Does your business have a Will?
Most people recognise the importance of having a Will to determine how their estate is
distributed when they pass. If you are self-employed, a partner or co-director, having a
‘Will’ or succession plan for your business is equally important.
Think about what may happen to your business when a key partner dies or is
incapacitated. Generally, business partners are mutually dependent – each relying on
the other/s for their skills, expertise and capital so the business can prosper.
The death or incapacity of a key player causes unprecedented interruption. The
continuing partners need to fill a void and, unless funds are available to buy out the
departing owner’s share, there is uncertainty over the future control and sustainability of
the business.
Business disruption due to the death or terminal illness of a partner however, can be
controlled through buy-sell insurance and an effective buy-sell agreement.
Why is buy-sell insurance important?
Buy-sell insurance can minimise the impact of losing a business partner by providing
lump sum funding towards a partner’s share after his / her death, total and permanent
disablement or in the event of trauma. The payment enables the continuing owners to
acquire that partner’s share.
Without business insurance, continuing partners may be unable to fund a buy-out and
be forced to wind up the business or transfer the outgoing partner’s share to an
unknown party.
If a business partner dies, the business may face demands from that partner’s legal
representative to freeze or sell assets to satisfy an interest claimed by the estate. The
business may also be subject to the unsolicited involvement by the legal representative
or family member of the deceased partner.
Buy-sell insurance and an associated buy-sell agreement prepared by a competent
lawyer minimises these risks.
What is a buy-sell agreement?
The buy-sell agreement incorporates the arrangements for partners to hold insurance
and sets out procedures for acquiring a departing partner’s share.
The insurance and agreement work together as a business succession plan by providing
the funding and process to sustain the business upon the happening of certain events.
Disputes are minimised and partners can plan with certainty.
What are the components of the buy-sell agreement?
The buy-sell agreement is fundamental in tying together the policy arrangements and
processes for sustaining the business when a partner leaves.
The agreement acknowledges the goodwill and value of the business and the respective
interests held by the partners. It sets out the rights and obligations of all partners and the
process for acquiring and transferring shares.
A typical agreement will consider:
• A buy / sell option for partners to acquire and dispose of shares and the events
that will trigger the right to exercise an option, whether they be death, permanent
disablement or trauma.
The agreement details the process and timeframe for exercising an option which
may vary depending on the type of event. For example, a longer timeframe may
be preferable following a traumatic event, giving a partner time to recuperate and
return to the business if recovery is possible.
Voluntary events such as retirement and resignation cannot be insured however
the agreement should facilitate procedures for buying out a retiring partner. This
may be through an instalment plan with the exiting partner retaining a
(proportional) interest in the business until fully paid out.
The agreement should bind the partners’ executors or legal representatives.
• Arrangements for funding insurance, the responsibility for payment of premiums
and the types of insurance to be taken out.
The agreement should specify how the policies will be held, which may be by
cross-ownership, individual-ownership, through the business entity itself, a trustee
or superannuation fund. Each method has its advantages and disadvantages.
Your accountant or lawyer will explain these to you and ensure that taxation
issues such as capital gains and fringe benefits are considered.
• An agreement for valuing the business and each partner’s share which will be
proportionate to their respective contributions.
A starting point for valuing the business may be the market value at the date the
insurance is taken out, indexed annually to account for future growth. Your
accountant can assist in preparing a formula based on predicted market
conditions and future profits – this should be reviewed regularly to take account of
changing circumstances and market fluctuations.
• Determining the level of cover required to sustain the business and buy out the
relevant share of a departing partner based on the market value and partner’s
proportionate interest. Provisions for maintaining and increasing cover in line with
the growth of the business should also be included.
• Terms to release the exiting partner from debts, guarantees, securities and future
business liabilities.
Conclusion
The sudden death, injury or illness of a key partner can have devastating effects on the
value and continuity of a business.
Holding buy-sell insurance with an effective succession plan will minimise the effects of
losing a partner and preserve the value and reputation of a business. Partners are then
free to focus on the development of the business knowing that their efforts will sustain
despite unforeseen events.
The matters to address when acquiring insurance and entering a buy-sell agreement are
complex and should always be discussed with your accountant and lawyer. A ‘Business
Will’ is a product of careful planning and regular review with your professional advisers.
If you or someone you know wants more information or needs help or advice, please
contact us on (03) 9600 0162 or email info@lordlaw.com.au.
