As we have noted in Part 1 of this series, business succession involves the development of strategies that will assist the business in continuing to operate in an effective manner should a particular event occur that may have a significant impact on the continuance of the business in the absence of any succession plan.
These events are usually death, trauma, and permanent disability. It must be noted that it is not confined to these events and may include any of the following:-
- Divorce, bankruptcy, fraud and/or prolonged sickness.
A Business Succession Plan should address at least the following:-
- The interest of the departing partner and his or her family;
- The interest of the surviving partner and his or her family;
- The impact of personal guarantees provided by the departing partner. (It is not well-known that in the fine print of most bank documents there is usually a clause stating if an event occurs to any of the partners (“the departing partner”) in the business it may constitute a default under the agreement and the bank is entitled to insist on repayment of the loan or additional security to replace the guarantee provided by the departing partner.)
The following are some alarming statistics:[i]
|No of Partners||Chance of One Partner Dying Before Age 65||Chance of One Partner Dying or Becoming Totalling Disabled Before Age 65|
|2 partners||35 in 100||52 in 100|
|3 partners||47 in 100||67 in 100|
|4 partners||57 in 100||77 in 100|
|5 partners||66 in 100||84 in 100|
|6 partners||77 in 100||89 in 100|
To deal with the issues raised above, and raised in Part 1 of this series, we always recommend to business owners to enter into a Buy/Sell Agreement. This Agreement is in effect a Business Will that provides for the continuance of the business after the happening of an event and secures the continuance of the business with minimum interruption.
Consider the following scenario:-
Joe and Tim are partners in a business. Both are married and Joe’s daughter is a second year law student at a well-known university in Qld.
Joe is involved in a car accident on the way to work and suffers severe injuries. After being in a coma for 4 weeks Joe eventually passes away. In his Will he left everything, including his share in the business, to his wife (“Modest”). Any of the following scenarios can now occur:- (this is not meant to be an exhaustive list)
- Modest is prepared to sell Joe’s share in the business to Tim but she believes Joe was the “rainmaker” in the business and therefore his share in the business was worth $1 million. She is only prepared to sell it to Tim for $1 million. Tim on the other hand believes Joe was always dragging the chain and his share in the business is worth nothing more than $100,000.
- After discussing the matter with her daughter (and obtaining ‘competent legal advice’ from her daughter) they decided her daughter will step into the shoes of Joe and continue with the business. Tim (60 years of age) has no interest in continuing with the business with Joe’s daughter as a partner, especially because she has already indicated she will “get the business back on track”.
- Joe has provided personal guarantees to the bank for the overdraft of the business. The bank has now indicated that Tim has 21 days to provide alternative security or the overdraft should be repaid.
The only way to avoid any of the above scenarios is to enter into a Buy/Sell Agreement where the parties agree to the following:-
1. Each partner gives an option to the other partner to buy its share in the business;
2. Each partner gives an option to the other partner or its estate to insist that the ongoing partner buy its share in the business;
3. What events will trigger the working of the Agreement;
4. How the business interest of a partner will be valued;
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 to agree and sign off on the Agreement.
It must always be remembered that a Partnership or Shareholders Agreement is not the agreement to deal with the issues raised above.
A Partnership or Shareholders Agreement is a working document and is in operation whilst the partners are still continuing with the business. It deals with the day to day running of the business with exit strategies that do not fall under any of the events discussed above.
A Buy/Sell Agreement only kicks in on the happening of an event and the relevant date is the date of the event. As we will discuss later, the date is important from a tax and stamp duty perspective.
In the next part of this series we will discuss the two most important elements of a Buy/Sell Agreement, the valuation of the business and the funding of the purchase of the business.
Should you wish to discuss the succession of your business and the effect they may have not only on the other partners but also your relatives, please contact our Property & Commercial Department manager Jess Kimpton on 07 5506 8245 or email firstname.lastname@example.org for an appointment.
We conduct regular seminars on business succession and specifically Buy/Sell Agreements to accountants, business advisors and their clients. If you feel that you, your staff, or your clients may benefit from such a presentation please contact us to arrange a suitable time and date.
[i] Source: Zurich Financial Services Australia Ltd