Are you carrying on a business with one or more business partners?
Have you considered who will assume control of that business in the event of your death? And how to protect your family to ensure they get fair value for your share of the business?
It is important that every business owner has a succession plan in place to cover what would happen upon their death or another trigger event.
Commonly, if you are in business with someone else this will involve entering into a buy/sell agreement supported by life insurance policies on each partner’s life. The proceeds from the life insurance policy provides the funding to enable your partner(s) to buy the business.
The buy/sell agreement (which should be drafted with the assistance of a solicitor) spells out when one of the owners must leave the business or can choose to leave and how they can expect the business to be valued.
What should you consider in a business succession plan?
A common way to ensure the smooth transfer of control of a business between partners is to enter into a buy/sell agreement.
The agreement is usually structured so that the remaining partners will purchase the share of the business of the partner who is leaving due to the specified event, such as death or disability. This can be done in a number of ways. It can be done either by way of options or by using a conditional contract.
The agreement is usually linked to an insurance policy on the partners’ lives. The proceeds from the policy provides the funding (all or some) to enable the remaining partners to buy the deceased's interest at the value nominated in the agreement.
The transfer of ownership of the deceased's interest in the business will result in a CGT liability. The transfer will be deemed to take place at its market value. The small business CGT concessions may be available to reduce the CGT liability.
Why use a Buy/Sell Agreement?
A buy/sell agreement is a tool to help business partners agree on what might happen in the future and how to best protect all of their interests – both for themselves and their families. It can avoid disputes at a future point in time and provide certainty for planning.
Business owners should discuss their succession plans with each other to ensure they are each comfortable with what will happen to the business and who might take over control, after all these are the people they could potentially find themselves in business with.
If a buy/sell agreement was not entered into control of the deceased person's interest in the business will pass to that person's beneficiaries. This may cause problems for the surviving partners of the business as well as for the deceased person’s beneficiaries. After all, who wants to run a business with their partner's spouse?
Traps in relation to Buy/Sell Agreements
If you enter into a buy/sell agreement care needs to be taken to ensure:
the agreement is regularly reviewed, checking that it still meets your needs and ensuring the formula or method used to calculate the purchase price of the business correctly reflects the value of the business, and
the life insurance policy is also updated as the business grows so it will provide sufficient money to enable the purchaser to buy the business.
The insured benefit under the life insurance policy might be set at a level to cover the sale of the life insured’s share of the business, but can also be set to provide additional funding to allow:
The beneficiaries to pay any CGT liability which may arise as a result of the sale, and
Debts owed by the business to be repaid.
Brett and Luke are co-owners of a sports store. If Brett was to die suddenly, and there was no business continuation plan, Brett's widow, Evette, would inherit half the store. Evette does not know anything about running a business, and she does not like Luke. This is not likely to be a harmonious partnership.
A better outcome may have been achieved if Brett and Luke had a business succession plan with a buy/sell agreement.
Under the agreement Luke would have to buy Brett's interest in the business, with the help of funding from a life insurance policy held on Brett's life. This would allow Luke to become the sole owner of the business and Evette to receive cash as fair value for Brett’s share of the business.
Luke would have full control of the business and Evette would have cash to move on with her life.
There are many options for structuring the buy/sell and the insurance policy. The best option will depend on your circumstances and needs.
In developing your business succession plan, the buy/sell agreement and the funding mechanisms we may need to work with your accountant and a lawyer to ensure the most efficient and tax-effective outcome is achieved. It is important that the terms of the buy/sell match the structure of the life insurance policies.
Contact us to consult further on your needs so we can help you to develop a plan to protect your family and the hard work you have put into your business.
Disclaimer: The information contained in this article is intended to provide general information only. The information does not take into account your circumstances, objectives or needs. You should not act or refrain from acting on the basis of this information. Please further contact Peer Wealth to discus your situation or answer any questions.