Buy/sell agreements and succession planning
Businesses who fail to plan for death or serious illness of a principal may live to regret it!
Imagine this – one of your co-owners falls seriously ill and needs to exit the business. Can you pay them out? How will you plan for the future?
If they die, you could be in business with their spouse. Is that OK?
Considering how unpalatable this prospect is, it’s surprising that more businesses don’t plan for death, continuing physical or mental incapacity or even a short-term absence. It’s called succession planning, and it’s not as hard as it sounds.
If you’re a sole trader, you can nominate a ‘caretaker’ in advance, who will look after the business during short- and longer-term absences, and who can arrange the sale of the business if you’re unable to do so. An agreement with this person is a good idea as it will formalise the arrangement and ensure expenses of that person can be covered.
Companies, partnerships and trusts
If you’re in business with others, a simple Buy/Sell Agreement can provide for you to buy an outgoing partner’s share of the business and give you the necessary control to ensure this occurs.
You’ll then have certainty about who you’ll be in business with on the death or illness of a co-owner. Supporting this with insurances that pay out when one of these events occurs is a clever way to fund the change of ownership.
Buy/Sell Agreements can offer different solutions for different scenarios
For example, on death or total and permanent disablement you’ll want to acquire the outgoing owner’s equity. Whereas, on temporary trauma or illness you’ll want to replace the missing revenue stream. In both cases, you might want to pay out debt and finance arrangements.
Key person insurance can provide the funding mechanism for both capital and income purposes and for all of these events. Policies can be purchased to take advantage of the most tax-effective structure. A good life adviser can arrange this for you and advise on the tax issues.
But the insurance is of little use without an effectively drafted Buy/Sell Agreement. On death or permanent disability, it can provide for the insurance proceeds to be used to purchase the outgoing owner’s share of the business at market value, ensuring a smooth transfer to the remaining owners. For temporarily incapacitated principals, the Buy/Sell Agreement can ensure the insurance proceeds replace the business income, thereby protecting cash flow and profitability.
If a principal can’t get insurance for any reason, the Buy/Sell Agreement can provide for other options, including an instalment payment plan or a vendor finance arrangement, where the exiting owner effectively funds the purchase. Alternatively, it could provide for the principals to put aside funds specifically for this eventuality – a form of self-insurance.
There are plenty of alternatives.
The Fold’s templated Buy/Sell Agreement can be customised to suit your chosen succession strategies. It’s available from The Fold’s eStore.
By Nicole Haverkamp and Charmian Holmes