Succession means ensuring the ongoing success of your business through a timed and smooth transfer of ownership and management. A business succession plan should define who will take over the business, when that person will take over it, and how they will take it over. For many owners, handing over control of their business can be confronting.
Planning for the unanticipated is a valuable instrument in any business. It provides peace of mind to all partnersin the business, but it also creates security for the business financiers.
We often find financiers insist on a Business Succession Plan before providing any funds to a business. A Business Succession Plan will comfort the financier and make any finance application easier.
We live in a real-world and not a perfect world. Therefore, if any business owner negates the opportunity to plan for their business, such business owner leaves the business susceptible to self-destruction. This act has been referred to as “business euthanasia” numerous times.
What is a business succession plan?
It is essential to know what a Business Succession Plan is and how such a plan will be to the business’s benefit.
To summarise, a Business Succession Plan is, in effect, a financial and tax plan that:
- It gives the business every chance of survival if any partner dies or suffers a permanent disability or trauma (an “event”).
- It ensures that their family members receive the actual value of the interest of such a partner.
- It allows for ownership transition without the additional financial burden to compensate the relevant partner or their estate for their share in the business.
- It bears comfort to all persons involved, including employees and the financier of the business.
- It organises the affairs of the business to reduce unnecessary capital gains tax, stamp duty and income tax for the remaining partners and the beneficiaries of the partner that suffered an event.
Issues to address
The most significant benefit of a Business Succession Plan is to provide certainty for everybody involved. Unfortunately, a verbal plan is not enough. One of the partners will not be around to confirm what was discussed, and this opens a field mine for lawyers to litigate until there is no value left in the business.
A Business Succession Plan should address, at a minimum, the following:
- The interest of the departing partner
- The interest of the surviving partner
- The affect of personal guarantees provided by the departing partner
- The terms of any finance arrangements and the potential requirement for additional security if one partner exits the business.
To deal with the issues raised above, we recommend to business owners enter into a Buy/Sell Agreement. In effect, this Agreement is a Business Will that provides for the business continuance after the happening of an event with minimum interruption.
Consider the following scenario:
Dave and Fred are business partners. Both are married, and Fred’s daughter is a second-year law student at a prestigious university in Qld.
Fred is in a motor cycle accident on the way to work and suffers severe injuries. After four weeks being in a coma, Fred eventually passes away. In his Will, he left his entire estate, including his share in the business, to his wife, Andrea. As a result, any of the following scenarios can now occur:
- Andrea is inclined to sell Fred’s share in the business to Dave, but she believes Joe was the “driving force” in the business and, therefore, his share in the business was worth $1.1 million. As a result, she is only prepared to sell it to Dave for $1.1 million. On the other hand, Dave believes Fred was always procrastinating, and therefore his share in the business is worth no more than $200,000.
- Following discussion of the matter with her daughter and obtaining competent legal advice from her daughter, Angela decided her daughter would step into Fred’s role and continue with the business. However, Dave is 65 years old and has no interest in continuing the business with Fred’s daughter as a partner, particularly because she has already stipulated she intends to get the business “back on track”.
- Fred has pledged personal guarantees to the bank for the business’s overdraft. However, the bank has now indicated that Dave has 21 days to provide alternative security, or the overdraft should be repaid.
The only way to circumvent any of the above scenarios is to implement a Buy/Sell Agreement in which the parties agree to the following:
1. Each partner proffers an option to the other partner to buy their share in the business
2. Each partner proffers an option to the other partner or their estate to insist that the ongoing partner buy their share in the business
3. What events will activate the working of the Agreement
4. the method of valuing the business interest of a partner
5. How the continuing partner will fund the purchase of the departing partner’s share in the business
6. The spouse or closest beneficiaries of the partners agree and sign off on the Agreement.
Partnerships or shareholders’ agreements
You must never forget that a Partnership or Shareholders Agreement is not the Agreement to deal with the issues raised previously.
A Partnership or Shareholders Agreement is a working document in operation whilst the partners are still in business. It deals with the business’s day-to-day running with exit strategies that do not fall under any of the events discussed previously.
A Buy/Sell Agreement only activates on the happening of an event, and the relevant date is the date of the event. This date is important from a tax and duty perspective.
The following are some issues that one should address in a Buy/Sell Agreement:
- Parties to the Agreement – including spouses and beneficiaries
- The events which will trigger the working of the Agreement
- Put and Call options
- How to determine the value of a partner’s interest in the business
- The most suitable funding mechanism to finalise the transfer of the business
Vogue Advisory Group – helping you to plan for the future and protect your business.
If you own a business, it is essential to work with a licensed financial advisor, please contact us and we can assist you.