Buy Sell Agreements

Business Succession Planning

Business Succession Planning is the term that describes the steps that should be taken in order to make possible the transfer of a business interest from one owner to another person(s), or entity, should the need arise in the future.

As business owners, you would have a long-term objective for your business.  Possibilities may include selling the business to someone else who can run it, transferring it to the remaining partners or passing control to a family member.

  • If you do have a long-term vision for the future of the business, how does that translate to the here and now?
  • What would you want to see happen to the business if either yourself or one of your partners were involved in a car accident on the way home tonight?
  • Would you or any one of your partner/s be able to raise the funds to buyout another partner's share of the business if it was necessary tomorrow?
  • Or the child you plan to hand the business over to, is he of she ready to sit at the helm?
  • And would they have the capital, resources and knowledge to be able to run the business, or would employing an interim manager give them a chance to learn the ropes, therefore giving them a better shot at long-term success?  Could the funds be found to pay such a person the professional wage required?
  • What is your business worth now and who do you want to take it over if you were unexpectedly out of the picture?


Remember that an appropriate Business Succession Plan will also identify how the business is to be valued in the event of an owner leaving.


Funding Business Succession

Few people in business have sufficient cash reserves or available credit to buyout a departing owner's interest in a business. Whilst further borrowing may be an option, the most economic answer is insurance.

A combination of life insurance, trauma and total and permanent disability insurance will provide comprehensive coverage so that you can be certain your business would have the money needed for a buyout should either yourself, or a business partner die or become critically ill. Any business person would agree that while there is never a good time to think about these matters, there is no worse time than when you are faced with a personal tragedy.

Why jeopardise the financial security of a successful business and possibly the personal assets of the partners when you have a choice. Payment by an insurance company can fund payment for a departing owner's interest in the business so the surviving partners can continue to run the business without having to find the money for a buyout.

The professionals you need to involve in preparing an effective business succession plan are all of the partners in your business, your insurance adviser, your solicitor and your accountant. This will ensure that you are fully informed of the tax consequences of the various methods of owning insurance policies as they relate to the circumstances of your particular business and your plans for the future. A Buy/Sell Agreement is the most common and popular agreement to use in a business succession plan.


What is a Buy/Sell Agreement?

It is a contractual agreement between proprietors of a business, which facilitates the sale of an outgoing proprietor's interests (e.g. Shareholding) once a specified event has occurred (e.g. trauma, death etc).
 
As well as providing a mechanism for the sale of the interest in the business, the Agreement also sets a price at which the interest will be sold and a means to fund the payment of the purchase price.  Due to capital gains tax and stamp duty considerations, it is common to have a Buy/Sell Agreement containing put and call options.  Continuing proprietors are granted an option to purchase an outgoing proprietor's interest in the business.  In addition, the outgoing proprietor (or his estate) is granted an option to sell his interest to the continuing proprietors.
 
As mentioned, Term Life Insurance and Trauma Insurance are usually the most cost-effective way of funding such a purchase.  As there may be capital gains tax consequences if there is a change of ownership in the policies, it is customary to either have the policies held by the individual proprietors or held by an insurance trust.  It is not uncommon, however, to have policies cross-owned or jointly owned.  Whichever method is used, care needs to be taken to ensure that the proceeds received will be tax-free.

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