The impact of death or disability on the value of a corporation
By Ed Morrow
Intl. Assoc. of Registered Financial Consultants
Earlier this year, Sara Lee Corp. announced that its CEO, Brenda Barnes, was taking a temporary medical leave of absence. Nearly four weeks later, the company finally disclosed that Barnes had suffered a serious stroke at the age of 56 and had resigned, permanently.
As grave as the situation was for Ms. Barnes and Sara Lee, it illuminates how critical a CEO's health issues are to an organization. According to research gathered by the Inc Business Owners Council from 1,400 business owners, the risk of disability is as much as 3.5 times greater than the risk of death during a person's working years.
Upon the receipt of the news, Sara Lee stock dropped 84 cents. Doesn’t seem like a lot, but when you consider there are 639 million shares, 84 cents represents a loss of $536 million in shareholder value.
Had the Sara Lee Board of Directors been prepared for the career-ending disability of their CEO, the situation may have been quite different for both its CEO and the company. It could have insured the talent of those who built the company's portfolio of leading brands into the global food and beverage powerhouse that it is today.
Barnes was the president, chairman and chief executive of Sara Lee, and had served in that capacity since 2004. Previously, she was the first female CEO of PepsiCo and a vice president of Frito-Lay. She has been listed in Forbes' list of The World's 100 Most Powerful Women since 2004, appearing in the top 10 in 2005 and 2006.
Every business is at risk
Most businesses have concentrated on the problems of growth, response to economic risks and market fluctuations – ignoring the risks of death and disability. They acknowledge their existence, but simply indicate, “We have other issues to deal with!” Many corporate founders and executives intend to work for a long time. They point to Warren Buffett and Sir John Templeton and say, “Why do I ever want to quit work?”
What do you believe will be the impact of Warren Buffett’s death on the value of Berkshire Hathaway shares? It is not possible to buy that much life insurance – especially on a man age 80.
Or consider what happens to the stock in Apple when Steve Jobs misses the Mac World conference due to publicly acknowledged illness, first described as “more complex” and finally acknowledged to be pancreatic cancer.
To not want to retire is a logical and commendable attitude, but no one can negotiate with Fate. Death will strike everyone, sooner or later. And often, it is preceded by an incident that causes a long term disability before death. The impact can be disastrous.
The stronger and more talented the leader, the greater the impact of a disability. Almost every business borrows money for expansion and to leverage the capital investment. Nearly every such loan agreement has a clause, hidden away in the document, saying in essence, “The lender may call for an acceleration of the principal due date upon the occurrence of any major event that affects the operation and continuity of the borrower.”
Who is the borrower?
Often, the founder or CEO has also signed (endorsed) the business loan agreement. When the lending institution learns of the disability or death, it calls the loan, and expects to be paid immediately in cash by the business or the estate of the deceased.This will suck out all of the liquid capital, leaving the business enterprise in an extremely difficult position – especially if competitors and suppliers know of the event, which they soon will, of course.
Conflicts of interest swiftly emerge
The executives running the business are fighting to continue profitable operations despite the loss of the leader, while the family is focusing on replacement of the salary revenue stream and the threats of declining business value. When everyone is at the maximum stress level, it is not a good time to negotiate a “fair and reasonable” business succession plan.
Negotiating a business transfer under such pressure is extremely stressful. Often, the emotional reactions are negative. This produces decisional paralysis – and the financial clocks keep ticking.
Business can easily decline
Some employees may leave voluntarily, others will be wooed away by competitors, and the pressure to sustain sales grows. The personal relationships of the departed or disabled executive no longer maintain the relationships with key suppliers and customers.
There is a multiplier effect
All of these pressures can, and often do, take place swiftly. The surviving officers in one firm said, “If all we had to deal with was suppliers, that would have been no problem. But the bank was calling in all the loans, and when our payments lagged, the delivery from vendors grew longer and the pricing increased. This reduced sales and profitability, we lost our best salesman, and soon the family was agitating for remedial action and threatening lawsuits!”
The solution is a process
There is no magic solution for these issues, because every firm has a different ownership and leadership structure. It is difficult for the executives and family decision makers to be objective. Often, not all problems can be resolved, certainly not at the outset. The solution is a process whereby a financial consultant provides guidance and analysis:
- Needs analysis
- Risk evaluation
- Business valuation
- Consider the options
- Fund the solutions
- Execute the documents
The consultant can generally gather and arrange the documents and financial reports swiftly, but often there are unique valuation or legal issues that require research. The best estimate is between four and eight weeks, plus the time for decisions to be made.
What does it cost?
The smallest element is the initial financial analysis, and this will range between $1,500 and $15,000, depending on the size of the firm (which usually equates with complexity) and the additional research that might be required. The financial consultant will then prepare a preliminary report and present it to the decision group. There are often a variety of solutions to consider, one of which is “going bare” and ignoring the economic risks. In most cases, an enterprise will decide to solve some of the problems now, and address others in the future.
This work may have already been done by the CPA firm as it prepared the firm’s financials. However, some potential solutions call for reorganization, and this will require accounting input.
Every firm will need new or revised legal instruments. Sometimes, a prototype document can serve as a good base. But in every case, this must be reviewed by the local counsel, especially if some offshore planning is recommended.
A wide variety of products might fill the needs of the business or the individuals, but they are quite different from those used for the standard family insurance situations. A great deal of shopping is often required, since there may be health issues and legal jurisdiction requirements.
Who is responsible?
In many cases, the family requires trust instruments to provide legal protection and financial management. The matter of who controls the trust is seldom adequately addressed. Normally, this is a trustee. Is the trustee an individual, an interested partner, a self-concerned heir or a disinterested corporation? Bank trust departments, for example, are very reluctant to operate a business. Who can terminate the services of a non-performing trustee? Who can transfer the trust if the business, family or beneficiaries become involved in a lawsuit that attempts to seize the proceeds?
Are there risks attached?
No, this is an exercise to measure, reduce and fund risks. It has been said that the IRS could be present during all the discussions, and they would not be likely to challenge any appropriate transaction, even if it lowered the tax liability. The steps of business planning are rather public – they are all documented in writing.
What are the risks of no action?
Statistics only indicate a portion of the damage that can be caused. They do not measure the anger of those trying to wrestle with problems that might have been resolved, the fear of executives and employees who are in doubt as to the business continuity, and the terrible losses when the forces are multiplied.
In a Business Owners Council study of 1,402 firms, 40.7 percent have addressed the issues of an owner’s death. Nearly 15 percent have addressed an owner’s or partner’s disability. The percent addressing the incident of a critical illness is not known.
Additionally, the study did not measure the extent to which the plans were partially or fully funded, nor did they inquire as to whether or not legal documents had been accurately drafted and properly executed.
But it is clear that there are an enormous number of businesses which should address these issues. This is a need that requires the services of a trained financial consultant.
Activating the process
If a business has not addressed these issues, or if the analysis was done more than five years ago and did not touch on five or six critical areas, then it is time to engage a financial consultant and start the process. The potential results of inaction are unbearably high, and the solutions are likely to be quite affordable.
As a responsible business leader (partner, officer, shareholder, director or founder) you owe it to the other stakeholders in your organization to take action on this issue.