The events that end family businesses are rarely commercial. A well-run business that has crossed four bridges is seldom killed by a competitor. It is ended by a death with no plan for the shares, a divorce in which a spouse's lawyer demands a valuation nobody agreed how to perform, a founder's retirement funded by a special distribution that empties the reserves, or a chief executive who leaves with nobody ready for the seat. Sooner or later every business meets these events, and one that has not prepared for them usually ends up selling shares to an outsider, paying a special distribution or cutting the payout.
A yield buyer knows this. Without evidence to the contrary, it prices the payout as ending with the current generation, and Continuity is the driver that supplies the evidence. It moves cash available for distribution by making the payout outlive the people who set it up, so that a buyer can rely on it through a change of owner or leader. Even then the buyer's forecast rests on the base rate for such changes, and a single survived event adds to that base rate without replacing it.
Where Continuity sits
Two drivers make the payout outlive the people who set it up and value the stakes in it. This essay covers the first.
Distribution coverage
- ContinuityThis essayMakes the payout outlive its founders: a funded buy-sell, successors, a liquidity route, a change survived
- Holder Value FileProduces the inputs for valuing a stake at a stated level, from the holding period to the holder's return
Cash available for distribution
A buy-sell whose terms are fixed before anyone needs them
At the centre is a buy-sell agreement covering death, disability, divorce, retirement, voluntary exit, an owner's bankruptcy and the termination of an employee-owner, with its terms settled in advance and its funding at least equal to the latest appraised value.
Disputes over a buy-sell start on a handful of terms, and the framework fixes every one of them. The agreement states the level of value at which a departing owner's interest is priced: nonmarketable minority for a minority holder, control for a controlling one. An independent appraisal on the framework's own valuation method sets the price, and any formula in the agreement only gives an interim price between appraisals. The departing owner or their estate and the company choose the appraiser together from a short list of credentialed valuers the agreement names. If they cannot agree, the board chooses, without the departing owner, and the agreement has a rule for further appraisers if the first two differ widely. The date of value is fixed relative to the trigger, and the appraisal has a delivery deadline. Finally, the agreement says whether life insurance proceeds the company receives are added to the value before the price is computed or left out of it, so that one death produces one price.
None of this looks important until it is missing. An agreement that is silent on the level of value produces two appraisals, one at control and one at minority, and a fight over which applies. Silence on the date of value lets each side pick the date that suits it. Silence on insurance proceeds lets an estate argue that the money the company received on the owner's death should raise the price the company pays for the owner's shares.
When a trigger arrives
The sequence a funded buy-sell runs on a death, disability, divorce or exit, with every term fixed before anyone needed it. Select a step.
Trigger
- What happens
- A death, disability, divorce, retirement, exit, bankruptcy or termination of an employee-owner
- Fixed in advance
- Which events trigger the agreement, for every owner
- Without it
- Argument about whether the agreement applies at all
Date of value
- What happens
- The value is struck at a date set relative to the trigger
- Fixed in advance
- The date rule, so neither side chooses the date that suits it
- Without it
- Each side's appraiser values a different day
Appraiser
- What happens
- One credentialed valuer chosen jointly from the agreement's list, with the board deciding if the sides cannot agree
- Fixed in advance
- The list, the selection rule, and what happens if two appraisals differ widely
- Without it
- Two appraisers, two numbers, and a court
Price
- What happens
- The appraisal at the agreement's level of value, delivered by its deadline, with insurance proceeds treated as stated
- Fixed in advance
- The level of value and the insurance treatment, so one death produces one price
- Without it
- A dispute over control or minority, and over whether the insurance raises the price
Payment
- What happens
- The purchase funded by insurance or the sinking fund, and the next distribution paid under the policy
- Fixed in advance
- Funding to the latest appraised value, refreshed often enough to keep pace with the business
- Without it
- A cut, a special distribution, or a sale to an outsider
Then the agreement is funded. A valuer from the agreement's list values the business at the level the agreement fixes, and policies or a sinking fund are sized to each owner's share of that price. The funding is checked every year, the gap is reported to the board, and the valuation is refreshed often enough that the funding keeps pace with the business as it grows. This is the work that takes away the buyer's discount for durability, the allowance it makes for a payout that may not survive the next death among the owners.
A successor for every seat
The chief executive seat and every lead seat need a named successor and a named emergency cover, with a development plan for each successor, and the board reviews all of it every year.
The emergency cover comes first because it is the one most often missing and the one needed soonest: who runs the seat tomorrow if its holder is gone today. The name is written down and the person named is told. Then the permanent successor is named and developed, with a date by which they should be ready. The board's yearly review covers both, and that includes the owner's own seat.
A liquidity route outside the payout
Owners who want more cash than the policy pays need a written way to get it: a sale of shares under the buy-sell at the latest appraised value, or to other owners, so that no owner's need is met with a special distribution.
The pressure this answers builds with each generation. In a family business with several owners, some will need more than the policy pays, for a house, a divorce settlement or retirement. With no route, each need becomes a request to the board for a special distribution, and every special distribution is a breach of the policy that a yield buyer will find. With a route, the owner sells some shares at a known price to the company or the other owners, and the policy is never reopened. The owners' agreement spells the route out: how much notice the owner gives, how the price is set and paid, and in what order the other owners and the company may buy. A payout that is not reopened every time an owner's circumstances change is one a buyer can treat as durable.
A change already survived
A buyer believes a change that has already happened more readily than a plan for one. So the distribution history should hold at least one change of controlling owner or chief executive, or a transfer between generations, with no distribution missed or cut and coverage keeping a margin above one through the year that followed.
Where no such change has happened, the business can plan its first leadership change as a deliberate transition. The board sets a date, the named successor takes the chief executive seat on it, and the policy stays the same throughout. The distribution history records the date, the change and the coverage through the year after it.
One change survived shows that the payout got through that change; it does not show that it will get through the next. The forecast therefore carries the base rate for leadership and ownership changes at businesses of this size, and the business's own record gains weight only as more changes accumulate.
A plan for every route
Ownership can pass in three ways, to family, to management or to an outsider, and each needs a written plan. Each plan states the tax treatment, how the price will be financed and what that does to coverage and the reserves, the governance during and after the transfer, and the value of the interest under that route at the stated level. The plan for the route the owners intend is kept current and reconciled to the buy-sell.
Counsel and the tax adviser build all three from the same valuation, so that they differ in tax, financing and governance and not in the value they start from. Each route's financing is then run through the policy's tests. A seller note, bank debt and an instalment gift each affect coverage and the reserves differently, and running them through the tests shows the board which routes the payout can carry before an owner proposes one. The intended route's plan is re-dated with every buy-sell appraisal. A buyer reading these plans sees a transfer the business has already priced, and so has less to discount for durability.
Can the payout carry the route?
Illustrative. An unfunded part of a buy-sell price paid to the estate as a seller note from the company. Each year's note payment comes out of the distributable base before the payout is covered, so the note's term decides whether coverage stays above the policy level, here the illustration's own 1.2.
In the illustration, the $560,000 the insurance leaves unfunded on a 40 percent stake is paid to the estate as a seller note over five years at 6 percent, about $133,000 a year from the distributable base, and coverage falls from 1.68 to 1.28, which the payout can carry. Squeeze the same note into three years and coverage falls to 1.05, under the illustrative policy level of 1.2.
If the owner died tonight
The owner's own check, read from the agreement and the file, in order. The first one that fails is the work to do this year.
What it does to value
Continuity ranks seventh on the bridge. Its value comes through two components of the holding-period premium a holder requires. A funded buy-sell with a fixed date of value and procedure narrows the range of how long a holder may wait for liquidity, and a fixed level of value and mechanism lower the cost of the eventual exit. Both feed the discount the valuation computes, so narrowing them moves value. Added to that is the reduction in the value lost to a forced buy-sell, multiplied by its probability.
The chair of the board is paid for this driver, and only when three tests pass together: the buy-sell funded at the full appraised value, a current valuation, and every senior seat covered.
What has to be in place first
The buy-sell and the liquidity route are written into the owners' agreement, so Continuity needs that agreement already aligned to the policy under Distribution Mechanics. The succession plan and the funding gap have to be reviewed by someone who is not a beneficiary, which means the board with an independent member from Board Governance. And the owners' insurability, or the business's cash for a sinking fund, has to be confirmed before the funding target is set, because an uninsurable owner needs a larger fund.
Knowing that it works
The progress measures follow the targets. Buy-sell funding is tracked each year as a share of the latest valuation, and the aim is all of it. Senior seats with both a named successor and an emergency cover are counted against all senior seats. The age of the latest valuation is watched so that it never goes stale. Transfer routes with a current plan at the stated level are counted against all three, with the intended route's plan kept recent.
Read as if the owner died tonight, the buy-sell should answer who buys, at what price, with what money, and how the next distribution is paid. The same night needs a named emergency cover for every senior seat, including the owner's own, and the owner should be able to say each name aloud.
Why it slips, and what holds it
A death, divorce or exit can arrive with the buy-sell unfunded, because the valuation was never refreshed and the business grew past its insurance. Owner or family pressure can override the policy when a need for cash turns into a request for a special distribution. Or a transfer is improvised when the event comes, and the route's tax, financing and value are discovered after the price is agreed.
Each has a safeguard. Reporting the funding gap to the board every year puts a gap in the minute book the year it opens. Handling owners' liquidity only through the written route means a need for cash is met by a share sale at the appraised value. And re-dating the intended route's transfer plan with every buy-sell appraisal means the appraisal cannot be filed without the plan beside it, so the route is priced before any event forces it.