It is very common for non-related people to go into business together but they rarely think about what is to happen to the business if one of them dies and even more rarely have an estate plan which contemplates business succession. The practical reality is that most business owners will spend more time planning a family vacation than how to exit from their business, or what is to happen to the business if one of them was to die unexpectedly. Often this is simply because they don’t know where to begin or they have a simple Will which they don’t realise is inadequate to deal with their business interests.
A business succession plan should help business owners in identifying their preferred exit strategy for the business as well as addressing matters such as long term illness, TPD and death of an owner and securing the survival of the business through transition of ownership.
I have a Will, is that not enough?
Most people are aware that they should have a Will to deal with their personal assets when they die, even if a lot put off actually preparing one. From a legal perspective, most Wills will get the job done when it comes to the technical legal transfer of a deceased’s interest in a business.[1] However, the vast majority of Wills do not take into consideration the practical and operational considerations and hurdles that may be encountered for the business or the surviving business partner and simply ‘getting the job done’ could have disastrous consequences for those left behind.
For example, the vast majority of simple Wills leave the whole or substantial part of the estate to a surviving spouse, children or other family members with little thought as to:
- whether the nominated beneficiary has the skills, experience or desire to step into the business and continue to run it in conjunction with the surviving business partner;
- whether a grieving spouse or child will be emotionally prepared to make business decisions in the immediate aftermath of the death of their loved one. A business generally doesn’t stop running just because someone has died - there are customers to satisfy, bills to be paid and decisions to be made;
- whether the surviving business partner will be comfortable having to continue to run the business in conjunction with the grieving widow/children;
- what impact a new owner may have on the clients of the business;
- whether the business structure is suitable for family to step in (eg company vs individuals in partnership);
- whether the business owners will have the financial capacity to buy each other out if needed; or
- whether it is more appropriate for the business to be sold and the profits distributed.
Business succession planning aims to take a more wholistic look at the business itself, the people running the business, any key employees and family members and aims to end up with a plan which hopefully will ensure that the wealth generated within that business is managed appropriately upon death.
What other options are there?
Depending on the type of business and the parties involved, it may be that a Will is all that is needed for example, if say the surviving spouse has the expertise to step-in and all parties are comfortable with this arrangement.
However, if the parties would prefer to either buy each other out or sell the business upon the death of one of the owners, then arrangements such as a Buy/Sell Agreement (with or without supporting key man insurance) could be appropriate either instead of, or in conjunction with a Shareholders Agreement (depending on the business structure).
A Buy/Sell Agreement is an agreement which by means of put and call options, binds the continuing owners of a business to purchase a departing owner’s interest on the happening of a specific event such as the death or TPD of one of the owners. A Buy/Sell Agreement may be drafted in a way that applies to any business structure such as a partnership, a unit trust or a proprietary company, whereas a Shareholders Agreement is limited to just a corporate ownership structure.
Generally, the obligations of the parties under the Buy/Sell Agreement are fully funded by the proceeds of a key-man life insurance policy, providing for the departing owner or his estate to be paid an amount equivalent to the departing owner’s interest in the business in the event of his/her death or TPD. By having the supporting life insurance policy, the remaining business owner does not have to come up with the money to fund the buy-out of the business interest, which otherwise could be problematic, especially for smaller business owners. The buy-sell agreement also deals with the procedures for giving effect to the agreement such as how the value of the interest is to be determined, how the payment is to funded and how the interest is to be transferred.
I started my business years ago, it’s probably too late
Business succession plans are dynamic plans which should be modified as the business grows and changes so where possible, business succession planning should start at the very beginning of the life cycle of a business when entity structuring decisions are being made and documents such as shareholder agreements (if a corporate structure) are being prepared. This will ensure that the business structure aligns with the owner’s proposed exit strategy and avoids a very costly restructuring process down the track.
As the saying goes ‘why put off to tomorrow what you can start today’. Whether your business is in its start-up phase, scale-up/growth phase or is already looking towards the exit phase, it is never too late to start business succession planning. A good business succession plan can be one of the most important documents that a business owner can make for themselves, their business, their family and their business partners.
[1] It should be noted that with complex business structures (eg use of family discretionary trusts), a simple Will may not always result in the intended beneficiary controlling business assets. A proper estate plan should look at succession of control of these entities.
