Succession Planning for your Business
A very high percentage of business owners do not have a legally enforceable Partnership Agreement or other legal document which governs what happens if your business partner dies or becomes permanently disabled. Some figures indicate that over 95% of businesses do not have these documents in place.
Common problems that arise from the death of a business partner
- Even though the deceased partner may have held life assurance for a specified figure and there was an agreement between the parties that this would be used to effectively pay for the deceased’s share of the business if he died, unless this is supported by a formal Buy/Sell Agreement, the money would be paid to the deceased business owner’s estate and his surviving wife could then seek to recover the 50% share in the business after her husband’s death. The fact that there was a verbal agreement between the partners and even where the business paid the premiums for the policy would not assist the surviving business owner or partner;
- In the absence of any insurance to cover the contingency of one of the partners dying, the surviving partner may not be in a financial position to borrow the funds or raise the capital to payout the deceased person’s share to his or her estate. This could result in the business closing down or being unable to continue;
- In the absence of insurance or a documented agreement, it could be that the death of the business partner places so much strain on the surviving partner and the business that they are unable to continue because of the hole left in the business by the deceased business partner. The surviving partner may not be able to afford putting on a person to replace the deceased business partner which could also have catastrophic consequences for the business continuing;
- Adequate insurance should be taken out to cover not only the value of the 50% share of the business partner but also the debt that the business is carrying as at the time of the death of the business partner and also the effect of the death upon the cash flow of the business. There also needs to be an allowance made for capital gains tax, GST and any other relevant outlays that may be applicable in the event of the death of a business partner;
- Even where adequate insurance is held, sometimes there can be a failure to agree on a proper value for the percentage share of the business that is taken over by the surviving business partner. A properly drafted Buy/Sell Agreement and Partnership Agreement ensures that there is a defined mechanism for valuing the business in the event that a person dies or wishes to sell his share in the business;
- A proper Buy/Sell and/or Partnership Agreement also ensures that the parties agree on whether the deceased business partner is to be replaced by someone else within the family or some other person. Imagine if your business partner died and you had to put up with his know it all 20 year old child! These issues can easily be resolved in a proper Buy/Sell Agreement and a Partnership Agreement;
- If a business partner is permanently disabled or even temporarily permanently disabled, there needs to be agreement around how this person is to be treated and the length of time that he continues to draw a salary etc. If proper insurance is in place supported by the appropriate Partnership Agreement, all these issues can be dealt with in what will normally be a very stressful time for both parties. Normally, the Agreement provides for an orderly exit of the disabled business partner and ensures that he continues to draw an appropriate salary from the company until such time as the insurance kicks in. In the absence of such an arrangement, it could be that the disabled person simply is unable to perform his duties as a business partner and loses both income and his equity position in the business.
Whatever the situation may be, it is potentially fraught with emotion and costs and the risk that the business will not survive the involuntary exit of one of the partners.
A Buy/Sell Agreement is usually referred to as a “Business Will”. The Agreement allows for the parties to agree upon a process that will be followed in the event any one of the partners in the business should die, suffer trauma or become permanently disabled.
The Agreement is entered into by the parties and their spouses at a time when everybody is still in a position to negotiate and agree upon the terms and conditions of the Agreement. The result of this is that when an event occurs the process in the Agreement is followed and this provides certainty and comfort of mind to all involved.
It is essential for every business to have a Buy/Sell Agreement in place between the partners to ensure a seamless and equitable transfer of a partner’s share in the business in the event of death, trauma or permanent disability.
Please do not hesitate to contact our offices should you require any further details in relation to Buy/Sell Agreements.
Written by: Barry van Heerden – Senior Associate
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