving spouse is exempt. Consult your lawyer and accountant to learn more.
…
The next time a customer brought up alternatives to chlorine, Todd asked some pointed questions. Why wasn’t chlorine an option? Was it the smell or feel of the water? Were there health issues? Were there environmental concerns? How much would they pay for a chlorine-free system?
After several such conversations, Todd started to get a sense of the market for chlorine-free pools. The customers tended to be professional people with children and at least some college education. Their major concern was health, followed closely by cosmetic issues like the effect of chlorine on hair and skin, and then by aesthetic and comfort issues like smell, taste, feel and eye irritation. A few customers had asthma, or children with asthma, and felt that the chlorine made their symptoms worse.
Although Carl had categorized these customers as “treehuggers,” they rarely mentioned environmental issues. When prompted by Todd, most of them agreed that environmental health might influence their buying decision if they knew more about it. But only two people volunteered it as an issue, and both of them had asthma.
When it came to price, they were noncommittal. A few of them conceded that they might pay “a little more,” but most of them assumed that using fewer chemicals would save money.
What interested me most was that there was a fairly wide range of customer viewpoints. It wasn’t some tiny niche of anti-progress types; Carl was totally wrong about that. What I found was five distinct types of customers, and it seemed to me that each of them represented a lot of people in the community.
The other thing was, although they were distinct, you could see their opinions converging. Maybe because they didn’t like chlorine, they were looking for more arguments against it, or more practical reasons to make the change they’d already set their hearts on.
Either way, I saw myself as having a lot of selling points if I offered chlorine-free pool service at a competitive price. That’s why I decided to make my move.
…
Gifts and Gift Tax
Gift taxes are imposed primarily to prevent people from escaping estate taxes by giving away their assets to family members. Thus, they are usually paid by the donor rather than the recipient.
The gift tax exclusion is indexed annually for inflation. In 2015, the exclusion was $14,000, meaning that you can give up to $14,000 away per year, per recipient, without affecting your $5 million estate tax exemption. In other words, if you have two children, you can give each of them $14,000 per year without affecting your exemption. Your spouse could do likewise, meaning that you can transfer $54,000 per year to your children. If you start early enough and live long enough, you can reduce your estate to the nontaxable level simply through the use of gifts.
Before embarking on this strategy, it’s important to understand what qualifies as a gift under IRS rules. As a basic rule of thumb, a gift is something for which you received no consideration in return. If the IRS finds that your gift was a reward, a bonus or any form of remuneration for services, it will view the money as taxable. Get professional help before giving gifts.
By making gifts of portions of a business that is appreciating, you can also reduce the growth of your estate.
One disadvantage of such gifts is that the tax basis of property you give is your cost of the asset, minus the depreciation you took on tax returns. Often, the tax basis in a small business is quite low, because it grew on sweat equity over time, and the owners took as much depreciation as possible.
Another disadvantage is that you must relinquish control of the business interest in order for it to qualify as a gift. If you retain stock, interests or the right to vote, the IRS will rule that the gift was never made.
A family limited partnership, which is a standard limited partnership composed only of family members, will allow you to start a planned giving program of limited partner shares. You retain general partner interest, so you still control the business.
You may not want an underaged child to control a substantial portion of your business if you die unexpectedly. Therefore, gifts to minors are usually made by way of a trust or family limited partnership. Trusts are also a very effective way of planning for someone to assist you in the event that you become physically or mentally disabled. However, gifts in trust require special planning to qualify for the gift exclusion.
Sale During Your Lifetime
Selling your business in installments can be another way of reducing estate taxes, transferring your business to your children, and ensuring lifetime income for you and your spouse.
You must feel confident that your family members can profitably run the business and make payments, or you risk losing control over your major income-producing asset. By using the installment sale method, you should be able to defer a portion of the tax on the gain through the term of the sale contract. You can often structure the transaction so that you retain a lien on the business assets, while providing family members with the flexibility to make payments from business profits. The main disadvantage is that family members won’t receive a step-up in tax basis equal to the value of the business at the owner’s death.
Buy/sell agreements can ensure that a closely held business remains in the family’s control, while also establishing the value of the business for estate tax purposes. There are also a number of hybrid agreements, which you should discuss with your lawyer.
Stock Options
Stock options are another method of freezing the value of the business in order to remove future appreciation from your estate. You may grant an option to your family to buy shares of the business at a set price, but be aware that unless it meets IRS requirements, it will be disregarded in valuing the property for estate tax.
Minority Discounts
It’s hard to assess the value of closely held businesses, because unlike shares of a corporation sold on a public exchange, their shares have no established market value. It’s also hard to assess the value of a closely held business when that goodwill rests primarily with the former owner.
Therefore, one of the most effective estate and succession planning techniques is the minority discount, which is also known as a discount for lack of control (DLOC). If you reduce your interest in your company to a minority position, you may be able to reduce its true value below its book value.
For example, if your estate owned 30 percent of a closely held corporation, and the book value of its shares was $10 each, your 10,000 shares would be worth less than $100,000, because a buyer would not pay that price to buy into a minority position.
There’s no set percentage for minority discounts, so you must work closely with your accountant and estate planning lawyer.
…
Todd didn’t feel right about planning his new business on Carl’s time, so he left Desert Spring in order to concentrate full-time on researching potential products and customers.
A few weeks later, he attended a trade show in Albuquerque and talked to some people who were selling an ozone-based purification system. Todd was intrigued...until he saw the price tag. They cost a lot more than the systems he was used to.
“Do people actually buy this stuff?” he asked.
The seller started talking about the explosion in eco-friendly goods and the appeal of helping the environment. But Todd was skeptical. He’d talked to enough customers to suspect that the environment was not high on their list of concerns. And he also knew that even though some customers were willing to pay a green premium, the price of this system was still on the high side. He’d have to research sales figures for alternative systems carefully before he took the plunge.
The most useful thing the salesman told me was that by going chlorine-free, I could get away from all those hazmat and fire regulations that had been a thorn in Carl’s side. Being able to start my business without worrying about those regs sounded great.
Of course, none of that meant anything unless the system really worked and people were willing to buy enough of them to keep me in business. So that’s what I focused on.
…
Retirement PLANNING
Planning and saving for retirement while running a growing business can be tricky even for the most well-organized entrepreneurs. According to a 2015 study by TD Ameritrade, only 30 percent of entrepreneurs pay into a retirement plan.
Finding the right plan requires making tradeoffs between flexibility, tax benefits and the size of allowable contributions. Obviously, this is a decision that requires input from your accountant, your family and your financial advisor. Common retirement plans include:
Traditional IRAs are available to business owners of all types. Taxes on contributions are deferred, meaning that you deduct them when you contribute, and pay taxes when you withdraw funds during retirement. You may also be assessed a penalty tax for early withdrawals. As of 2015, the contribution limit is $5,500 if you’re under 50 and $6,500 if you’re over 50. The contribution deadline is your tax return deadline. In other words, you have until April 15 of the current year to make a contribution that will count toward the previous year.
Roth IRAs are very similar to traditional IRAs. The major exception is that you pay taxes on contributions and withdraw funds tax-free during retirement. This option tends to be better for young entrepreneurs who expect to be in a higher tax bracket later in life.
Solo 401(k). This plan—which is also known as a one-participant 401(k)—covers one business owner who has no employees, as well as his or her spouse (provided the spouse also earns an income from the business). As of 2015, you can contribute as much as $18,000 in wages per year if you’re under 50, and up to $24,000 if you’re over 50. Your spouse can make equivalent contributions. Also, you can make an employer contribution in addition to your employee contribution. And if necessary, you can borrow 50 percent of your balance, up to a limit of $50,000. For contributions to apply in a given year, the plan must have been set up by December 31 of that year and funded by the due date of your following year’s tax return.
Simplified Employee Pension (SEP) IRA. The major benefit of a SEP is its simplicity. IRS filings are not required, and no documents need to be prepared other than a one-page 5305-SEP form. As of 2015, you can contribute up to 25 percent of your self-employment income, or $53,000, whichever is less. The downside is that you must also provide the plan to all eligible employees. This may not be feasible in the early years of your business.
Savings Incentive Match Plan for Employees (SIMPLE) IRA. Unlike SEP IRAs, SIMPLE IRAs allow employee contributions and mandate an employer match. Annual contributions may be up to 3 percent of compensation, but as of 2015, they may total no more than $12,500 for employees under 50, and $14,000 for employees who are 50 and older. For contributions to apply in a given year, the plan must have been set up by October 1 of that year, and employee contributions must be made by December 31.
401(k). In this plan, employees make additional contributions—which may be matched by the employer—to a retirement plan trust. There are limitations on the amount of contributions that can be made by the owners or highly paid employees. However, 401(k) plans do have the advantage of being paid with income before it is taxed.
Pension and profit-sharing plans are available to closely held corporations. These include profit sharing plans with discretionary contributions made from profits; defined benefit plans with a benefit formula based on each employee’s years of service and final pay; and money purchase pension plans that fix a percentage of the employee’s compensation as the employer contribution. These plans may offer greater benefits than an IRA or 401(k), but picking the right one can be difficult. Discuss your alternatives with your accountant and a pension plan lawyer.
Even if you don’t plan to rely on Social Security for your retirement, you shouldn’t ignore it. You may lose benefits if you have excess earnings after starting Social Security, so arrange your business income accordingly. For example, stock dividends are not defined as earnings, and salary can be shifted to family members who provide services to the business. Pension plans may also allow you to defer benefits.
…
While working on his business plan, Todd realized that he needed to test the ozone system in his own pool. If it didn’t work, there was no point in going any further.
He monitored the water over two months, frequently checking pH, bacteria growth and water quality. He was pleased to see that the treatment worked, and he was even more pleased to find that his family seemed less inclined to take long showers after swimming. That meant less water, less energy, less shampoo...it was amazing how connected everything was!
On the other hand, the system had a significant learning curve. For some customers, that would be no problem. For others, the higher maintenance needs were likely to be a dealbreaker.
Todd had other concerns, too. The purification system only worked when the pump was running. How much would this increase energy costs? Would the pumps and filters be able to handle the increased circulation? Granted, customers would be paying less for chemicals, but what would it cost them to achieve those savings?
Over the next couple of weeks, Todd did his best to figure out exactly what it cost to maintain a normal swimming pool. He didn’t just look at the upfront cost. He also looked at the time involved, which he knew was a big issue for many of his customers. Sweeping, changing filters, applying algaecide and testing pH were not things that most pool owners liked to do. If the new system required more maintenance of this sort, price-conscious customers were unlikely to pay more for it.
At the end of the day, I believed that my customers could get real health and financial benefits from the system, but only if they stayed on top of maintenance. That wasn’t a sure thing, to say the least.
At the same time, if they didn’t keep up with maintenance, and the system broke down, I knew exactly who they’d blame.
The whole thing was seeming way too risky for me. I was starting to feel like I’d walked into a brick wall.
…
Business Failure and Bankruptcy
Bankruptcy is the inability of a business to pay its debts. Sometimes this results from a catastrophe, such as illness, the default of a large customer, a lawsuit, a fire or the call of a large debt by a lender. It can also be caused by undercapitalization, poor cash management or overexpansion.
In the following pages, we’ll introduce the different types of bankruptcy. Do not use this brief, simplified summary as a substitute for expert legal advice.
Needless to say, the decision to file for bankruptcy should not be taken lightly. Bankruptcy can seriously damage your credit score for seven to 10 years. However, unpaid debts can have a similar effect on your credit score, and may take longer to settle outside of bankruptcy proceedings.
Start by contacting your lawyer immediately. If your lawyer recommends filing for bankruptcy, you should seriously consider doing so. Here are some of the issues your lawyer will probably consider:
Your business structure. Whether you are a sole proprietorship, a partnership, a corporation or an LLC affects the bankruptcy options available to you.
Type of debt. Is most of your debt personal or business debt? How much of it is actually dischargeable through bankruptcy proceedings?
Your long-term plans. Do you want to keep your business running? Or are you ready to bail out?
The viability of your business. Is your business on its last legs, or is it simply facing tough times?
Assets versus liabilities. If you owe more than you own, bankruptcy is likely to be a better bet.
Your creditors. Are they willing to negotiate with you privately to settle your debts? If so, it may be better to find a mutually beneficial agreement instead of going through bankruptcy.
Chapter 7 (Liquidation)
Chapter 7 covers the most extreme (and most common) cases of bankruptcy: those in which you must liquidate all nonexempt assets and property to pay your debts. Exemptions vary by state.
No more than 180 days before you file for Chapter 7, you must undergo credit counseling from an approved source.
Once you file for Chapter 7 bankruptcy, creditors must stop their collection efforts. This automatic stay is temporary, but it can provide much-needed breathing room.
If you run a partnership, a corporation or an LLC, filing under Chapter 7 will essentially transfer control of your business to a bankruptcy trustee, who will dissolve the company, liquidate its assets and distribute the proceeds to your creditors in order of their legal priority. Once you enter into bankruptcy, you can’t sell, give away or discard any business property unless the court gives its consent.
Note that if you personally guaranteed a business debt, limitations on liability will not protect you. You will have to file Chapter 7 yourself to discharge this debt.
Sole proprietors may have the option of protecting some assets and continuing the business. Because the law treats sole proprietors and their businesses as one and the same, you must personally file bankruptcy to discharge business debts. However, this means you can use personal exemptions to protect business assets.
You may have to undergo a means test to determine whether you’re eligible for Chapter 7 protection. The court will compare your income—as listed on your most recent tax return—to the median income in your area. If you earn less than the median income for a household of your size, you’re exempt from the means test and may be able to file immediately. If you earned more than the median income in the six months before filing, and you have the ability to pay at least 25 percent of your unsecured debt, you may need to file for Chapter 13 bankruptcy instead (see below).
If more than 50 percent of your debts are business debts, you are exempt from the means test. To demonstrate that your debts are business debts, as opposed to consumer debts, you will need to show supporting documentation. What qualifies as business debt varies by state, so get legal advice.
Once you have completed Chapter 7 bankruptcy, you may not file again within six years of your filing date. Similarly, you can’t file under Chapter 7 if you went through Chapter 7 or Chapter 13 within the previous six years.
Chapter 13
Instead of liquidating your assets to repay your creditors, Chapter 13 allows you to retain your assets and pay your debts out of your income over three to five years. To be eligible, you must demonstrate that you have enough disposable income to repay eligible debts on schedule. Your monthly repayment plan is based on the median living expenses for your area, as determined by the IRS. If the IRS median proves to be lower than your actual expenses (which is not unlikely), you may legally request a hearing on the matter.
Businesses may not file under Chapter 13. However, you can personally file under Chapter 13 for business debts for which you are personally liable. This would include business debts incurred by a sole proprietor.
To be eligible for Chapter 13, you must show the court that you have filed federal and state income tax returns for the previous four tax years. If you can’t provide this proof, your application will not be accepted. There are also limits for secured and unsecured debt in Chapter 13 eligibility; these amounts change annually.
Chapter 11
Chapter 11 is a reorganization plan for businesses. The filing process can be complicated and costly, but if approved, Chapter 11 will allow your business to continue operating under legal guidelines that protect the interests of its creditors. This is the only such option for partnerships, corporations and LLCs.
During the reorganization process, stay in contact with customers to bolster their confidence. Keep creditors and stockholders informed about all developments. Your investors are probably more concerned than anyone about your business, so keep them apprised of the details through emails, or better yet, personal phone calls.
Last but not least, be open with your employees. Involve them in the reorganization plan, and keep them focused on the tasks at hand. After all, your business’s future may depend on them.
Learning from Bankruptcy
Although no entrepreneur enjoys going through bankruptcy, many cite it as a decisive factor in the success of their next business venture. To get the benefits of bankruptcy, consider these questions:
Was it caused by bad luck or by a specific weakness?
What new skills could help you to succeed next time?
Did you create an exit strategy and review it often?
Did you stick to your core competencies?
Did you grow too quickly? Too slowly?
Were you undercapitalized?
Did your business invest too much effort on new customers and not enough on the ones it had?
Did you file for bankruptcy protection too late?
…
After doing all those tests, I wasn’t feeling great about my chances. But my daughter Erica really believed in the idea. She’s a teacher at Dona Ana Community College, and she said I should go talk to an SBDC counselor. I didn’t want to, at first. I felt it was like admitting I was a bad businessman. But Erica said, “Dad, getting help when you need it makes you a good businessman.”
When Todd showed up for his appointment with SBDC counselor Estelle Silva, he didn’t expect much. He’d spent the past three months thinking about his business idea. What would she know about pools that he didn’t?
As it happened, Estelle didn’t know very much about pools. But she knew a lot about business. She pointed out that when it comes to selling a product, there are usually more issues to consider than which system cost more. Granted, Todd’s informal research suggested that customers were unwilling to pay much more for a chlorine-free pool. However, they also said they were concerned about their health. Estelle felt this indicated some room for negotiation.
The problem, Estelle said, was that Todd’s research hadn’t been thorough enough. He’d done a good job of gathering information. But on the other hand, he’d interviewed customers as a representative of Desert Spring, which may have made them less willing to talk about price.
Estelle suggested conducting formal research by creating an online survey with standardized multiple-choice questions. She helped him come up with questions that would reveal customer attitudes about conventional pools, chlorine-free pools, health and the environment.
Assuming he got a good response rate, she believed the answers would give Todd a more realistic picture of his customers.
…
Managing Risk
You have four basic ways of managing business risk: Buying insurance, getting help from qualified advisors, creating standard operating procedures, and planning for disruptive events like disasters and economic downturns.
In addition to being necessary for the survival of your business, risk management improves your odds of getting capital from lenders and investors.
Insurance
No two businesses have the same insurance needs. The standard advice is to insure anything you can’t afford to lose. If you can’t afford to pay 100 percent of a business loss, you need insurance.
Having adequate insurance is usually a condition for getting a bank loan. In a sole proprietorship, insurance is especially important because you’re personally liable for all acts of the business.
If you’re operating a business from home, be aware that household insurance usually won’t cover it. Buying a separate policy, or upgrading existing insurance, is a necessary cost of doing business.
The Insurance Worksheets will help you consider whether you have the type and amount of insurance you need.
Choosing an Agent
Insurance agents work for one or more insurance companies and receive a commission on each policy they sell.
Direct writers represent one insurance company, so they tend to be very familiar with the policies they offer.
Independent agents represent multiple insurance companies and tend to offer a wider range of coverage and prices.
The best way to find an agent is to ask your banker, accountant or mentor for a recommendation. A good insurance agent will ask enough questions about your business to identify all the threats it faces, select a plan that’s in your best interests, and offer it at a competitive price.
Always get three bids and check references carefully. You should understand exactly how your premium is calculated, and make sure the agent’s estimate is correct. Because your agent is your contact with the insurance company, you’ll need to have confidence in him if a claim arises.
Choosing Coverage
The basic steps to developing your insurance program are:
Make a list of risks you face.
Review the coverage you already have.
Check with local and state government offices to find out whether they mandate specific forms of insurance for your type of business.
Get professional advice.
Determine what further insurance you need and where to buy it.
Most businesses should have automobile, fire, liability and workers’ compensation insurance. Insurance firms offer free risk analysis, so it’s wise to talk to several agents who understand your industry and can identify uninsured risks.
The cost of insurance can vary depending on your situation. If you belong to an industry group or professional association, it may offer discounted rates. You may also be able to reduce your exposure to risk by changing how you do business. For instance, if you’re facing high premiums because of a specific risk, consider outsourcing that business function to another company. That way, you get the work done and the outside firm takes on the risks.
Types of Insurance
The insurance industry divides coverage into two basic categories: property and liability, and life and health.
Property and Liability Insurance
Property policies protect your building and other physical assets. Liability policies protect you against claims for injury or property loss resulting from negligence.
Property and liability coverage is often offered in a package policy. Be cautious when assessing such plans; never assume they will meet all of your needs.
Liability insurance protects your business if, for example, someone is injured on your site and sues. Its cost usually depends on your type of business; a plating shop would typically pay more for coverage than a shoe store.
Product liability insurance covers injury and property loss claims arising from your product’s defects or design flaws.
Professional liability insurance protects people who are self-employed in such fields as law and accounting from being sued for malpractice.
Completed operations insurance protects contractors and manufacturers against damage or injuries that occur after a job has been completed. For example, if you build a staircase that collapses six months after you build it, completed operations insurance would cover costs arising from this incident.
Business property insurance protects equipment or assets against theft, fire, flood, vandalism and other unfortunate events. Other hazards—such as windstorms, hail, smoke and explosions—can also be covered. The coverage is written for a specific value, such as the cost of replacing a building, and premiums are based on this value.
Business interruption insurance protects against revenue losses due to fire, flooding and other disasters. It’s important for businesses with a high risk of fire damage, such as restaurants.
Business crime insurance covers losses due to burglary, robbery, embezzlement, counterfeit money and employee theft.
Commercial auto insurance is similar to personal auto insurance. Most policies cover damage to your vehicle, damage to other vehicles, and injuries to drivers, passengers and pedestrians. If your company has more than five vehicles, fleet insurance will cover them all on one policy. If you’re transporting people for a fee, you need a special type of endorsement or policy.
Electronic data processing (EDP) insurance protects against damage to computers and data from mechanical failures, power surges and viruses. A good EDP policy will cover the cost of business interruption and data recovery.
Cybersecurity insurance protects against losses due to hacking and other cyber crimes. These policies can be written to include business losses, computer forensics, reputation management and the cost of credit monitoring for customers whose data were stolen. Premiums are usually based on the company’s size and industry, the amount and type of data it stores, and the strength of its security system.
Website insurance protects against loss of money, libel and copyright infringement arising from your website, as well as damage to computers and data resulting from vandalism and viruses.
Surety or fidelity bonds guarantee that you will perform some specific action for a customer. Bonding is very important in the construction industry, where the bond guarantees you have the financial capacity to perform. If you fail to perform as agreed, the client can get a settlement to cover their losses.
Key-person insurance protects against financial loss caused by the death or disability of a key employee or partner. The key person is covered by life and disability insurance, and the business is usually the policy owner and beneficiary. This insurance is particularly important for closely held business.
Home office insurance covers office equipment and other valuable business property that may not be included in a standard homeowner’s policy. It normally entails either a home business endorsement to an existing homeowner’s policy, or a separate home business policy. You may need to meet annual sales limits to qualify, and certain high-risk businesses may not be eligible.
Life and Disability Insurance
Life and health coverage is usually part of employee benefit packages, but it can also insure owners.
Workers’ compensation covers employees who are injured on the job. Most states require that benefits cover medical and rehabilitation costs as well as lost wages. Workers’ compensation also covers business owners against lawsuits by the spouse or children of a worker who was permanently disabled or killed. Check with your state insurance commissioner’s office to learn more.
Life insurance often comes as part of a health insurance package. Otherwise, term life insurance can be purchased at a reasonable cost. Some disability policies cover business overhead when an owner is temporarily disabled, and convert to permanent disability policies in the event that the owner can’t return to work.
Social Security covers certain types of long-term disability that make work impossible. The amount of the benefit depends on your age at the time of the disabling sickness or injury, as well as your record of covered earnings. Social Security also provides survivors’ benefits to your spouse or children in the event of your death.
Health Insurance
Health insurance protects your bank account, your family and your business against the high cost of unexpected illness and injuries. Going without it, or getting less coverage than you need, is false economy at its worst.
Under the Affordable Care Act, all Americans must carry a minimum level of health insurance. People who do not have insurance must pay a penalty unless they qualify for an exemption.
Insurance may be purchased directly from an insurer; through a broker, agent or online seller such as eHealth; through a trade or business organization or a local chamber of commerce; or through the Healthcare.gov marketplace (or its state-run equivalent), which connects users with insurance plans in their area. The main difference between buying insurance inside and outside the marketplace is that outside plans don’t offer income-based subsidies.
If you don’t have employees, you are eligible to buy insurance through the individual Health Insurance Marketplace. However, some states allow solo entrepreneurs who have a business license to purchase a small business plan. You can also get coverage by providing an employee health plan through a Small Business Health Option Program (SHOP) exchange. Businesses with fewer than 10 employees may be eligible for a premium subsidy of up to 50 percent. Visit www.healthcare.gov/small-businesses/employers to learn more.
A health insurance broker can help you choose coverage that makes sense for you and your business. To find a licensed broker in your area, visit the National Association of Health Underwriters at www.nahu.org.
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Todd knew he had to give people a reason to complete his survey, so he decided to appeal to their curiosity and economic interests. In return for completion, he’d send them 10 tips guaranteed to lower the cost of pool maintenance.
In the meantime, he continued to research and test alternatives to traditional pool chemicals. He reasoned that while pool owners might not be willing to spend the money for a new system, they might be willing to try out greener additives.
He found a lot of variation. Some didn’t work as advertised. Some were similar to traditional chemicals, but they were more expensive, or required more frequent applications, or were harder to use. A couple were just ordinary pool chemicals with a new, green-looking label. After performing the feasibility tests that Estelle recommended, he found several that would be appropriate for his business.
A month later, he went over his survey results with Estelle. As she’d suspected, he got very different responses this time around. Based on the results, they concluded that Todd should emphasize the health and luxury angle: fewer chemicals, improved skin condition, and a more pleasant, comfortable experience.
Although the green side of the business focused mainly on energy savings, Estelle felt that Todd’s target customers were curious about the environmental benefits, and suggested that Todd should stay up to date on this issue.
“That could be the benefit that pushes someone to buy,” she told him. “You need to be able to make a good case for it.”
We also decided I’d offer two months of free maintenance with the new system. That way, I’d prove to customers that it really does work when you follow the procedures. After that, customers could either take over the maintenance or continue to have us handle it for a small monthly fee. I have to say, I came away from that meeting feeling a lot more positive about things.
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Finding Professional Advisors
Every entrepreneur needs professional advisors to help with the legal aspects of protecting a business. Ask for recommendations from fellow entrepreneurs and business leaders, and interview prospects to find someone with the right personality, outlook, skills and hourly rate. Last, ask for references and check them.
Accountant
A qualified accountant is probably the most important advisor you can have. A business that starts without the help of an accountant may later find that the accounting system isn’t set up properly, that tax reporting hasn’t been done correctly, or that the accounting system isn’t set up to expand as the business grows.
Performing daily bookkeeping chores in-house or through a bookkeeping service will save money and leave your accountant free to concentrate on more complex tasks.
Banker
You’ll probably need outside capital during the course of your business, either for major improvements—such as upgrading facilities or equipment—or for cash flow management and operating funds.
It’s difficult for a banker to respond quickly to a loan request without having had the opportunity to review your business plan and tax returns, and to visit your facilities, so it’s a good idea to establish a strong relationship with a banker well in advance.
Lawyer
The most practical way of selecting a lawyer with expertise in your industry is through a referral from your accountant or banker, who should be familiar with local business law firms. You can also contact your county bar association or chamber of commerce.
Your Operations Manual
Another way to manage risk is to develop standard operating procedures for all your important business functions.
Such procedures often develop naturally. Suppose you run a retail shop, and you’ve found that the best time to wash the floor is after you close each night. That way, the floor will dry before your customers return.
Probably without meaning to, you’ve developed a standard operating procedure: You know that following this procedure reduces the risk that a customer will slip and fall in your store.
It takes discipline, but many successful business owners develop an operations manual that describe all such standard procedures. This is especially helpful as a guide for temporary help. When you can’t be at your business, the manual tells your stand-in how to keep things running smoothly and safely.
Business Continuity Planning
Business continuity planning means preparing your business to survive disasters and disruptions, including fires, floods, earthquakes and tornadoes.
No business is too small to benefit from a continuity plan. Statistics show that many small businesses fail to survive relatively minor disasters like building fires and floods. Businesses that have a plan in place stand a much better chance of getting back on their feet after a disruption.
Here are the basic steps involved in continuity planning:
List all necessary business functions, who performs them, and what equipment and supplies they require. Compile contact information for key individuals and list their everyday responsibilities. If disaster strikes, can any of these personnel telecommute or work at another site? Do they have the equipment they need? Also, specify who will manage the business if you are injured or otherwise unavailable.
Identify threats and the business functions they threaten. Take steps to minimize the damage these threats can do to your inventory, equipment and data. For instance, back up essential data online or on a remote computer. If you have a delivery vehicle, you should know where to rent a replacement in case it’s unusable. List multiple replacement options wherever possible.
Compile contact information for suppliers, major customers, insurance agents, equipment repair specialists, attorneys, accountants, bookkeepers, lenders, investors and other key partners and contractors.
List the type, amount and location of hazardous materials or equipment in your facility for the benefit of emergency responders and rescue teams. Include a map, if possible.
Make copies of essential documents, including business licenses, leases, contracts, tax documents, financial records, loan documents, personnel files, and any other documents you need to run your business. Where necessary, get legally valid official or notarized duplicates. If you don’t want to put all these documents into your plan, make sure key employees know where to find them. You should also store electronic versions at a secure online location.
Compile information relating to online services. This list should include emergency contact information for your ISP, Web host, domain registrar, and cloud services, as well as account numbers, user names, passwords, answers to verification questions, and any other information needed to access crucial online services.
Choose a secondary work site to use until your primary site is restored or replaced. This could be a local hotel, a trailer or even your garage. Whatever location you choose, make sure it’s clearly identified in your plan. If possible, list multiple sites in case your first choice is unavailable.
Get employee input. Before you finalize the plan, give employees a draft version and hold a roundtable meeting to get their comments.
Distribute the finished plan. Every member of your team should have a copy at work and home. Also, store a copy online so they can access it from remote locations and mobile devices.
Revise the plan as necessary. When things change, your plan needs to change too. Update it promptly to reflect new equipment and software, personnel changes, customer and vendor changes, and so forth. Clearly date each revision of the plan, collect and discard the outdated hard copies, and update any online versions.
Test your plan regularly. It’s better to learn about mistakes during a practice run than in the middle of a crisis. To be effective, your test should assume a worst-case scenario in which your business location is destroyed. If your plan doesn’t work as it should the first time, fine-tune it and try again within a month or two. Once you’re satisfied with your plan, test it annually.
The Business Continuity Worksheet will get you started. To learn more, visit the Federal Emergency Management Agency at www.ready.gov/business.
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Eight months and an SBA loan later, EcoZone Pools was open for business and doing well. It had three employees and was adding new accounts every months.
I think three things made our rollout successful. First, I studied our customers and familiarized myself with the new systems. Whatever there was to know about these products, I learned it inside and out.
Second, I had a great team that was able to deal with the problems we hadn’t planned for.
Last, I had great suppliers who backed me up when I needed them. When a customer had a question my team couldn’t answer, they came through with the right answers, right when we needed them. Without that commitment, we would’ve lost a lot of business.
All in all, I’m very happy about where things are heading. I feel like if I can travel this road, anyone can, and I’m excited to see where it leads us.”
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Conclusion
It takes a lot of time, money and hard work to establish a business, so it makes sense to protect your investment by preparing for contingencies right from the beginning.
Seeking out the advice of accounting, insurance, banking, and law professionals enables you to make informed decisions that will protect your business, your customers, your employees and your family.
Developing lasting relationships with these advisors will help you to manage known business risks and to respond to new ones as they come up.

Reducing Insurance Costs Improving safety and security reduces the risk of loss, which in turn reduces the cost of insurance. Here are a few safety measures every business owner should take. Your agent may have additional suggestions. Secure doors and windows. Although it’s possible to break into almost any building, most criminals are looking for easy pickings. Adequate lighting, barred windows, secure doors and security systems greatly reduce the risk of theft. Fire safety is one of the biggest factors in insurance costs. Install smoke alarms and test them every month. Avoid faulty appliances and dangerous electrical connections. Store flammable chemicals safely, and keep fire extinguishers charged. Keep your site safe for visitors. Walkways should be clean and dry. Steps should be sturdy and well maintained. If you have a home-based business, keep children’s toys off the floor and control your pets. Keep your business safe for employees. Provide adequate ventilation and safety gear. Replace hazardous chemicals with safer alternatives wherever possible. Create a safety policy, and hold regular safety meetings. Go green. Many insurers offer premium credits and discounts for owners of green commercial buildings and fuel-efficient vehicles. Ask your agent about incentives for green policies or improvements.

| NxLeveL® TECH TIP BUSINESS RESOURCES AND THE WEB
Disaster Recovery as a Service Disaster recovery as a service (DRaaS) provides businesses with offsite infrastructure for fast recovery from computer system failures, outages and scheduled downtime. These services maintain a continuously updated cloud-based replica of an enterprise’s data and applications, which can be deployed within minutes in the event of a system failure. As with any cloud-based services, due diligence is a must. Issues to consider include: Cost. DRaaS is usually offered on a subscription basis. Additional charges may apply in the event that disaster recovery is actually needed. Investigate costs and billing carefully before choosing a provider or service level agreement (SLA). Recovery time. What does “recovery” mean? Does it mean meeting some minimum level of operability, or does it mean a full return to normal functionality? How quickly will your system be restored? Make your needs and expectations clear when negotiating contracts. Backups. Will the service simply mirror your existing system, or will it also provide backups of your data? Will it be able to restore files if you accidentally delete them, or is the service only available for large-scale disasters? Location. If your provider is in the same city, what happens if you both get hit by the same tornado or earthquake? Generally, it’s best to choose a provider outside your area. Security and compliance. If you must comply with data security regulations (such as the Health Insurance Portability and Accountability Act, or HIPAA), do the vendor’s data centers—and any subcontractors—meet all relevant standards?

Hazardous Materials Inventory Preparing an inventory of the hazardous materials at your site is an essential step in continuity planning. Be sure to include common chemicals like ammonia, bleach, paints and solvents, which may be dangerous by themselves or when mixed accidentally. Your inventory should identify these compounds by name, manufacturer, ID number (if any), amount, hazard class and location. Take careful note of chemical concentrations, if they’re listed; there’s a big difference between a 3-percent hydrogen peroxide solution and a 10-percent solution. Chemicals that lack information (e.g., a unlabeled bottle of pickling acid) should be identified and labeled if possible, and brought to a waste disposal facility if not. Once you’ve prepared your inventory, gather the Material Safety Data Sheets (MSDS) for each chemical and add them to your continuity plan along with a map detailing where hazardous materials are stored. Depending on the size of your facility, and the amount of materials you store, you may also want to apply radio frequency identification (RFID) tags to your chemical containers so that they can be tracked with an inventory management system. This will make them easier to locate in the event of a building collapse, fire, flood, hurricane or tornado.